[Note: This post was updated on 29 June 2022]
2020 was eventful for MNEs with IP (e.g. patents, trademarks, etc.) registered in Germany due to the uncertainty surrounding the treatment of such IP under German tax law. A new decree of 11 February 2021 provides for simplifications.
At the beginning of 2020, German tax experts held controversial discussions about whether the mere entry of IP in a German register would result in a German limited (corporate) income tax liability. This would mainly concern IP exploited in other countries, so that the only German connection would be its German registration. The Federal Ministry of Finance confirmed this view by decree of 6 November 2020 (see TAXpod). To great surprise, the same Ministry published a draft bill just two weeks later in which it proposed a retroactive repeal of the respective regulation (see blog and webinar). However, the draft bill was amended in January 2021. In this new draft, the intended deletion was withdrawn, and the status quo ante was restored.
Implications for MNEs
This brief background to events provides an idea of the uncertainties that have existed in dealing with German registered IP. How should taxpayers and their advisors go forward? If limited tax liability is indeed to be assumed, the first step would be to conduct an intensive tax investigation of the past seven years or more, followed by a full disclosure. In addition, implications for ongoing license payments must be considered: the foreign licensee would be obliged to withhold taxes for the account of the foreign licensor (Sec. 50a German Income Tax Act [ITA]).
On the other hand, Double Tax Conventions (DTCs) concluded by Germany with other countries often provide for an exclusion of the German taxation right. However, in the case of a withholding tax obligation (Sec. 50a ITA), the legally prescribed procedure must be considered: the licensee must generally withhold taxes and the respective licensor is entitled to obtain a subsequent refund. This procedure would lead to considerable time and effort spent by both taxpayers and tax authorities, usually without any additional German tax result if the applicable DTC were to restrict Germany’s right to tax (which is usually the case).
A new decree by the Federal Ministry of Finance provides for procedural simplifications and thus leads to a significant mitigation of the problem.
No withholding tax obligation for a licensee if the licensor is (undoubtfully) entitled to DTC benefits
For remunerations that have already accrued to the licensor or will accrue before 1 October 2021 [NEW: before 1 July 2023], the obligation to withhold taxes and file a tax return for the licensee has been suspended. This, however, only applies if the following requirements are fulfilled:
- the licensee is not a German tax resident;
- the licensor is a tax resident of a DTC state, is entitled to treaty benefits under the applicable DTC and the remuneration is also attributable to the licensor for tax purposes (if transparent partnerships are licensors, the tax residency of its partners is decisive);
- the licensor (or an authorized licensee) applies for an exemption certificate with the German Federal Central Tax Office (Bundeszentralamt für Steuern [BZSt]) by 31 December 2021 [NEW: by 30 June 2023];
- contractual relationships including sublicensing relationships must be disclosed to the BZSt;
- the relevant passages of the contracts must be translated into German.
Several contractual relationships between a licensor and the same licensee can be combined in one application. If the licensor has received remuneration before 1 January 2014, the applicant must send a copy of the application to the relevant local tax office.
The simplifications are not applicable if the licensor’s DTC entitlement is “doubtful”. Such doubts are said to exist in the case of hybrid or dual-resident companies or other conflicts of qualification.
If the application is rejected by the BZSt, withholding taxes must be remitted within one month of notification of the rejecting administrative act.
If the license payment is accrued after 30 September 2021 [NEW: after 30 June 2023], the general rules apply, i.e. the obligation to withhold taxes and a possible subsequent refund. However, if an exemption certificate has already been issued by BZSt, at the latest with effect from this date, the licensee is not obliged to withhold any taxes.
Determination of tax base in case of a bundle of IP
In addition to the procedural simplifications, the decree indicates how to calculate the German share in cases where a bundle of licensed IP exists. It rejects a cost-based approach as “not appropriate”. Instead, the total remuneration shall be apportioned by a top-down approach considering the principles of causation. As a result, a revenue-based approach appears to be more appropriate from a tax authorities’ point of view.
A foreign licensor receives a total remuneration of EUR 20m from licensing a bundle of IP. The worldwide sales from the licensing amount to EUR 200m, of which EUR 100m has been generated in Germany. The bundle of IP includes rights registered with the German Trademark and Patent Office (DPMA).
Under a revenue-based approach, the licensor’s German taxable income amounts to EUR 10m.
Disposal of German registered IP
The decree points out a seller’s legal obligation to file a tax return when German registered IP is involved. If the seller is tax resident in a DTC state and the DTC assigns the right to tax the capital gain exclusively to the country of residence, a tax return may be filed claiming a capital gain of EUR 0 (zero). Contractual relationships including German translations of relevant passages must be submitted to the competent tax office.
The decree is late, but still welcome. It contains necessary simplifications. In particular, the deadline for submitting an application to the BZSt by 31 December 2021 seems reasonable. However, the disclosure of a plethora of documents seems unnecessary: the licensor’s DTC entitlement to benefits can also be proven otherwise and easier.
The revenue-based approach favored by the Federal Ministry of finance might cause disputes with taxpayers. In German tax literature, the cost-base approach rather appears to be compatible with general transfer pricing principles. In addition, the revenue-based approach reminds one of BEPS Pillar One with the idea of expanding taxation rights of market states without further physical connection (“nexus”) to that state. Whether this understanding is also applicable to the (current) determination of taxable license income is doubtful.
Finally, it should be noted that the decree should in any case be understood as a “last warning” for affected licensors/licensees with German registered IP if they have not yet approached the German tax authorities. It is highly questionable if a new legislative attempt to repeal the regulation will be made after the failed attempt at the end of 2020. However, there remains a bit of hope as there is a growing lack of understanding at an international level. We will have to wait and see whether the legislator will relent.
Meanwhile, the decree creates a bridge in DTC cases so that affected taxpayers can clean up the past and create clarity for the present and future.
[Update: With decree of 14 July 2021 and decree of 29 June 2022 the Federal Ministry of Finance has extended the application of the simplified procedure. It can be applied to remunerations that accrue to the licensor before 1 July 2023. An application for exemption must be filed with BZSt by 30 June 2023.]