EN    EN EN 
 
EN    EN  COMMISSION OF THE E UROPEAN COMMUNITIES 
Brussels, 14.9.2009 
SEC(2009) 1168 final 
  
COMMISSION STAFF WORKING DOCUMENT 
 
Accompanying the 
 
COMMUNICATION FROM THE COMMI SSION TO THE COUNCIL,  
THE EUROPEAN PARLIAMENT AN D THE EUROPEAN ECONOMIC AND 
SOCIAL COMMITTEE 
on the work of the EU Joint Transfer Pric ing Forum in the period March 2007 to March 
2009 and a related proposal for a revised  Code of conduct for the effective 
implementation of the Arbitration co nvention (90/436/EEC of 23 July 1990) 
 
EU Joint Transfer Pricing Forum – Summary Report on Penalties 
 
{COM(2009)472 final} 
{SEC(2009)1169} 
 
EN 2   EN TABLE OF CONTENTS 
1. Introduction and context .............................................................................................. 3 
2. Definition of penalties.................................................................................................. 3 3. Scope of this summary report ...................................................................................... 4 4. Penalties and EU laws.................................................................................................. 5 5. Main features of the Transfer Pricing report compiled by JTPF Business members... 5 
6. The taxpayer's conduct - case scenarios....................................................................... 6 7. Transfer pricing adjustments and penalties.................................................................. 6 8. Cancellation or mitigation of penalties in  case of Mutual Agreement Procedure ....... 7 
9. Conclusions................................................................................................................. .7  
ANNEX.......................................................................................................................... ............ 9 
 
EN 3   EN 1. INTRODUCTION AND CONTEXT  
1. Most EU Member States have rules whic h aim at enforcing taxpayers' compliance. 
These rules are regulated by na tional legislation and, therefore, can vary widely. In 
addition to penalties for non-compliance with transfer pricing documentation 
requirements, there exist penalties for unc ooperative behaviour of a taxpayer. Also, 
more and more countries now have rules wh ich apply if transfer  pricing adjustments 
are made by tax administrations to bring a ta xpayer's transfer pricing in line with the 
arm’s length principle.  
2. The issue of penalties was already discusse d but not finalised dur ing the Forum's first 
mandate from 2002 to 2004. The Forum agreed, therefore, to incl ude the issue of 
penalties levied on transfer pricing adju stments in its work programme for 2005 and 
2006 (see doc. JTPF/008/REV4/2004/EN). The work programme states that the Forum could identify the exact nature and ex tent of the problems of penalties related 
to transfer pricing (exc luding criminal penalties) and examine the scope for 
solutions. 
3. In 2002 and 2003 the Forum and the IBFD undertook surveys on transfer pricing 
rules in Member States that included pena lties related to transfer pricing. In 2004 a 
Business Member of the Forum, Prof. Maisto, submitted to the Forum a comparative 
study on penalty regimes within the EU rega rding transfer pricing documentation and 
adjustments. This "Transfer Pricing Penalt ies Report" was updated in 2005 to cover 
the 10 new Member States (see doc. JTPF/011/BACK/2005/EN). 
2. D
EFINITION OF PENALTIES  
4. Penalties are designed to provide disincen tives for non-compliance in order to make 
tax underpayments and other types of non-co mpliance more costly than compliance. 
The compliance at issue may relate to pro cedural requirements such as timely filing 
of the tax return or providing necessary information, or to the substantive determination of tax liability. 
5. In the area of transfer pr icing penalties generally fall  into one of the following 
categories: 
(a) Documentation related penalties, i.e. ad ministrative (or civil) penalties imposed 
for failure to comply with the documentation requirements of a Member State at the time the documentation was due to be submitted to the tax administration; 
(b) Co-operation related penalties, i.e. ad ministrative (or civil) penalties imposed 
for failure to comply in a timely manner with a specific request of a tax administration to submit additional information or documents going beyond the EU TPD or the domestic documentation re quirements of a Me mber State; and 
(c) Adjustment related penalties , i.e. penalties imposed for failure to comply with 
the arm's length principle usually levied in the form of a surcharge at a fixed 
 
