On February 11, 2021, the German Federal Ministry of Finance (GFMF) published a decree (the Decree), confirming their position that German withholding tax (at a rate of 15.825%) is due and payable on gross royalties that are payable or that have been paid to a non-German tax resident recipient, even if:
- The licensee is not tax resident in Germany, and
- The only nexus to Germany is that the intellectual property (IP) rights underlying the royalties are entered in a German public register.
In addition, the Decree sets out detailed procedural guidelines, especially with respect to past taxation periods.
Under the Decree, affected taxpayers must come into compliance for prior tax periods before September 30, 2021, and for any royalties that are paid after September 30, 2021. Prior to the Decree, German lawmakers abandoned a plan to require a stronger German nexus in these cases. While the initial proposal for a legislative bill (prepared by the GFMF) published in November 2020 included such a plan, the current amended version of the bill, which was published in January 2021, does not.
The Decree’s legal basis
In general, under the German Income Tax Act (GITA), any person that is not subject to unlimited income tax liability in Germany (generally based on German residency) may be liable to German income tax on income from certain German sources (i.e., limited income tax liability). German taxation, in the latter case, usually is effected through tax withholding (i.e., a payment debtor must retain and remit applicable withholding taxes to the competent German tax office for the account of the payment creditor — the tax debtor). Thus, any such payments of German withholding tax to the competent German tax office have, in principle, a discharging effect. However, according to several GFMF decrees, as confirmed by Germany’s highest tax court (Bundesfinanzhof or BFH), the withholding tax obligation of the payment debtor does not require the payment debtor to be tax resident in Germany.
Pursuant to a provision of the GITA – which historically received little to no attention with regard to payments involving only non-German parties – income derived by a non-German tax resident from licensing IP rights entered in a German public register is German source income, and thus, subject to limited income tax liability (see section 49 para. 1 no. 2 letter f, no. 6 GITA).
It has been the prevailing view in the German legal literature that this provision of the GITA be narrowly interpreted and apply only where one of the parties is resident in Germany, in order for it to be compatible with German constitutional law, European law and basic German tax law principles (for example, transfer pricing principles). Notwithstanding these legal concerns, the Decree confirms the German tax authorities’ intent to apply and enforce this provision, on the basis of its plain language, with respect to any royalties paid between non-German tax resident parties, to the extent that any underlying IP rights are entered in a German register.
General thrust of the Decree
The Decree is primarily aimed at the source taxation of royalties as described in the following scenario (the Base Scenario):
A non-German tax resident licensee (who does not maintain a German permanent establishment) pays royalties to a non-German tax resident licensor for licenses to use IP rights (i.e., patents, utility models, trademarks and designs) that are entered in a German public register (i.e., the register of the German Patent and Trademark Office), as well as possibly in other non-German registers.
The Base Scenario is typically found in the case of multinational groups, where licenses to use IP rights are often passed down through multiple group levels.
Note: The German tax authorities have made it clear that royalty payments to a non-German tax resident licensor with respect to patents that have been entered in the German patent register on the basis of patent applications filed with the European Patent Office are equally subject to German withholding tax. In contrast, royalty payments to a non-German tax resident licensor with respect to European Union trademarks (i.e., uniform rights) are not subject to German withholding tax, as these rights are not entered in a German register (but in a European register, which is maintained by the European Intellectual Property Office in Spain).
If license payments to a non-German tax resident licensor relate to a bundle of IP rights entered in the IP registers of several jurisdictions, including Germany, only the portion of the royalties attributable to the German IP rights is subject to German withholding tax. If this portion is not apparent from the documents (e.g., license agreement, etc.) disclosed to the German tax authorities, the total amount of royalties must be apportioned appropriately (top-down approach), if necessary by way of estimation. The sales generated on the basis of the licenses, for example, can be used as a basis for estimation.
Procedural guidelines under the Decree where treaty benefits apply
Procedural relief for taxation periods until and including September 30, 2021
For the Base Scenario, the Decree provides a simplified way to settle and terminate the German withholding tax proceedings. This simplified procedure is available for any taxation periods (not yet time-barred) until and including September 30, 2021, and does not require any tax payments, provided that the non-German tax resident licensor is entitled to claim treaty benefits (i.e., a tax exemption) under a German income tax treaty (and certain additional formal requirements are met).
Note: This simplified procedure is only applicable to licensors who (1) are tax resident in a treaty state (i.e., a state with which Germany has concluded an income tax treaty, e.g., the US), (2) are eligible for treaty benefits, and (3) whose treaty benefits are not unilaterally restricted by German tax law. Furthermore, the following issues may prevent the application of the simplified procedure:
- Beneficial ownership: The licensor must qualify as the beneficial owner of the underlying IP rights under the treaty, as determined by the German tax authorities.
- There must be no reasonable doubt as to the availability of treaty benefits: The Decree expressly states that the simplified procedure is not available in case of hybrid structures, double residencies or other qualification conflicts under treaty law or if there are indications of such circumstances.
- Substance test: The simplified procedure does not apply if the licensor does not comply with the German substance test (which is relevant if and to the extent the ultimate shareholder is not eligible for treaty benefits and the licensor (intermediate company) does not carry out substantial business activities of its own).
The licensor, or the licensee, if so authorized by the licensor, must submit the tax declarations under the simplified procedure to the German Federal Central Tax Office by December 31, 2021, at the latest. The licensee also is entitled to file these declarations without a proxy, in case the contractual relationship with the licensor no longer exists, and the licensee can show that the licensor is prevented from filing or is unwilling to do so.
