On May 28, 2021, the German parliament approved a law on the modernization of relief from withholding tax (WHT), and on June 9, 2021 the law came into legal effect. The draft bill has already been discussed in an earlier article.
The main changes of the new tax rules relate to the following:
- new procedural rules to obtain relief from German WHT;
- a new specific anti-treaty shopping rule;
- new transfer pricing rules.
New Procedural Rules to Obtain Relief from German Withholding Tax
Starting January 1, 2022, the provisions regarding the tax withholding relief procedure will be governed by a new Section 50c of the German Income Tax Act (GITA). The legal effect is, however, marginal—the current relief procedural rules have been maintained. Taxes will still have to be withheld on cross-border dividend and royalty payments even in cases where a double tax treaty or an EU directive provides for relief.
The current two-stepped approach will be maintained, according to which the payer is required to withhold and remit taxes and the payee may claim a tax refund under the applicable double tax treaty or EU provision. As of now, the payer may only refrain from withholding tax where the payee has been granted an exemption certificate. Upon request, the Federal Central Tax Office will issue such a certificate if the legal requirements are met.
According to the legislation, going forward exemption certificates for royalties will be issued even if it is unclear whether a tax liability exists. This new interpretation of the law should in particular be relevant to the so-called IP registration cases. According to a new interpretation of the German WHT laws, starting this year the German tax authorities hold nonresident licensees and licensors liable to withhold and remit taxes in Germany on extraterritorial royalty payments as long as the licensed intellectual property (IP) rights are registered with the German trademark and patent office. The new law will provide more legal certainty for these taxpayers.
The certificate of exemption still needs to be granted at the time dividends or royalties are paid. Otherwise, the payer is required to withhold and remit taxes on behalf of the payee and a refund needs to be requested when the exemption has eventually been granted, affecting the company’s cash flow. It is to be expected that the refund will be paid out in a simplified procedure in these cases.
The exemption certificates will only be issued with prospective effect for a maximum term of three years. Going forward, unlike under current provisions, the payer will still have to make quarterly declarations of “zero” WHT even where an exemption certificate has been granted. This is likely to increase compliance costs.
New Specific Anti-Treaty Shopping Rule Against Treaty Shopping and EU Directive Shopping
Dividends and royalties paid by a German company to a foreign payee are subject to German WHT of up to 15%–25% plus solidarity surcharge. A relief under an EU directive or according to applicable double tax treaty provision is only granted if the requirements of the German anti-treaty/directive shopping rule are met.
The European Court of Justice has found that the current version of the law conflicts with EU law, and the anti-treaty shopping rule has therefore been modified.
According to the new rule, the payee of dividends/royalties is only entitled to any relief from German WHT if:
- it has shareholders who would also be entitled to the same treaty or directive relief if they directly received the tax-inducing payment; or
- the source of income has a significant connection with a genuine economic activity of the foreign company; or
- it provides proof that there are no main purposes for the interposition of the foreign payee to obtain a tax advantage; or
- the main class of shares in the foreign payee is traded substantially and regularly on a recognized stock exchange.
Whether the adoption of the principal purpose test (i.e., proof of payee’s economic purpose) will be beneficial for the taxpayer’s position remains to be seen.
Overall, the new provision has not led to the long-expected easing of the German anti-abuse requirements but has set an even higher standard. For instance, according to the parliamentary notes, the shareholder of the foreign company should no longer be (hypothetically) entitled to the same treaty relief if it is entitled to treaty relief under a different legal provision (e.g. under another double tax treaty), even if both legal provisions stipulate the same amount of treaty relief.
The new rule shall apply to all open cases, unless the former anti-abuse/anti-treaty shopping rule (i) was in effect at the time of payment, and (ii) allows for the relief from German withholding taxation.
New Transfer Pricing Rules
Starting in financial year 2022, new transfer pricing rules will apply.
The most significant change is that the new law places more significance on the functional and risk analysis. In line with developments at Organization for Economic Co-operation and Development (OECD) level, based on the new law, transfer pricing audits will focus more on the actual circumstances of the case, and to a lesser extent on the contractual arrangements (substance over form).
The new rules also abandon the hierarchy of transfer pricing methods previously prevalent in Germany, and thus bring the transfer pricing framework into line with international standards. Now, taxpayer and tax auditor must determine the “most appropriate transfer pricing method” under the individual circumstances of the case. Going forward, even more weight should be put on forensic work in tax audits.
Next to more details on the valuation of arm’s-length transfer prices, a highlight of the new law is the adoption of the DEMPE concept of the OECD into German law. DEMPE, which stands for development, enhancement, maintenance, protection and exploitation of IP rights, and was first introduced by the base erosion and profit shifting (BEPS) project into the OECD Transfer Pricing Guidelines 2017, has now been introduced into German domestic tax law.
Going forward, the concept of functional ownership of an intangible asset will replace the significance of legal and economic ownership. Accordingly, group companies performing or contributing to the performance of the DEMPE functions will be deemed to participate in the (residual) profit generated with the intangible. The financing (for example, of the development or creation of an intangible asset) on the other hand, no longer entitles to profit share derived from the use of the intangible. The concept of economic ownership as previously proposed by the OECD is thereby abandoned.
The new law also provides for a new binding price adjustment clause. Especially in license arrangements, taxpayers need to examine after seven years whether the actual profit generated with the intangible deviates significantly (by more than 20%) from the profit expectations on which any original valuation was based. If this is the case, and no price adjustment clause has been agreed, the German tax authorities must adjust the taxpayer’s income.
The Bundesrat, the upper house of the German parliament, had proposed the adoption of the OECD paper on Transfer Pricing Guidance on Financial Transactions into the bill. This approach has however been abandoned. The existing rules therefore remain unchanged.
Procedurally, the law introduces very detailed legislation on advanced pricing agreement (APA) procedures into German procedural law. In the past, the APA procedure was based on double tax treaty rules and a fairly detailed circular by the German Federal Ministry of Finance. The introduction of statutory rules should facilitate the process and lead to more legal certainty. Going forward, APA procedures are no longer limited to transfer pricing but will also encompass all other cases of double tax treaty protection.
Further Proposed Changes
Further, the new law establishes, among others, new rules on:
- usage of tax losses in case of legal reorganizations;
- tax certificates in case of WHT on capital income and the exchange of information on tax arrangements using the capital markets, among others relating to investment funds.
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.
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