EN 4   EN amount or a certain percentage of the tr ansfer pricing adju stment or the tax 
understatement. 
6. As opposed to administrative (or civil) pena lties, which are generally imposed by the 
tax administration, criminal penalties are imposed by a public prosecutor or court and 
are virtually always reserved for cases of very significant fraud. 
7. Member States may use different names for penalties that accomplish the same 
purpose. Also, national compliance practi ces depend on the overa ll tax system and 
the judicial system in the Member State. Penalties can, therefore, take the form of 
monetary deterrents, e.g. a surcharge or additional tax imposed as a consequence of underpayments of tax in addition of the am ount of underpayment, or, for example, a 
reversal of the burden of proof where a taxpayer has not acted in good faith.  
8. Penalties related to transfer pricing adjust ments must be distingui shed from interest 
for late payment of tax. Some commentators consider commercial interest for late payment of tax as penalties where su ch interest is non deductible. Tax 
administrations, however, generally take the vi ew that interest for late payment of tax 
at a commercial, i.e. market, interest rate does not constitute a penalty. Such interest can be considered as compensation for the "interest free loan" that the taxpayer has 
enjoyed due to his underpayment of tax. 
3. S
COPE OF THIS SUMMARY REPORT  
9. This paper concentrates on adjustment rela ted penalties, i.e. penalties imposed for 
failure to comply with the arm's length pr inciple usually levied in the form of a 
surcharge at a fixed amount or a certain per centage of the transfer pricing adjustment 
or the tax understatement.  
10. As regards documentation related penalties, the JTPF in its activity report from 1st 
January 2004 to 31st May 2005 recommends in paragraph 38 of the conclusions on 
documentation rules: 
"A Member State should not impose a documentation related penalty, where a 
taxpayer complies in good faith, in a reasonable manne r, and within a reasonable 
time 
(a) with standardized and consistent documenta tion as described in paragraphs 20 
to 25 or with a Member State's domes tic documentation requirements; and 
(b) properly applies his documentation to determine his arm's length transfer 
prices." 
11. The report continues in paragraph 39: 
"A taxpayer avoids the imposition of a co-operation related penalty where he has 
agreed to adopt the EU TPD approach and pr ovides, upon specific request or during 
a tax audit, in a reasonable manner and within a reasonable time additional information and documents going beyond the EU TPD." 
 
EN 5   EN 12. As the Forum agreed not to discuss criminal penalties and as documentation related 
and co-operation related penalties were alr eady addressed in the JTPF activity report 
from 1st January 2004 to 31st May 2005, in particular in the conclusions on 
documentation rules, these issues ar e not discussed in this paper. 
13. The EU Arbitration Convention at Article 12 offers business the certainty/comfort 
that they would not suffer from unresolved transfer pricing related double taxation in 
the single market. The elimination of doubl e taxation is, however, not secured if a 
serious penalty is imposed on a taxpayer (A rt. 8 (1) of the Arbitration Convention). 
Member States have laid down their defini tions of a serious penalty in the meaning 
of Art. 8 (1) of the Arbitration Conven tion in unilateral de clarations to the 
Arbitration Convention. 
14. The Commission Services have already point ed out in the past that some of the 
unilateral declarations appear to contain a rather broad defi nition of the term "serious 
penalty". This could, in certain circumst ances, constitute an impediment to the 
effective access to the Arbitration Convention.  This issue may, therefore, need to be 
addressed by the Forum. 
4. PENALTIES AND EU LAWS  
15. Penalties are governed by Member States' dom estic laws. However, it might be the 
case that the application of  the Convention for the Protection of Human Rights and 
Fundamental Freedoms (“ECHR”) and the conformity of domestic penalty regimes with EU legislation and principles (d iscrimination, proportionality, compatibility 
with freedom of establishment, etc.) should also be seen as a more severe penalty 
regime for cross-border transactions as compared to domestic transactions might 
constitute an infringement of the fundamental freedoms as laid down in the EC Treaty. 
5. M
AIN FEATURES OF THE TRANSFER PRICING REPORT COMPILED BY JTPF  
BUSINESS MEMBERS  
16. According to the Transfer Pricing Penalti es Report, nearly all Member States 
administrative or civil penalties can be imposed in case of transfer pricing 
adjustments and no specific penalty regime in  relation to transfer pricing adjustments 
exists.  
17. The rules for interpretation and specifi cation of the amount of penalties are 
somewhat mixed; some countries regulate these issues in detail whereas other 
countries leave the application of general pe nalty principles to the discretion of the 
tax authorities. In most Member States th e penalty consists of a percentage of the 
profit adjustment or the additional tax. The range is between 5 % and 30 % of the profit adjustment or between 10 % and 200 % of the additional tax. In most Member 
States the penalty can to some extent be  waived under the administrative discretion 
of the tax administrations. 
 
