I. Introduction

Today, two weeks after the German Federal Parliament (“Bundestag”), the German Federal Council (“Bundesrat”) also passed the Tax Amendment Act 2022 (Jahressteuergesetz 2022). As part of the Tax Amendment Act 2022, the taxation of so-called register cases has been amended. Unfortunately, expectations that this taxation would be completely repealed have been disappointed. Instead, the taxation of register cases will be partly continued:

  • On one hand, the scope of the register case taxation has been limited to transactions between closely related parties, particularly affiliated groups. However, such cases will only be taxable if Germany's taxation right is not excluded under a Double Taxation Agreement (“DTA”) and the domestic anti-treaty shopping rules.
  • On the other hand, register case taxation is also applicable if the creditor is domiciled in a non‑cooperative jurisdiction (“Tax Haven”). Currently, 12 countries are classified as Tax Havens.
  • In all other cases, the taxation of register cases has fortunately been completely abolished. This applies to transactions between non-related third parties (as long as they are not domiciled in a Tax Haven) that have been proven to be particularly problematic in practice (“Third-Party Cases”).

For all register cases that remain taxable under the new regime, the German government has carved into stone problematic issues that the tax administration had previously created in November 2020 by “inventing” a highly unusual interpretation of long-existing regulations of the German tax law. For fiscal reasons, the German government disregarded all doubts regarding the constitutionality, massive compliance costs, and administrative burdens for the affected taxpayers resulting from this taxation.

This client alert is of interest for all clients who are domiciled outside of Germany and who sold or licensed IP rights that were registered in Germany in the past, or who are planning to do so in the future.

II. Background

Enterprises with their registered seat and headquarters outside of Germany are only subject to German (corporate) income taxation if there is a special territorial connection (“Nexus”) to Germany (beschränkte Steuerpflicht, “Restricted Tax Liability”).

According to the previous wording of the relevant section of the German Income Tax Act (Einkommensteuergesetz), such a restricted tax liability could arise out of the selling or licensing of IP property rights that are entered in a German public register or book (“Register Rights”). For the last nearly 100 years, the German tax administration took the view that domestic (German) revenue must be generated from these Register Rights in order to cause a respective Restricted Tax Liability. This was generally only the case if the licensee or the buyer of the Register Right was domiciled in Germany.

Since November 2020, the German tax administration surprisingly has taken the view that solely the registration in a German register suffices to constitute a Restricted Tax Liability, even though the relevant parties to the transaction have no other “nexus” to Germany at all, and especially do not generate any domestic income (“Register Cases”). Under this interpretation, income from license payments and capital gains related to Register Rights have generally been subject to German taxation, even if none of the parties is domiciled in Germany.

In the case of a disposal of Register Rights, the seller needs to file a tax return in Germany and pay taxes on the profit from the sale. In the case of license payments, the licensee is required to deduct withholding taxes at the rate of 15.825% (“WHT”) from the gross license payments; the licensor receives only the net amount. The licensee is liable for the withholding of the WHT.

If the seller is domiciled in a country that has concluded a DTA with Germany, the German taxation right with respect to the respective income is generally excluded.

In contrast to the disposal of a Register Right, the exemption under a DTA does not “automatically” apply to income from the licensing of Register Rights. In such cases, the licensor has to apply for an exemption from WHT and must fulfill numerous requirements concerning its “substance” (e.g., employees, office premises) and activities under the so-called anti-treaty shopping rules. The licensee is obligated to deduct WHT (despite a DTA) until the exemption is granted. Any WHT withheld prior to the granting of the exemption can generally be refunded upon application.

Against this background, the German tax administration's position on the taxation of Register Cases is of particular importance since it applies this tax regime retroactively. As the parties to the underlying transactions were not aware that the transactions could be subject to WHT, they have never applied for any WHT exemptions in the past. In order to comply with the German tax administration's position, affected companies are generally required to file the relevant necessary tax returns and applications. Even in cases where the German right of taxation is excluded by a DTA (i.e., where ultimately no tax revenue accrues for Germany), this involves a massive administrative burden. This raises substantial doubts regarding the constitutionality of such taxation. 

The German tax administration was apparently aware of this and introduced a simplified application procedure (at least) for cases in which the licensor is “obviously” entitled to relief from WHT under a DTA. However, particularly in the case of third-party licensing cases, it was hardly possible for the parties to fulfill their legal obligations. With its first draft bill of the Tax Amendment Act 2022, the German Federal Ministry of Finance (Bundesfinanzministerium) had proposed (once again) to abolish (almost) completely the taxation of Register Cases—at least for future cases. However, the German government decided otherwise.

III. New tax regime for Register Cases under the Tax Amendment Act 2022

With today's consent of the Federal Council to the Tax Amendment Act 2022, the relevant section has been amended. Under this new regulation, the taxation of Register Cases will remain in two constellations:

  1. Transactions in which the creditor is domiciled in a Tax Haven. The German Federal Ministry of Finance regularly decides which countries classify as Tax Havens. Currently, this is the case for the following 12 countries: American Samoa, Anguilla, the Bahamas, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, Turks and Caicos Islands, the U.S. Virgin Islands, and Vanuatu. This tax regime for Tax Havens applies to all cases from January 1, 2022.
  2. Transactions between closely related parties. A respective close relationship generally requires an (indirect) shareholding of at least 25%. Therefore, the taxation of Register Cases particularly applies to group structures.

    For licensing transactions between closely related parties that are exempt from the taxation under a DTA (and the German anti-treaty shopping rules), the tax exemption will “automatically” apply from January 1, 2023. Accordingly, in such licensing cases, an application for an exemption from WHT by the licensor is no longer required

    However, if the licensor is not domiciled in a DTA country or cannot fulfill requirements of the German anti-treaty shopping rules for relief from WHT, the taxation of Register Cases remains in full effect (also for past cases). The retroactive effect for closely related party cases is considerable and is only limited by the general statute of limitation: If the affected parties have not complied with the taxation of Register Cases in the past (e.g., by filing tax returns, etc.), which is typically the case, all transactions within the last seven years are generally taxable.

As the taxation of the Register Cases will be limited to the two scenarios above, all other cases (i.e., the Third-Party Cases) are no longer taxable. This applies to all past and future Third-Party Cases.

IV. Outlook

The exclusion of Third-Party Cases from taxation under the Tax Amendment Act 2022 is highly welcomed. Unfortunately, the taxation of Register Cases between closely related parties and parties (licensors and sellers) domiciled in Tax Havens remains in place. On a positive note, however, licensing transactions between closely related parties that are exempt from WHT no longer require formal filings and applications.

There are generally many doubts about whether Register Case taxation is constitutional and whether it complies with European legal standards. These doubts also apply to the taxation of Register Cases under the Tax Amendment Act 2022. Consequently, it will ultimately be up to the courts to decide on the legality of Register Case taxation.

Until the courts ultimately decide on this matter, affected parties continue to be confronted with a massive financial and administrative burden. Affected enterprises will have to review all transactions with closely related parties over the last seven years and, if necessary, file respective tax returns or applications. Due to the considerable constitutional doubts, it needs to be reviewed on a case-by-case basis whether an objection or a lawsuit should be filed against any tax assessment. The same applies to tax assessments for transactions after December 31, 2022, among closely related parties or creditors domiciled in Tax Havens. For the future, it should also be considered whether the taxation of Register Cases can potentially be avoided by restructuring of licensing streams.

We would be pleased to assist you if you have any questions regarding these issues.

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.

© Morrison & Foerster LLP. All rights reserved