Should the tax declarations under the simplified procedure be rejected by the Federal Central Tax Office (e.g., due to doubts about the existence of treaty benefits, or for formal reasons, like expiration of the deadline), then the licensee has to file respective withholding tax returns and pay the declared withholding tax within one month after the rejection, irrespective of any objections filed against the rejection.
No procedural relief for taxation periods after September 30, 2021
The Decree further clarifies that, with respect to the Base Scenario, the normal withholding tax procedure applies to periods after September 30, 2021, even if treaty benefits are available. This means that, as of this deadline:
- German withholding tax at a rate of 15.825% must be retained, reported and paid to the Federal Central Tax Office by the licensee, unless the licensor has received an exemption certificate based on treaty benefits from the German tax authorities and forwarded it to the licensee before a royalty payment is made (in this case, the licensee’s obligation to file withholding tax returns continues even though the tax due is zero), and
- To the extent German withholding tax has been retained and paid, the licensor has to apply for a refund, provided that treaty relief is available.
Should a licensee fail to retain and pay German withholding tax, then the licensee becomes directly liable for paying the withholding tax (i.e., secondary tax liability) in addition to the licensor. A licensee’s obligation to pay German withholding tax can be enforced by the Federal Central Tax Office by means of separate tax assessment notices. In addition, the withholding tax liability may also be enforced directly against a licensor (i.e., the tax debtor) by means of separate tax assessment notices.
Procedural guidelines under the Decree where no treaty benefits apply
The tax consequences in the Base Scenario are much more severe if no treaty relief is available. The Decree confirms that in such a case, only the normal withholding tax procedure applies, meaning that the licensee must retain, report and pay German withholding tax at a rate of 15.825%, without the possibility for the licensor to have the withholding tax refunded. This is true not only going forward, but also for any prior taxation periods that are not yet time-barred.
German taxation of gains from the sale of IP rights
The sale of IP rights entered in a German register by a non-German tax resident owner is not subject to German withholding tax, but is nevertheless subject to limited German income tax liability. Consequently, the Decree confirms that such a non-German tax resident seller must file a German income tax return and declare any gain from such sale, irrespective of where the purchaser is resident for German tax purposes. According to the Decree, this applies even if Germany has no taxation rights under treaty law. In that case, however, the submission of a zero tax return (without calculating the capital gain) is sufficient.
Note: For German tax purposes, a license (as opposed to a sale) requires that there is a time limit on the granted use of the licensed IP rights. If, however, the right to use IP rights is unlimited in time, then the license is deemed to be a sale of the licensed IP rights for German tax purposes.
Eversheds Sutherland Observations: Despite limited enforcement options for the German tax authorities outside of Germany, it is anticipated that there will be an increasing number of cases in which the German withholding tax will be imposed on royalty payments between non-German tax resident licensees to non-German tax resident licensors. Indeed, the Decree follows public reports of filings by non-resident taxpayers seeking to come into compliance with the position taken by the German tax authorities. Compliance with the Decree also may become relevant in the context of due diligence or other compliance reviews.
As noted above, the position in the Decree is subject to legal challenge, and it is expected that it will be challenged in the German tax courts, likely on the grounds that the excessive interpretation of the statutory basis (i.e., section 49 para. 1 no. 2 letter f, no. 6 GITA) by the German tax authorities violates German constitutional law, European law and basic German tax law principles. Such a legal challenge will, however, take many years, leaving taxpayers with limited options aside from compliance with the Decree, particularly as to the Base Scenario (as described above).
Need for action from a procedural tax law perspective
First of all, it should be noted that, in the Base Scenario, there are obligations to act for both the licensor (tax debtor) and the licensee (payment obligor), which depend on each other. Both parties must therefore coordinate their actions, which can lead to difficulties or commercial issues, especially outside of group situations. In particular, in the Base Scenario, for periods until and including September 30, 2021, the licensee is only exempt from paying German withholding tax retroactively if the licensor (successfully) carries out the simplified procedure under the Decree or if he can prove that the licensor is not able or willing to carry out this procedure and he carries out this procedure (in his own name) instead.
It is also important to note that the issuance of the Decree (and also the preceding decree published in November 2020) effectively eliminates lack of knowledge as a viable defense for taxpayers that fail to comply with respect to open tax years, and on a going-forward basis. Indeed, at least going forward, any consequences under German criminal tax law with respect to tax offenses must also be taken into account.
With regard to any past taxation periods which are subject to the simplified procedure under the Decree or for which German withholding tax may have to be declared and paid retroactively (e.g., in the absence of treaty benefits or when the deadline for the simplified procedure has expired), it should be noted that under German procedural tax law the statute of limitations for tax assessments is:
- Generally four years,
- Five years in the case of negligent tax reduction, and
- Ten years in case of tax evasion.
However, the statute of limitations does not begin to run before the end of the third calendar year following the calendar year in which the withholding tax was payable.
Moreover, in the event of tax evasion, the amount of withholding tax to be paid retroactively will also bear interest at a rate of six percent.
Affected taxpayers, especially those in the Base Scenario where no treaty relief is available, may consider whether to lodge an appeal together with the filing of the German withholding tax returns.
Need for action from a tax planning perspective
In addition to the above measures to come into compliance under the Decree, consideration should be given to:
- Review of existing and future commercial licensing agreements and the allocation of withholding tax liability, and any mitigation obligations, if the rights include German registered IP;
- Deregistration of IP rights in German registers (to the extent IP protection in Germany is no longer needed or can sufficiently be achieved in other ways – e.g., German trademarks remain enforceable under certain circumstances even if they are not registered); and
- Revisiting ownership of German IP rights within the multinational group.