EN 6   EN 6. THE TAXPAYER 'S CONDUCT - CASE SCENARIOS  
18. The imposition of penalties is generally in fluenced by the taxpayer's conduct. It is, 
therefore, important to have a common unde rstanding of the terms used in this 
context. Broadly speaking, there are four  types of conduct: (i) good faith, (ii) 
negligence, (iii) gross neglig ence, and (iv) fraudulent inte nt or wilful conduct. To 
enable Tax administrations' members to pres ent their thoughts, th ey were asked to 
comment on four purely illustrative case scenar ios. These scenarios and an analysis 
of the answers received are set out in the annex. 
19. This annex therefore is to be considered as  a useful insight into  tax administration's 
reasoning processes in the field of penalties related to transfer pricing adjustments. 
20. However the Forum did not consider it useful to deepen its comparative analysis with 
a view to trying to reach an agreement on the definitions of (a) good faith, (b) 
negligence, (c) gross negligence and (d) wilful conduct/fraudulen t intent. Most tax 
administration members felt that it woul d be difficult to reach meaningful 
definitions, and to do so would in any case not be especially helpful to taxpayers since each transfer pricing case is very dependent on the facts of the case. Some tax 
administrations merely commented that thes e definitions were a matter of domestic 
law and therefore not appropriate to  be considered in the Forum. 
7. T
RANSFER PRICING ADJUSTMENTS AND PENALTIES  
21. As transfer pricing is not an exact scie nce, there will usually be a range of 
possibilities in which the arm's length pri ce will be found. This lack of precision 
means that transfer pricing by nature repres ents a potential for tax disputes, transfer 
pricing adjustments and possible double ta xation. Business claims that it is often 
difficult for a taxpayer to prove  its transfer pricing is ar m's length, for example due to 
the lack of comparables. 
22. A taxpayer's transfer pricing may, therefor e, be non arm's length without negligence 
or wilful conduct. It follows that failure to meet the arm's length standard should not 
per se give rise to the presumption of w ilful conduct or negligen ce as the facts and 
circumstances need to show additional elemen ts leading to the evidence of intent or 
negligence. The OECD Guidelines also stress in paragraph 4.33 that it would be 
unfair to impose sizable penalti es on taxpayers that made a reasonable effort in good 
faith to set the terms of their transactions with related parties in a manner consistent 
with the arm's length principle. 
23. In the light of these features of transf er pricing, the Members examined whether 
specific penalty rules for transfer prici ng as opposed to general penalty regimes 
would meet tax administrations and taxpaye rs concerns. Tax administration members 
concluded that penalty regimes are a matter for domestic law and most tax 
administration members seemed to feel that  the inter-action of transfer pricing and 
penalties could be accommodated in existing penalty regimes.  
24. A Business Member has proposed that in  case of an adjustment, no negligence 
should be alleged in the event that a so -called “reasonable documentation test” has 
been met. Such reasonable documentation te st would be met if (i) the taxpayer has 
 
EN 7   EN collected the essential information regardi ng the disputed contro lled transaction and 
(ii) such information is collected and available as from the date of filing the tax return for the relevant tax period. Howeve r the forum did not co nsider that this 
approach should be deepened because transactions are not acceptable on the basis of the documentation provided but well on the ba sis of evidence that the transaction is 
arm's length. 
8. C
ANCELLATION OR MITIGATION OF PENALTIES IN CASE OF MUTUAL AGREEMENT 
PROCEDURE  
25. Even if currently penalties are generally reduced or waived in case a settlement 
between the taxpayer and the tax administ ration has been reached or following a 
downward transfer pricing adjustment resu lting from a mutual agreement procedure 
(MAP) or arbitration, the JTPF consider ed as appropriate to include some 
considerations on this is sue in its conclusions  
9. CONCLUSIONS  
This section represents the Forum's conclusions in the area of penalties  in transfer pricing. 
The JTPF excluded criminal and documenta tion penalties from its deliberations. 
1. Penalties for transfer pricing adjustments  
The JTPF considers that transfer pricing holds unique difficulties for both taxpayers and tax 
administrations. Transfer pricing, famously, is  not a science – see the OECD guidelines 1.45 
and 4.8. The determination of the arm's length price is very fact dependent. It is often difficult 
to determine the arm's length price. Under these circumstances, it is inappropriate for tax administrations to automatically, without havi ng regard to the facts of the case, impose a 
penalty merely due to the existe nce of what turns out to be incorrect transfer pricing. The 
Forum also explicitly agrees  with the consider ations in paragraph 4.28 of the OECD 
guidelines. 
2. Penalties for transfer pricing adjustments and subsequent MAPs.
 
