Background
Parallel imports may arise, both in the pharmaceutical industry and in other sectors, when price levels in foreign markets are significantly lower than in Germany. For drug traders outside the group, it can be worthwhile to buy medicines cheaply abroad and sell them at a higher price in Germany, which is still below the price offered by the German sales subsidiary. In pharmaceuticals, the so-called import promotion clause (Section 129 para. 1 no. 2 SGB 5) provides a regulatory particularity: Under certain conditions, domestic pharmacies are obliged to sell medicines from parallel imports.
In the case under dispute, the domestic marketing and sales subsidiary of a foreign pharmaceutical group had increased the remuneration for sales representatives by bonuses which also reflected parallel imports. The tax authorities had argued that the marketing of drugs by the domestic subsidiary benefited the parent company in two ways: On the one hand, it caused drug sales directly via the group distribution company. On the other hand, it promoted parallel imports via third EU countries. The distribution subsidiary did not receive any remuneration in this respect. In opposition, the taxpayer stated that the parallel imports actually harmed the parent company. Due to the lower price level in the third EU country, the parent company could only realize a reduced profit margin as compared with direct imports into Germany through its subsidiary.
The reflection of parallel imports in sales representatives' salaries was at arm's length; this was not in dispute.
In its ruling dated 20 July 2021 (case no. 1 K 1388/19), the Nuremberg Tax Court had rejected a transfer price adjustment.
The Federal Tax Court as a court of legal revision has not made a final decision and has referred the case back to the local tax court. The rationale of the decision, however, reveals a Federal Tax Court nearly certain that transfer prices have to be adjusted. It is now up to the local tax court to determine the amount of the adjustments.
The Federal Tax Court rejected the notion that the bonus payments had inadequately reduced the subsidiary profit. The court regarded them as being in line with the arm's length standard since the subsidiary had received equivalent employee service in exchange. At the same time, consideration of parallel imports in sales representatives' bonuses reflected common unrelated party behavior. This, in the eyes of the court, suggested that an independent sales subsidiary would have demanded compensation from its parent/manufacturer (mn. 19). Above all, the court did see a sales benefit for the parent company. In its ruling dated 11 December 2024 (case no. I R 41/21), the court held that the parent company/manufacturer should have remunerated the subsidiary for the sales increase resulting from parallel imports. In the Federal Tax Court's view, the subsidiary's sales and marketing efforts inevitably generated economic benefit for the group as a whole (mn. 17). The Federal Tax Court required the local tax court to determine the amount of a necessary transfer price adjustment (hidden profit distribution).
Interestingly, the tax court had found that the German subsidiary's return on sales of 6 % to 6.5 % was "significantly above the median of the comparable companies" (mn. 66). The local tax court had, thus, assumed that this margin also rewarded the subsidiary's promotion of parallel imports. The Federal Tax Court rejected such set off in the case. The court missed factual findings by the local tax court that would have supported this set off. Further, the court located the burden of proof for a parent – subsidiary setoff arrangement with the taxpayer (mn. 24).
Practical conclusions
The decision will give tax authorities a significant boost when challenging transfer prices for parallel imports. Taxpayers should expect the authorities to enforce corresponding taxation even more.
The decision should also be considered in structuring and documentation. It should generally be good practice to agree on the (implicit) reflection in transfer prices of the subsidiary's (unwelcome) promotion of parallel imports. Also, taxpayers should economically determine and document this aspect of sales subsidiary remuneration. This should make it difficult for tax authorities to demand additional remuneration for the German sales subsidiary or adjust its profits.
Obviously, the court procedure has not succeeded in putting on the table the economic and regulatory complexity of parallel imports in the pharmaceutical industry. The Federal Tax Court rashly rejected the argument that parallel imports harmed the manufacturer more than they helped. The question is: What would happen in the absence of parallel imports? Would domestic drug sales go down (if so, the Federal Tax Court would be right) or would drug sales be the same, albeit concluded at higher prices (if so, the taxpayer would be vindicated)? The Federal Tax Court implicitly assumes the further. The import promotion clause, however, indicates that at least the legislator had no confidence in the price elasticity of domestic drug demand. Therefore, one may doubt whether the Federal Tax Court approach is economically sound.
The ruling has potentially far-reaching consequences not only for foreign multinationals operating domestic sales subsidiaries, but also for German multinationals selling abroad as well as for other industries with significant parallel imports.
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