On 5 and 6 January 2022 the German Federal Ministry of Finance (BMF) issued two new circulars on the application of the royalty deduction limitation rule (‘Lizenzschranke’). In scope of these circulars are, among others, Swiss companies that benefited from the cantonal privileges or are still preferentially taxed due to individual tax rulings.
Since 1 January 2018 the German royalty deduction limitation rule (Section 4j EStG) reduces the deductibility of expenses for the use of rights in Germany if the corresponding income received by the foreign licensor is subject to lower taxation deviating from standard taxation, the income tax incurred is less than 25% and the recipient is a related party of the German payor.
However, a deduction limitation does not apply if the preferential taxation applied to the relevant income at the level of the recipient complies with the OECD's nexus approach.
How does the BMF define “harmful preferential taxation”?
The BMF defines the term harmful preferential taxation broadly, stating that harmful preferential taxation is not limited to intellectual property (IP) regimes such as royalty boxes.
In other words, also companies benefiting from a preferential taxation for other income including royalty income may fall within the scope of this term. In addition, for the criteria of preferential taxation to be satisfied, it is irrelevant whether the recipient generates non-preferentially taxed income as well as income subject to preferential treatment. Finally, individual tax rulings between foreign tax authorities and recipients of royalty payments may also meet the criteria of a harmful preferential taxation.
Former holding, mixed and domiciliary companies
Different to the circular dated 19 February 2020, which only refers to the Nidwalden license box, the circular dated 6 January 2022 extends to the former Swiss cantonal tax privileges, i.e. holding, mixed and domiciliary regimes. According to the relevant provisions in place until 31 December 2019, any income (including royalty income) was subject to reduced or no taxation at cantonal level.
As for the cantonal tax privileges no or only administrative or predominantly foreign-related business activities in Switzerland were allowed; as per the BMF, the exemption for nexus-compliant regimes does not apply.
Since the cantonal tax privileges were relevant only until 31 December 2019, any non-deductibility of the royalties paid to companies benefiting from the cantonal tax privileges only relate to the tax periods 2018 and 2019.
Swiss companies benefiting from individual tax rulings
In addition, individual tax rulings between the Swiss tax authorities and recipients of royalty payments may also meet the criteria of a harmful preferential taxation.
According to the BMF circular, proof that a royalty payment to a foreign recipient is subject to standard taxation and not to harmful preferential taxation can generally only be provided by submitting documents from the recipient’s accounting records and from the foreign tax assessment notice issued for the tax assessment period together with the basis for calculation.
Specifically, the documents to be submitted must show that:
- the royalty income has been recorded in the profit determination of the recipient;
- the royalties have been included in the tax calculation in their full amount;
- the royalty income was not reduced by the deduction of deemed operating expenses or similar favorable regulations that are linked to the royalty income;
- no reduced tax rate/no full tax exemption for the royalties has been applied; and
- the right granted for use is owned by the recipient of royalty payments, while the legal basis for the sublicensing to the German taxpayer must also be indicated.
Given the above, and depending on the interpretation of the BMF, Swiss companies benefiting from the special tax rate as a transitional rule and possibly also those that have agreed on a step-up based on the old law may fall within the scope of the royalty deduction limitation rule. Whether companies that have been granted tax relief and are therefore obliged to create or maintain local substance in Switzerland are also covered must be examined on a case-by-case basis.