On Nov. 6, 2020, the German Ministry of Finance issued guidance on a law concerning extraterritorial intellectual property (IP) transactions. In the brief declaration, the German Tax Authorities asserted that German tax liability could result from a limited or unlimited transfer of intellectual property rights if such rights are registered in a German register. No further requirements need to be met in order to trigger tax liability. Thus, the relevant German law1 allows for German Tax Authorities to tax payment for the licensing or sale of IP that is registered in a German Register2, even if neither party resides in Germany (e.g. two U.S. companies that have a patent registered in Germany). This would also include patents registered in a German register due to an application via the European Patent and Trademark Office after the European Patent Convention. Additionally, payments for missed withholding would be due going back up to 13 years under the statute of limitations (e.g. royalties to a French licensor paid for by a US licensee for use of a patent registered in Germany in 2014 would be taxable in Germany for past and future transactions related to the patent, including any sub-licensing).
Affected taxpayers can include anyone who has IP registered in Germany or who pays royalties for the use of IP registered in Germany. This could potentially have a large financial statement impact for taxpayers subject to these rules as they may be required to book a substantial tax liability for any missed German withholding tax.
The withholding tax rate for royalty payments relating to IP registered in Germany would be a flat rate of 15.825%, which could potentially be mitigated via double tax treaties or European Directives (see Potential Taxpayer Solutions below). For payments prior to 2013, taxpayers could remit withholding payments and file taxes with the appropriate local tax office in Germany. For payments post 2013, taxpayers could remit withholding payments and file taxes with the German Federal Tax Office. Additionally, gains from the sale of IP registered in Germany would also be subject to tax at a flat rate of 15.825%; however, the taxpayer could potentially avoid this via double tax treaty if there is one in place.
In order to be compliant with these German withholding rules, taxpayers who failed to withhold and remit tax at the time a payment was made must file a tax return with the German Federal Tax Office and remit the tax with respect to payments made after Dec. 31, 2013. For payments made before this time, the taxpayer would need to make withholding payments and file taxes with the local appropriate tax office.
The sale of IP rights registered in Germany is generally not subject to withholding; however, the recipient of the gain would need to pay tax on gains from the sale and file a tax return with the competent tax office in Germany unless a double tax treaty or European Directive exempts the gain from German taxation.
Criminal liability could arise if a taxpayer willfully or deliberately fails to pay taxes on time. Tax Authorities can only bring criminal charges against a responsible person and not a company. In order to mitigate any risk in regards to any criminal proceedings, the taxpayer may consider making a formal disclosure of all unpaid taxes in the past 10 years.
Potential Taxpayer Solutions:
As mentioned above, relief from the German withholding tax may be available under a relevant double tax treaty or and European Directive. The payor of the royalty does not have to withhold on the payment if the payee has provided a valid exemption certificate issued by the German Federal Tax Office. If there has been no withholding, both licensor and licensee are liable for the withholding payment.
Double tax treaties also may provide relief from tax imposed on any gain from the sale of IP registered in Germany under the capital gains article of the treaty. There may be significant risk for taxpayers who do not have a double tax treaty in place with Germany.
Potential Taxpayer Examples:
US Company A sold IP registered in Germany to US Company B in 2019. US Company A needs to pay tax on any capital gains resulting from the sale of the IP registered in Germany and file a tax return with the German Federal Tax Office unless it can claim the capital gains tax exemption under the capital gains article of the US-Germany treaty. In case US Company A is entitled to the exemption, no German tax would be due and not tax return would have to be filed in Germany.
Irish company (licensor) gives limited rights to an IP registered in Germany to a US Company (licensee). US Company pays royalties to Irish company and has done so since 2012. In case of a negligent tax avoidance, the US Company (licensee) would have to pay withholding tax and file a tax return for all payments made since 2012. For payments made after Dec. 31, 2013, the tax return would have to be filed with the German Federal Tax Office; before this time, withholding payments and tax filings would need to be made with the local appropriate tax office. The European Interest and Royalty Directive may provide relief from withholding in the future, but the Irish company would need to apply for and receive an exemption certificate prior to any royalty payments being made in order for the US Company to avoid withholding on payments as they are made. In case no exemption certificate has been issued in the past covering payments since 2012 and no tax has been remitted to the German tax authorities, both the Irish company and US Company would be liable for withholding tax on the royalty payments. After the tax payment, Irish company could apply for a tax refund based on the European Interest and Royalty Directive or Ireland-Germany treaty at the German Federal Tax Office covering tax payments of the past four years. Ultimately, Germany would not tax the royalty payment as far as the European Directive or treaty applies and refunds are not time barred. However, the European Interest and Royalty Directive or any double tax treaty regulations do not exempt from the obligation to withhold taxes without a valid exemption certificate in place covering the payment.
While it is not entirely clear how the German Tax Authorities could enforce this law with respect to transactions between non-German parties, it is clear that an auditor could ask US taxpayers to book a liability under this provision, creating a potentially substantial financial statement impact. It is important to note that this law has been in existence for almost 100 years and in practice has never been applied to entirely extraterritorial transactions. Most recently, the German Ministry of Finance has included the issue in a draft bill that would limit the application of the law to a domestic exploitation of IP effectively excluding extraterritorial cases. The provision is part of a larger legislative initiative and an implementation is not expected before 2021.
1German section 49 (1) No. 2f and No. 6 of the Income Tax Act (ITA)
2DPMA Deutsches Patent und Markenamt (German Patent and Trademark Office)