Ministry of Finance report suggests potential relief on German withholding tax on extraterritorial royalty payments 

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Eversheds Sutherland (US) LLPA new report (the Report)1 published by the German Federal Ministry of Finance (the MOF) suggests that there may be some forthcoming relief for taxpayers impacted by a nearly century-old tax provision which requires extraterritorial withholding tax on certain royalty payments between non-resident taxpayers. The MOF previously published a circular (the Circular), confirming its position that German withholding tax (at a rate of 15.825%) is due and payable on royalties that are payable or that have been paid to a non-German tax resident recipient, even if:

  1. The licensee is not tax resident in Germany, and
  2. The only nexus to Germany is that the intellectual property (IP) rights underlying the royalties are entered in a German public register.

The licensee is required to withhold, declare, and remit German tax unless a treaty-based (or European Union Directive based) exemption certificate has been issued to the licensor by the German tax authorities.  With respect to payments made in 2013 and later, without a certificate, but where a treaty clearly applies, the German tax authorities introduced a “simplified procedure” whereby licensors could apply to the Federal Central Tax Office for a certificate of exemption which would apply to past payments. Other simplifications were later introduced to allow taxpayer to apply for general exemption certificates covering a group of separate license arrangements at a time. The US-Germany treaty and most other German treaties would provide protection for such payments.

Please see our previous Eversheds Sutherland Legal Alerts HERE and HERE for additional information and a detailed background about the Circular, including the Circular's legal basis and procedural guidelines.

As discussed in detail further below:

  • The deadline for application for retroactive exemption has been extended to June 30, 20232;
  • The legal and factual complexities with respect to the exemption filings has resulted in a significant administrative burden and substantial backlog for the Federal Central Tax Office;
  • There is unlikely to be any future tax revenue in 90% of cases; 
  • The withholding tax has been criticized internationally as inconsistent with the OECD's Inclusive Framework agreement; and 
  • The declining revenue combined with international criticisms of the withholding tax may support the elimination of the withholding tax prospectively.

Filing deadline extended for past years

Of most immediate relevance, MOF has extended by a circular issued on June 29, 2022, the period of time that taxpayers may file for an exemption from withholding tax for past years under the terms of an applicable tax treaty. The deadline to apply was June 30, 2022, but that deadline has now been extended to June 30, 2023.

Evaluation of the MOF position for future years

The Report reaffirms the MOF’s overall legal position that the withholding tax applies and notes that the Federal Fiscal Court has ruled in favor of the MOF with respect to some of the legal issues raised by application of the tax. The Report acknowledges that there are legal and policy considerations still remaining. In addition to complex legal and factual considerations related to individual cases, determining the tax base for purposes of applying the tax is complicated by, among other things, the lack of a specific apportionment formula. According to the Report, these complexities have resulted in many of the filings being at least partially incorrect.

Given the complexities of the filings, the existence of complex cross-border licensing arrangements, and the difficulties of addressing past tax years, review by the Federal Central Tax Office of both applications for exemption for past years and current declarations is complicated and time consuming and there is a substantial backlog. Against this backdrop, the Report recognizes that in the overwhelming majority of cases, no additional tax revenues are expected due to the application of a tax treaty and the Federal Central Tax Office will be unable to timely process even the past-year exemption applications which have been received thus far, let alone the substantial number of applications that were expected to be filed by the June 30 deadline. It has become clear that the tax authorities were unable to issue exemption certificates in time for the quarterly withholding tax return due by October 10, 2022.

Is a change expected for the future?

The Report observes that multinational entities have largely restructured IP holdings since 2018 to ensure relief from withholding tax is available. Thus, it is expected that in nearly 90% of cases, there is unlikely to be any future tax revenue. 

Further, the Report acknowledges that the withholding tax has been criticized internationally and is perceived as a unilateral extraterritorial measure, which is inconsistent with international efforts related to the Organisation for Economic Cooperation and Development’s Inclusive Framework agreement (i.e., the agreements with respect to the introduction of a global minimum tax and reallocation of certain taxing rights). Although the Report refutes criticisms that compare the withholding tax to digital services taxes as "inaccurate from a technical tax perspective," the criticisms must be "taken seriously from a political point of view." The declining revenue combined with international criticisms may support the elimination of the withholding tax prospectively, although the Report stops short of specifically making that recommendation. Even if the tax is eliminated prospectively, there is no indication that there would be any change with respect to the application of the law to prior years, as the Report suggests that additional tax revenue in past non-treaty cases are expected to be significant.

Eversheds Sutherland ObservationsWhile future relief may be available, for now taxpayers without an exemption certificate must continue to comply with the application of the extraterritorial tax. To the extent they have not already done so, taxpayers are well advised to review their existing and future commercial licensing agreements and the allocation of any withholding tax liability including any mitigation obligations with respect to German registered IP. Companies may also de-register IP in Germany, to the extent that IP protection is no longer desired in Germany (or can sufficiently be achieved in other ways). Restructuring IP ownership may also be feasible. 

Certain companies may hold German IP in an aggregate portfolio (knowingly or unknowingly) with a single royalty being paid. In those cases, it may be beneficial to segregate the German IP and pay a separate royalty just for the German IP portion – however, this may result in valuation and other legal/commercial issues. 

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1The Federal Ministry of Finance's report evaluating the current legal situation with regard to the taxation of persons subject to limited tax liability who derive German income from the assignment of rights entered in a German public record or register (so-called register cases) (English translation). 

2The Federal Ministry of Finance's letter regarding Remuneration within the meaning of section 49(1)(2)(f) and (6) Income Tax Act for the temporary transfer of rights entered in a domestic public book or register (English Translation). 

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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