Germany’s Annual Tax Act 2022 contains significant changes to the tax treatment of transactions between nonresidents relating to payments for the licensing or sale of intellectual property (IP) registered in Germany (“register cases”). The act, which applies as from 21 December 2022, specifically allows Germany to tax register cases in two circumstances, i.e., where payments are made to related parties and no tax treaty is applicable and where the party to whom a payment is made is resident in a noncooperative jurisdiction. Payments in all other cases now generally fall outside the scope of Germany’s right to tax. This has been an area fraught with controversy and confusion, so the clarifications in the Annual Tax Act are welcome.
In principle, the registration of IP rights (e.g., patents, trademarks, utility designs, etc.) in Germany creates domestic tax nexus, which in turn gives rise to limited tax liability. Section 49 of the Income Tax Act (ITA) provides that income derived from the licensing or sale of IP rights registered in a German public registry is considered domestic-source income, regardless of where the IP owner is resident, thus giving rise to limited tax liability in Germany where the IP owner is a nonresident. In other words, all income flows connected to a right registered in Germany (including extraterritorial flows) are considered German-source income—it is not necessary that there be any further nexus with the country for German taxing rights to be triggered. As a result, under these rules, the licensing or sale of an intangible asset may be taxable in Germany even if neither party to the transaction is resident in Germany. Registered rights for these purposes include IP rights entered in Germany‘s registry based on an application submitted to the European Patent and Trademark Office.
The Federal Ministry of Finance (BMF) issued a circular on 6 November 2020, which stated that the mere registration of IP in Germany is sufficient to allow Germany to claim taxing rights to income from the licensing or sale of the IP even if none of the parties to the transaction is resident in Germany (for prior coverage, see the article in the July 2021 issue of Corporate Tax News). This guidance gave rise to concerns about how the rule could be enforced and the tax compliance obligations of affected nonresidents, as well as the potential withholding tax burden where the tax rate is not reduced under a tax treaty. The BMF issued another circular on 11 February 2021, which contained a temporary simplified procedure under which a nonresident in a tax treaty country could request an exemption from withholding tax at source. The simplified procedure originally was to apply through 31 June 2022, but it has been extended for an additional year through 30 June 2023 (the extension will only be relevant for related party transactions where a tax treaty is applicable and the remuneration accrued by 31 December 2022).
The Annual Tax Act 2022 makes substantive changes to the tax treatment of register cases and codifies the treatment. For these purposes, the act identifies three types of remuneration:
German limited taxation in register cases now applies only where payments are made to related parties and no tax treaty is applicable or where payments are made to a noncooperative jurisdiction. Payments made in all other cases fall outside the scope of Germany’s right to tax.
In situations where the licensing or sale of IP rights is between nonresident related parties, Germany’s right to tax depends on whether a tax treaty is applicable. If the recipient of the payment is not resident in a tax treaty jurisdiction or if Germany’s substance requirements cannot be met, the previous taxation of registered cases continues to apply. In the case of a sale, the recipient must file a tax return and pay the corresponding tax to the Federal Central Tax Office, and in the case of licensing, withholding tax will have to be declared and remitted to the tax authorities by the payer. If a treaty granting an exemption from withholding tax is applicable and the exemption is not restricted by the domestic anti-treaty shopping rules, the withholding tax exemption applies automatically and the recipient of the payment does not have to submit a request for the exemption.
If the rights are transferred between related parties, royalty payments received up to 31 December 2022 generally result in income subject to limited taxation in accordance with the prior rules (including the possibility of using the simplified exemption procedure available through 30 June 2023).
Where the recipient is resident in a noncooperative tax jurisdiction, the remuneration is taxed as domestic income in both licensing and disposal cases, regardless of whether the transaction is between nonresident third parties or nonresident related parties. Germany’s noncooperative jurisdiction list contains the same 12 countries as the EU blacklist (i.e., American Samoa, Anguilla, Bahamas, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, Turks and Caicos Islands, the U.S. Virgin Islands and Vanuatu). Discussions on expanding the list are underway.
The most important change made by the Annual Tax Act 2022 is the elimination of German taxation of remuneration from the licensing or sale of rights between nonresident third parties (other than parties resident in noncooperative tax jurisdictions). Subject to certain exceptions, payments from the licensing of rights to such third parties is no longer be subject to German tax and thus the obligation to declare and pay German withholding tax is removed. The relevant provisions of the new law are applicable to all open cases with respect to unrelated third parties, i.e., no obligation to file a tax return in the case of a sale and no need to declare and pay withholding tax in the case of licensing.
The definition of third parties for these purposes is the definition used for German transfer pricing purposes—essentially, where there is a less than 25% ownership percentage and no controlling influence.
The Annual Tax Act 2022 reduces the declaration and tax obligations in many cases where IP rights are registered in a public register in Germany where there is no other nexus with Germany. Nevertheless, potentially affected parties should be careful to monitor their compliance with the requirements under the new law for falling outside the German tax net. In particular, they should examine their transactions with related parties to determine whether protection under an applicable tax treaty is available and whether there is sufficient substance to satisfy the domestic anti-treaty shopping rules at the level of the income recipient.