It is often the case that a transfer pricing adju stment is subsequently reduced during a Mutual 
Agreement Procedure. The JTPF considers that wh ere such an adjustment initially attracted a 
tax geared penalty and such a penalty was applie d it is appropriate that the penalty is reduced 
commensurately. This would put th e penalty in line with the fina l, agreed tran sfer pricing. 
This, however, would not necessarily be the case for criminal penalties or penalties 
considered as serious under the Arbitration Convention. 
Such a reduction would not have to take place,  however, if the taxpay er would gain a better 
result than would be availa ble under a domestic procedure. 
3. Penalties and the Ar bitration Convention  
The Arbitration Convention currently excludes taxpa yers who have incurred  a serious penalty. 
The situation at the moment under the Arbitrat ion Convention where 27 different definitions 
of a serious penalty exist does not sit easily with the idea of  a single market. Therefore the 
 
EN 8   EN JTPF will in the future look at what precisely a serious penalty should be for the purposes of 
the Arbitration Convention. The idea behind this  work would be to cl arify what a serious 
penalty is in terms of transfer pricing and to prevent taxpayers from being disadvantaged from 
different definitions within the EU. The JTPF will seek to define in which cases a penalty should be considered as serious. 
 
EN 9   EN ANNEX  
Penalty scenarios for illu strative purpose only. 
Case scenarios  
ManCo is a large joint stock company inco rporated in Member State A and resident 
therein for tax purposes. ManCo is engaged in  manufacturing consumer products through 
a factory located in Member State A and sells finished produc ts to its subsidiary SubCo 
which is resident of Member State B.  
Case I  
ManCo undertook an economic study to con firm its compliance with the arm’s length 
principle and commissioned a tax expert's opini on to confirm compliance with State A’s 
transfer pricing regulations. Intercompany pricing is fina lly agreed by ManCo and SubCo 
on the basis of the economic study and tax exp ert's opinion. State A’s tax administration 
makes a transfer pricin g adjustment to ManCo. 
Case II   
ManCo's CFO neither undertakes an economic st udy to establish/check compliance with 
the arm’s length principle nor requests a tax expert's opinion to confirm compliance with 
State A’s transfer pricing regulations. Stat e A’s tax administration makes a transfer 
pricing adjustment to ManCo. 
Case III  
ManCo sells its items to SubCo applying the cost plus method at a mark up of 1 per cent. 
ManCo's CFO neither undertakes an economic st udy to establish/check compliance with 
the arm’s length principle nor requests a tax expert's opinion to confirm compliance with 
State A’s transfer pricing regulations. Stat e A’s tax administration makes a transfer 
pricing adjustment to ManCo. 
Case IV  
ManCo sells its items to SubCo at cost plus  5 per cent, but makes arbitrary transfer 
pricing adjustments (properly documented an d reflected in its accounting records) to 
reduce the group’s taxable income (tax rate is higher in State A than in State B). State A’s 
tax administration makes a transfer pricing adjustment to ManCo.  
 
 
Possible interpretations of the Case scenarios  
 
EN 10   EN 1. Case I – probably good faith behaviour evidenced by taking expert advice and 
providing sufficient supporting information or documentation. 
2. Case II- it is likely that the taxpayer has b een at least negligent if no evidence of 
arm's length pricing was produce d, either to put in place th e transfer pricing policy or 
to justify it during the audit. However, the lack of a tax advisor's opinion or economic study is not conclusive when  assessing culpabili ty; a taxpayer who 
accumulated documentation based on internal  comparables could be acting in good 
faith even if those comparable s turned out to be incorrect. 
3. Case III – there is nothing in this scenario to indicate that the taxpayer has been more 
or less culpable than  in Case II but here a methodology has been selected with no 
reference to internal comp arables nor any economic st udy or tax advisor's opinion. 
Therefore it is likely that the culpability of  the taxpayer is worse than in the previous 
cases; the precise size of the mark up chos en is not conclusive when considering the 
culpability once the transfer pricing is shown to be wrong. 
4. Case IV – here the situation is the same as in Case III (especially if one views the 
size of the mark up as not conclusive when  assessing culpability) until the arbitrary 
adjustments are made. As the adjustments were arbitrary they were not made to 
change the transfer pricing in place at th e time the transactions took place to arm's 
length pricing for the tax return. The adjust ments were made for some other purpose 
– one can assume that it is possible, perh aps likely, that they were made to push 
profits into a lower taxing country and not in accordance with the arm's length principle. This would affect the culpability  of the taxpayer. E qually, the adjustments 
may have taken place so that a sales mana ger could enjoy a greater salary bonus. The 
facts would have to be examined. If the adjustments had not been made arbitrarily 
but to adjust the profits in line with a documented transfer pricing policy, then the 
taxpayer would have grounds for arguing a much reduced degree of culpability 
(perhaps even good faith), even if the tran sfer pricing policy wa s later discredited 
during an audit. The mere fact  that an adjustment is made  to a transacted price should 
not merit a penalty: the reason for the adjustment needs to be examined. 
Analysis of tax administration comments
 
