Executive summary
On 29 June 2022, the German Ministry of Finance (MoF) published an update to the guidance issued on 11 February 2021 and 14 July 2021 addressing the nonresident taxation of royalty income and capital gains relating to rights solely because these rights are registered in a public German book or register (for background, see EY Global Tax Alert, German Ministry of Finance finalizes guidance on German extraterritorial taxation of intellectual property, dated 11 February 2021).
The update extends the cutoff date and filing deadline for the application of a retroactive exemption for “clearly” treaty-protected royalty payments and stipulates that this procedure is applicable for payments made in the past or by 30 June 2023 (before the updated guidance, the applicable cutoff date was 30 June 2022). In addition, the deadline to file an application for exemption as the key requirement for this procedure has been pushed out to 30 June 2023 as well.
The extension of the applicable deadlines for a retroactive exemption is in line with one of the key conclusions included in the report issued by the German MoF to the Finance Committee of the German Parliament on the evaluation of the issue (see EY Global Tax Alert, German Ministry of Finance issues report on extraterritorial taxation of intellectual property to German Parliament, dated 17 June 2022).
Detailed discussion
Extraterritorial taxation
“Extraterritorial” intellectual property (IP) transactions include the licensing or sale of IP rights between, or in the case of a sale by, parties not resident in Germany.
Based on the wording of the German statute provisions (Sec. 49 (1) No. 2f and No. 6 Income Tax Act (ITA)), where a non-German resident person licenses or sells IP that is registered in a German public register (German-nexus IP), Germany can claim a taxing right under domestic law.
Under the plain language of the statute, a German taxation right may cover German-nexus IP licensing or sale transactions which take place solely between, or in the case of a sale by, nonresident parties. The statute also does not differ between transactions which occur between related or unrelated parties.
Taxation of royalty income is generally administered by way of a withholding tax of 15.825% to be withheld, declared and transferred by the licensee. A capital gain is generally taxed through a nonresident tax return to be filed by the seller. The rule is currently subject to a controversial debate and causes significant issues for both taxpayers as well as the German tax authorities.
Royalty payments already made or to be made by 30 June 2023
The guidance stipulates that a licensee can abstain from withholding, declaring and transferring withholding tax on royalty payments made to a foreign licensor in the past or by 30 June 2023, if the following requirements are met:
- The debtor of the remuneration, the licensee, is not resident in Germany at the moment of the payment. For a corporation, this means that it has neither its corporate seat nor its effective place of management in Germany.
- The recipient of the remuneration, the licensor, is resident in a jurisdiction with which Germany had an applicable treaty in place at the moment of the payment. Further, the licensor needs to be:
- Actually entitled to treaty benefits
- The beneficial owner of the income for purposes of the treaty
- Able to meet the requirements of the German anti-treaty shopping rules
- The licensor files an application for an exemption from withholding taxes with the Federal Central Tax Office by 30 June 2023 (to the extent the application includes the years 2013 and before, a copy of the application is to be sent to the local tax office (Munich)). A separate application for the licensor is required for each license agreement unless the different contracts are entered into between the same parties. This means that multiple contracts between a specific licensor and the same licensee can be covered by one application but separate applications have to be filed if a licensor has multiple licensees.
- Together with the application, all agreements relating to the remuneration covered by the application have to be disclosed to the Federal Central Tax Office. For group internal transactions, it is required, in addition, to disclose all additional agreements conveying the same rights to other related parties.
- A German translation of the essential sections of the agreements disclosed in accordance with the above has to be provided in addition to the original documents. According to the guidance, the essential sections concern the conveyance of the rights, the ownership of the rights as well as the remuneration and payment terms.
A licensee can only abstain from withholding tax if all of these requirements are cumulatively met for a specific licensor. The guidance further allows that a licensee may apply for the exemption instead of the licensor if the licensor authorizes the licensee to do so. If the license no longer exists, the licensee can apply for an exemption even without an authorization of the licensor if it can be demonstrated that the (former) licensor is either not able to or not willing to do so.
In addition, this simplification is not applicable in cases in which the actual eligibility of the licensor for treaty benefits is doubtful, taking into account not only the treaty but also the German domestic anti-treaty shopping rules. According to the guidance, relevant doubts exist in particular in the case of dual-resident or hybrid entities or in the case of other qualification mismatches. If the recipient of the royalty payments is a tax transparent partnership for German tax purposes, the guidance allows application of this relief if the requirements are met at the level of the partners.
If the Federal Central Tax Office should reject the application for an exemption from withholding tax, the 11 February 2021 guidance provides that all withholding tax returns for the remuneration in question must be filed within one month after the rejection. This applies even if an appeal is filed against the rejection of the application. The guidance is not entirely clear whether this only applies to withholding tax on payments for which the licensee abstained from withholding in accordance with the guidance or whether this also applies to “historic” royalty payments.
Royalty payments made after 30 June 2023
The exception explained above does not apply for royalty payments received by a licensor after 30 June 2023. According to the 11 February 2021 guidance, the general provisions of the ITA should apply in this regard.
Capital gain transactions and income determination
The updated guidance does not provide for any changes to the stipulations regarding capital gain transactions or income determination included in the original guidance dated 11 February 2021 (see EY Global Tax Alert cited above on 11 February 2021 guidance for details).
Implications
The extension of the applicable cutoff date and filing deadline for a retroactive exemption in treaty protected cases is a welcome move by the tax authorities to be seen in light of: (i) the processing time of filed applications given the very high number of filings; and (ii) the reevaluation of the overall issue based on the evaluation report mentioned above.
The report issued by the MoF also concluded that the current rule should be abolished for the future (but not retroactively), except with respect to taxpayers resident in jurisdictions listed on the European Union (EU) list of non-cooperative tax jurisdictions. However, it does not address the timing of a potential prospective change of the law to abolish the rule for taxpayers not resident in jurisdictions listed on the EU list of non-cooperative tax jurisdictions. Given the connection made in this regard to the Organisation for Economic Co-operation and Development Base Erosion and Profit Shifting project, it seems reasonable to expect such a change in conjunction with the implementation of Pillar One and Pillar Two legislation, which is currently anticipated during the first half of 2023. Notwithstanding the conclusion of the report, the chances of success for such a legislative change remain to be seen.
For additional information with respect to this alert, please contact the following:
Ernst & Young GmbH
- Christian Ehlermann, Munich
- Daniel Kaeshammer, Freiburg
- Stefan Koehler, Frankfurt
- Michael Schaden, Stuttgart
- Oliver Wehnert, Düsseldorf
Ernst & Young LLP (United States), German Tax Desk, New York
- Tobias Appl
- Thomas Schmitz
- Jasan Bsharat
- Alexander Schega
- Laura Peschel
- Janina Kolb
For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.
