The German tax authorities (GTA) in 2020 expressed their intention to employ for the first time a law which has been in effect since 1925, to levy withholding taxes on royalties paid between two nonresident parties in consideration of the right to use trademarks and patents registered with the Deutsche Patent- und Markenamt (DPMA), the European Patent Office (EPO), or the European Union Intellectual Property Office (EUIPO), among others.
After some confusion caused by arbitrary measures taken by the German Federal Ministry of Finance (MOF) in November 2020, the MOF has recently published a new circular requesting the declaration and remittance of withholding taxes, while providing administrative relief in treaty cases in return for full transparency.
Extent of the Limited (Nonresident) Tax Liability
The wording of the law seems clear. According to Section 49(1) no. 2 (f) sent. 1, no. 6 of the German Income Tax Act (GITA) any income “generated by (aa) renting and leasing [i.e., licensing] or (bb) the sale of […] rights […] which are entered in a domestic public book or register” is deemed domestic income in Germany.
The GTA follow a literal interpretation of the law, holding licensors of extraterritorial royalties and sales payments liable to pay income taxes in Germany. No other nexus than the mere registration is required.
Multinationals should not accept this literal interpretation too easily. There are good arguments against it. Whether a registration as an EU trademark with the EUIPO—other than with the DPMA or the EPO—is an entry in a “domestic public book or register” is, for example, questionable. Also, the German Federal Constitutional Court has ruled that a nexus may only be assumed where income is economically derived from a domestic source. This is in line with the history and the systematic analysis of the other cases covered by the law.
Overall, despite the emerging clear position of the GTA, there are good arguments for multinationals to challenge any limited (nonresident) tax liability, which is an essential precondition for any withholding tax obligations.
Recent Legal Developments
The GTA first publicly applied a literal interpretation of the relevant provision of the limited (nonresident) tax liability with a circular dated November 6, 2020. This was a novelty because neither the current version of this provision nor its preceding version from 1925 has been applied in this form before.
With a draft bill dated November 19, 2020 (Referententwurf zum Abzugsteuermodernisierungsgesetz), the MOF put the literal interpretation in question again, as the draft bill provided for the repeal of the relevant provision of the limited (nonresident) tax liability. According to the explanatory notes to the draft bill, withholding taxes on extraterritorial royalty payments and capital gains would lead to “inappropriate results” and cause unnecessary extra work for the GTA in treaty cases.
The fact that the draft bill was to apply in all open cases reinforces the impression that the MOF had departed from the literal interpretation of the law. However, by cabinet resolution of January 133, 2021, the German government failed to adopt the repeal.
In response to the government decision, the MOF published yet another circular dated February 11, 2021 which provides significant relief for treaty cases.
Withholding Tax Obligations
According to Section 50a(1) no. 3, (5) 1 of the GITA the licensee is liable to withhold income taxes on royalty payments which are deemed domestic income. The payer of deemed domestic income must file tax returns and remit withholding taxes to the Federal Central Tax Office (FY 2014 onward) or the competent local tax office (until FY 2013) quarterly, irrespective of treaty protection. The licensor may then as a second step request a withholding tax refund within four years after the year of payment.
If the licensee fails to declare and pay withholding taxes within the statutory deadline, its duty to comply remains in place until the income taxes have been paid. The licensee may be held liable by the GTA to declare and pay taxes for subsequent years.
No similar rules apply where German-registered intellectual property (IP) is transferred permanently (i.e., sale). Here the transferor will be held liable to file an income tax return and pay domestic income taxes directly.
According to German Federal Tax Court rulings and a circular by the MOF (Federal Tax Court dated May 17, 2005, I B 108/04; dated August 22, 2007, I R 46/02; circular dated November 25, 2010, Federal Tax Gazette I 2010, 1350, para. 101), a nonresident person may be held liable to pay withholding taxes even if it does not have a permanent establishment in, or another affiliation with, Germany. In its circular of November 6, 2020, the MOF refers to these duties and requests the affected nonresident licensees to declare withholding taxes on the licensor’s behalf for all open years (normally going back to FY 2013).
Otherwise, licensee and licensor may both be held liable for unpaid withholding taxes. No interest applies but penalties may apply if the parties are held to have acted negligently.
In light of the arbitrary position of the MOF in the circular of November 6, 2020, and the draft bill by the MOF of December 19, 2020, the argument can certainly be made that taxpayers have not acted negligently by refraining from declaring withholding taxes on past royalty payments so far. This legal uncertainty should, however, have been resolved when the German government did not adopt the repeal of the law in its cabinet resolution and when the MOF reconfirmed its earlier position by the circular dated February 11, 2021.
There is now a risk that the GTA will hold the directors of the affected companies liable to declare, remit and pay withholding taxes for all open cases. If the directors fail to disclose the relevant cases to the GTA, they would likely be deemed to have acted negligently—if not intentionally—considering the settled position of the GTA. According to German law, this suffices to commence criminal investigations for tax evasion in case of late declaration.
