With a large industrial manufacturing and consumer market and beneficial intellectual property (IP) protection laws, Germany is a very popular country in which to register IP. However, these benefits have been recently tarnished by an old provision in the German tax law that could allow for non-resident taxation on transactions of IP registered in Germany.
The German Income Tax Act (Einkommenssteuergesetz §49 (1) Nr. 2f and Nr. 6 in combination with §50a) contains an approximately 100-year-old provision which has come into focus this year with tax experts and the German tax authorities. The confirmed literal interpretation of the provision suggests that IP that is merely registered in Germany can create a German tax nexus. As a result, overseas transactions between non-residents involving German registered IP can create a limited tax liability in Germany for the transaction participants.
For licenses, the portion of the royalty payment associated with German registered IP is subject to a 15% withholding tax (WHT) in Germany plus solidarity surcharge (a 5.5% supplementary tax charge introduced in 1991 to cover the costs of German reunification). This WHT rate is increased to 18.83% if WHT is not actually withheld and paid by the payor. For a sale rather than license of IP, the seller is subject to German income tax at prevailing rates on the gain on sale determined in accordance with German tax rules.
Example 1: A Bermuda resident company owns patents or patented IP rights, some of which are registered in Germany. The Bermuda resident company licenses the rights to the patented IP to its subsidiary in Ireland. The Irish company pays a royalty to the Bermuda resident company for these rights. The portion of the royalty payments associated with German registered IP may be subject to German WHT.
Example 2: A Singapore resident company owns certain patented technology, some of which is also registered in Germany along with other large markets. A U.S. company acquires the share capital of the Singapore company. Subsequent to the acquisition, the IP owned by Singapore is legally transferred to the U.S. acquirer, and non-U.S. exploitation rights to the same IP are licensed to a subsidiary in the UK. The Singapore resident company may be subject to German income tax on its gain on sale of the German registered IP to the U.S. The U.S. acquirer may be subject to German WHT on license royalty payments from the UK, with the UK having a German WHT obligation.
These provisions are applicable to taxable transactions regardless of the relation of the parties. It should also be noted that definitions of what is a sale or license or otherwise taxable transfer of beneficial rights is nuanced under German law.
The provisions of this domestic law may be exempted in many of Germany’s double tax treaties, however, the treaty treatment must be claimed by the taxpayer and approved by the Germany tax authority prior to the transaction. If the proactive claim is not made, the associated German taxes should be paid and a refund can be claimed under the treaty. While questions exist over Germany’s ability to actively enforce the law on non-resident companies, there are potential German criminal tax evasion consequences to directors of the non-resident companies that do not withhold or file appropriate tax returns. The provisions of the law create a potential tax interest in non-resident transactions for Germany. Therefore, disclosures of associated transactions may also be required under the EU’s new DAC 6 provisions.
Historically, the provisions of this law have not been enforced by the German tax authorities or considered by the German tax court, and taxpayers and their advisors have not specifically dealt with its provisions. Consequently, there is little guidance or experience on how to apply the provisions. Taxpayers and their advisers need to assess:
- What constitutes German registered intangible;
- The German tax characterization of transactions based on the specific terms and conditions of the transactions; and
- Whether tax treaty exemption provisions apply.
After the relevant taxable transactions and registrations have been identified, taxpayers then need to navigate the various valuation considerations needed to determine only the portion of the transaction value associated with the German registrations. While gross transaction values associated with this potential German tax liability are often considerable, the value ultimately associated with the German registrations of IP are often less material, e.g. because the transaction value may cover many other countries and IP that is not registered in Germany. The art comes with articulating the elements that explain how the taxable amounts are determined in a manner that is both compelling and avoids unnecessary uncertainty in the mind of the German tax authorities given their approach to evaluating such issues.
Since April 2020, when this German tax issue surfaced, many non-German companies have had to review their historical and current transactions for potential liabilities. The initial focus and concern was on the pharmaceutical and medical device industries, but the issue potentially affects intangible transactions in the internet, technology, automotive, financial services and many other industries with value associated with their intangibles and intellectual property.
While relatively unusual in an income and withholding tax context, non-resident taxation rights are more common in the context of capital gains tax. Germany is not alone with this type of non-resident taxation on IP registered or assets located locally (for instance, the UK ORIP tax regime). With more and more attention being paid to IP as a result of the OECD BEPS initiative and the global pressure on public financing as a result of COVID-19, broader use of this type of non-resident taxation is likely to become more prominent.
Valuation and consulting for financial reporting, federal, state and local tax, investment and risk management purposes.
Comprehensive transfer pricing advisory covering compliance, planning, controversy and implementation.
Transfer Pricing Controversy/Expert Services
Economic review, analysis of proposed settlements and objective expert testimony in litigation.
Transfer Pricing Valuation Services
Value a range of intangible property, functions and other interests for tax purposes.
Financial Transactions Transfer Pricing Services
Valuation and strategic implementation of financing arrangements covering loans, guarantees, cash pools and preferred equity.
Transfer Pricing Global Compliance Services
Global and local transfer pricing documentation, benchmarking and Country-by-Country reporting compliance.
Transfer Pricing Operational Services
Enhance internal strategic reviews, implementation strategies and assistance in evaluating planning structures and third-party tools.
Transfer Pricing Strategic Planning Services
Duff & Phelps’ Transfer Pricing Strategic Planning Services are designed to assist companies when setting up new operations, integrating new acquisitions and divesting existing business lines.