Time to review your German licensing relationships? Time to review your German licensing relationships? - Update

In an unexpected development the German Ministry of Finance has released a draft bill on 20 November 2020 to amend the German WHT rules in a way that the mere registration of IP in Germany would no longer make it subject to German WHT or capital gains taxation. The proposed rules shall be effective for all open assessments so that the change would effectively also apply for past transactions. In the explanatory notes to the draft law it is stated that the change is made to avoid unnecessary administrative burden in cases where there is treaty protection. However, the language of the law does not limit the change to treaty situations. It remains to be seen whether this is by intent or a mistake.

It has to be noted that this is just a draft of the Ministry of Finance, it would first need to be approved by the government and then go through the legislative process. As this came as a surprise we currently do not have any insight in how likely and in what timeframe this could become law. Nevertheless the review and filing of cases with the German tax administration should stay on-hold since we expect clearance soon. We will keep you updated as soon as more information becomes available.

German tax filing and withholding tax obligations can be triggered by IP structures without an obvious nexus with Germany. In light of increased scrutiny from the German tax authorities – supported by data mining technology – non-German companies should evaluate their licensing relationships now.

Under Art. 49 (1) No. 2 Letter f and No. 6 of the German Income Tax Act ("Einkommensteuergesetz"), a limited tax liability exists even for foreign entities on income generated through:
 

• Licensing or the sale of rights (i.e. trademark, patent or design register etc.) registered at the German Patent and Trademark Office, irrespective of where the IP owner is resident or where the exploitation of the IP takes place, or, alternatively,
• IP whose exploitation takes place in a German permanent establishment or other German facility
  

The underlying legislation has existed for many years. However, it’s only recently (in a letter dated 6 November 2020) that Germany’s Federal Ministry of Finance officially commented that the registration of a transferred right in a domestic register is sufficient to trigger tax obligations, i.e. without any other German nexus.

At the same time, German tax audits are increasingly focusing on licensing relationships in group companies, leading to subsequent withholding tax claims. Alongside current transfers of rights, old cases within the scope of the fiscal limitation periods may be affected by this increased scrutiny. The tax authorities have also started to data-mine the German Patent and Trademark Office's online register. We expect that they will soon take a proactive approach and reach out to MNEs found in that register for statements.

The first action point for Swiss companies is to clarify their situation and potential exposure. It’s relatively easy to check whether any IP is registered in the German Patent or Trademark Office via the website of the German Patent and Trademark Office. At the same time, companies should verify whether any royalty/license payments have been made to a non-German-resident licensor within the group or to third parties within the fiscal limitation period (i.e. seven years). In a final step, companies should find out whether any IP has been transferred within the group or to third parties in the last seven years, keeping in mind that German law does not require a license payment flow from Germany for tax obligations to be triggered.

A certain degree of legal interpretation is involved in defining whether IP is exploited outside of Germany, in a German permanent establishment or other facility, and this assessment is the basis for whether affected foreign companies are required to submit tax returns and tax registrations to the German tax authorities.

If a German nexus is found to exist and no (withholding) taxes have been paid in the past, a coordinated disclosure of the facts to the German tax authorities should be discussed. If there are indications of potential tax evasion, the next steps should be carefully defined and coordinated with legal experts.

In other cases, non-German licensees should file tax declarations and pay potential (withholding) taxes. In the case of withholding taxes, the licensor may be able to claim respective refunds if a reduction under EU law or the Swiss-German Tax Treaty is available for the Swiss licensor (subject to review of strict German anti treaty shopping rules).

Given the increased scrutiny and complexity of the situation, companies may benefit from expert support to establish their liability for German (withholding) tax and any outstanding liabilities from prior undeclared periods. A proactive approach will help avoid unwelcome surprises further down the line.