5. The comments from tax administrations recogn ised that real life cases are often more 
complex than can be encompassed in any illustrative example. Nevertheless, the 
relevant facts that need to be considered for any particular purpose are often fewer in 
number than the total facts of a case and mo st tax administrations have been ready to 
comment on the Case scenarios to further the discussion. Tax administrations have 
different interpretations of what good faith, negligence, gr oss negligence and wilful 
misconduct consist of, and in real life cases categorising act ions will be very 
dependent on the facts. Despite this, there is a large degree of consistency in the 
comments received. In particular, tax ad ministrations frequently had the same 
reasoning and viewed the same facts as most important. Looking at the answers 
provided , one can extract these points as the ones that were most relevant to the tax 
administrations: 
6. There is a question over whether the company is negligent or worse in not using the 
right comparable. There is also a question of whether a company discharges part of its responsibilities by pa ying a tax advisor for an opinion of its transfer  pricing; the 
 
EN 11   EN taxpayer of course remains responsible for his tax return but some taxpayers might 
genuinely believe a tax professional's opini on, not knowing that the opinion would be 
unacceptable to tax administrations. 
7. The main difference between Cases I and II se ems to be that in Case I the taxpayer 
genuinely tried to put in place an arm's length transfer pricing policy and obtained 
evidence that it had done so from profe ssional advisors, even if the evidence was 
later found to be incorrect. In Case II, the taxpayer may have assumed that the 
transfer pricing policy was arm's length but did not check. Alternatively, the taxpayer 
may have been (mistakenly) confident th at the internal comparable was a good one. 
A third alternative is that  the taxpayer may have known that the transfer pricing 
policy was not arm's length. The truth would depend on the facts of the case. 
8. Tax administrations who can exercise disc retion in the application of penalties 
tended to assume that the taxpayer in Case I was less culpable than the taxpayer in Case II. However, tax administrations do not  hold the view that  a taxpayer, through 
the mere act of consulting with a tax a dvisor or commissioning an economic study 
(or a functional analysis), can automatica lly avoid a penalty. It is not compelling 
proof of "good faith" behaviour where a tax advisor's opinion and economic evidence 
have been produced but most tax administration seemed to believe that in the 
majority of cases it was at least indicat ive of "good faith" behaviour. On the other 
hand, to follow a transfer pricing policy th at was manifestly not arm's length is 
unlikely to be viewed as "good faith" beha viour whatever the ec onomic evidence and 
opinions that had been paid for. If the taxpayer had known, or should have known, 
that the independent retail company wa s not a comparable then the taxpayer's 
culpability is worse. 
9. There is a difference between having a bundant documentation which only reveals 
non arm's length transfer pricing and pr oducing documentation as evidence which 
proves transfer pricing is arm's length. In  Cases I and II the transfer pricing was 
equally incorrect. In Case II,  less documentation was availa ble than in Case I – but 
this did not result in most tax administrations automatically assuming a greater degree of culpability in Case II although some  did so. All recognised that the degree 
of culpability would depend on a ll the facts in a real case. 
10. In Case III no comparable is used at all. Th ere is nothing at all to substantiate the 1% 
mark up. Most tax administrations concluded that this behaviour was more likely to 
attract a penalty and that the level of culpability was beyond negligence, probably 
gross negligence. 
11. In Case IV, nearly all tax administrations  concluded that the taxpayer's behaviour 
would attract a penalty. Th e level of culpability ha d probably gone beyond gross 
negligence and bordered on w ilful misconduct and intent. The key fact in this 
conclusion was seen as the taxpayer's arb itrary behaviour, whatever the motive. The 
motive for that arbitrary beha viour might also be a factor  when assessing the degree 
of culpability involved: if the facts reve aled that the taxpayer's behaviour was 
motivated by a desire to minimise tax payabl e, this might result in a greater level of 
culpability. But even without considering motivation, for most tax administrations 
the taxpayer's behaviour would have attrac ted a penalty. Intent is not the most 
important factor for some tax administrati ons which chose to focus on the action of 
 
EN 12   EN the taxpayer. Motive of course remains diffi cult to assess objectively, behaviour is 
easier to categorise.