This means that even in cases where taxpayers (justifiably) disagree with the literal interpretation applied by the GTA, affected companies would still need to disclose the relevant facts of each case, including detailed information on the license arrangement, the actual royalties paid and the parties involved (Section 153 of the General Tax Code). For full compliance, it may even be advisable to file a so-called zero declaration (i.e., showing the taxable base while declaring taxes of 0 euros).
New Entitlement to Administrative Relief in Case of Treaty Protection
Against this background, multinationals should exploit the administrative relief provided by the MOF circular of February 11, 2021 as much as possible. The circular applies to both past cases (FY 2013–2020) as well as to ongoing royalty payments taking place until September 30, 2021. Accordingly, no declaration and remittance of withholding taxes is requested if:
- the licensee is not a resident of Germany;
- the licensor may claim treaty protection in the relevant financial years;
- the licensor requests the issuance of an exemption certificate with the Federal Central Tax Office no later than December 31, 2021 for each individual license arrangement;
- the licensor discloses the relevant license agreement to the Federal Central Tax Office together with the request for the issuance of an exemption certificate; and
- the relevant passages of the license agreement are translated into German and submitted together with the license agreement in the original language.
Any royalty payments taking place after September 31, 2021 are subject to the regular (withholding) tax declaration and remittance obligations, unless the Federal Central Tax Office has issued an exemption certificate prior to the payment.
If the Federal Central Tax Office rejects the issuance of an exemption certificate (e.g., due to the limitation of benefits clause in the double tax treaty, or due to domestic anti-treaty shopping and anti-abuse rules), the licensee would still be required to declare withholding taxes for past years one month after the rejection has been received.
A sale of IP rights must be electronically declared with the local tax office in Munich by the transferor, irrespective of treaty protection. If treaty protection applies, however, the transferor may submit a zero declaration in paper form. Nevertheless, the transferor must still disclose all relevant documents, in particular the transfer agreement and a translation of the most significant clauses of this agreement.
In any case, late surcharges (Section 152 of the General Tax Code) would be levied if nonresident taxpayers fail to submit all documents necessary for tax assessment with the local tax office in Munich by September 30, 2021.
Despite the recent developments, withholding taxes in Germany are not inevitable. This however requires full transparency vis-à-vis the German tax authorities.
Recommendations for Treaty Cases of IP Licensing
In treaty cases of IP licensing the following approach is advisable:
- disclosure with the Federal Central Tax Office that the multinational is investigating relevant cases;
- filing the request for an exemption certificate for each license arrangement protected by a double tax treaty, referring to the circular of February 12, 2021;
- as a precaution, a copy of this application should be sent to the local tax office which is responsible for the withholding taxation of royalty payments taking place in FY 2013 and any permanent transfer of IP. This local tax office should be informed that (i) FY 2013 is time-barred and, if given, (ii) no IP sales have taken place from FY 2013 onward so that it has no jurisdiction over these cases.
In preparation for a situation where the Federal Central Tax Office refuses to grant an exemption certificate it is advisable to:
- apply for tax ID numbers with the Federal Central Tax Office (FY 2014 onward);
- determine the affected royalty payments for all open years (on a quarterly basis) and an appropriate royalty split on a per licensee basis;
- prepare and submit a zero withholding tax declaration one month after rejection by the Federal Central Tax Office together with a cover letter challenging the GTA’s position.
If the Federal Central Tax Office holds the licensee liable to remit withholding taxes in Germany despite the zero declaration, each affected licensee would have to appeal within one month after the respective tax assessment has been received (two months if sent to the foreign address of the licensee).
Recommendations for Non-Treaty Cases of IP Licensing
In non-treaty cases of IP licensing the following approach is advisable:
- licensee applies for a tax ID number with the Federal Central Tax Office (FY 2014 onward);
- determination of the affected royalty payments for all open years and an appropriate royalty split on a per licensee basis for each quarter for the relevant financial years;
- submission of withholding tax declarations in form of zero declarations for all open years together with a cover letter. As a precaution, a copy of this letter is sent to the local tax office describing the tax office’s lack of jurisdiction over these cases;
- zero declarations should be filed each quarter; in a side letter the multinational should outline its legal position.
In the long run, it could be advisable to reorganize the structures being established for German IP rights. For instance, in order to benefit from administrative relief the nonresident licensor could relocate to a treaty jurisdiction, or permanently transfer the German IP to a related party which is a resident in a treaty jurisdiction.
Moreover, the German IP rights could be de-registered if IP protection does not provide any benefit. However, a German income tax liability may be prompted when Germany’s rights to tax gains from future profits relating to the IP is restricted or excluded.
Further, concluding gross-up clauses with third party licensees could be considered.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Lars H. Haverkamp is a Tax Lawyer and Associated Partner at Flick Gocke Schaumburg, Düsseldorf; Sven-Eric Bärsch is a Tax Adviser and Partner at Flick Gocke Schaumburg, Frankfurt.