German IP Tax Challenges and How US Multinationals Can Respond

In a June 8 letter to US Treasury Secretary Janet Yellen, House Republicans objected to the infamous Section 49 withholding tax—implemented by the German tax authorities on extraterritorial royalty payments and sales income from the transfer of ownership in intellectual property registered in Germany.

What Section 49 Is About

In late 2020, the German tax authorities first expressed their intention to employ a law dormant since 1925, deeming royalties and sales income paid to a non-German tax resident as German-source income, even if:

The payor isn’t a tax resident in Germany, and
The only nexus to Germany is that the IP rights are entered in a German public book or register.

According to several circulars issued by the tax authorities since 2020, the registration of the IP with the German trademark and patent office, Deutsche Patent-und Markenamt, is deemed a sufficient nexus for a tax liability in Germany. Registrations with the World IP Office or the European IP Office shouldn’t lead to German-source income, while double-registrations should be covered.

After an initial outcry on the unenforceability of the provision, the tax authorities allowed for retroactive exemption under a simplified procedure, if:

All information and documents relevant for assessment for the period 2013 to 2022 are submitted;
The relevant exemption form is filed by the recipient;
The recipient of the payment is entitled to claim protection under a double tax treaty; and
German anti-abuse regulations are satisfied (including the anti-treaty shopping rule).

The deadline for submission is June 30, which is why the timing of the House Republicans’ letter is no coincidence.

While repeal has been expected several times, the German parliament has upheld the law, with the following amendments taking effect as of Jan. 1:

Royalty and IP sales payments between unrelated third parties are exempt for all open cases;
Royalty and IP sales payments between related parties are only out of scope if payments are exempt from German taxation under the applicable double tax treaty with the country of residence of the recipient (for example, Article 12 of the Germany-US income tax treaty), and domestic anti-abuse rules are satisfied; and
Royalty and IP sales payments to a resident of a “non-cooperative tax jurisdiction” per the EU blacklist are taxed irrespective of whether the payment is made between related or unrelated parties.

US Problem with Section 49

Beside the compliance burden, US multinational enterprises face particular difficulties with Section 49. On one hand, the limitation of benefits clause in the Germany-US income tax treaty, and the definition of a resident company, are particularly strict. On the other hand, many MNEs maintain transparent intermediary holding companies across jurisdictions, impacting the German substance and anti-abuse requirements. Benefits applicable to EU companies can’t be claimed, while all disclosed royalty-related information is shared with all EU member states under European Council directive DAC7 with a likely knock-on effect in the next tax audit.

Both the recipient of the payment (licensor) as well as the nonresident payer (licensee) may be held liable under German tax law. In the absence of treaty protection, nonresident licensees are particularly exposed.

The German parliament upheld this provision in two separate votes, making a repeal currently unlikely. The objection by the House Republicans due to “concerns about the disparate tax treatment” may be deemed groundless, with German recipients paying taxes on their worldwide income.

Nevertheless, criticism is well placed. According to standing German Constitutional Court precedents, there are constitutional limits to the assumption of a domestic tax nexus (the principle of territoriality and impartiality). Moreover, the provision, as applied since 2020, seems out of place in the overall design of the German withholding tax regulations, that focus on “domestically generated income.”

In addition, the purpose of the law should supersede the broad wording of the law, and there are reasons to believe the regulation as applied by the German tax authorities violates primary and secondary EU law.

What’s Next

Unless an MNE has already filed for exemption under the simplified procedure, meeting the June 30 deadline would be difficult.

MNEs impacted by the law should, as of Jan. 1, determine whether treaty protection applies, whether German anti-abuse regulations are satisfied, and prepare robust documentation for future audits and investigations.

If withholding taxes are to be paid, MNEs should:

Rearrange the affected transactions, for example, by royalty-free transfer of IP or cancellation of German IP registration; or
Determine a royalty split by top-down or revenue split approach (double registrations to be considered—brace for other valuation methods to be challenged by the authorities); or
File a zero declaration, outlining why the law is considered illegal—constitutional, purpose of the law, or EU law reasons—with tax court proceedings to be expected.

Despite the burden it places on MNEs, tax court litigation might be the only choice for those enterprises affected by Section 49, considering that registration with the German trademark and patent office is common practice, withholding tax on worldwide royalties is substantial, and a political solution currently seems unlikely.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Lars H. Haverkamp is a partner with Eversheds Sutherland (Germany) Rechtsanwälte Steuer-berater Solicitors Partnerschaft mbB.