Germany’s tax treatment of cross border royalty payments to non-residents

TABLE OF CONTENTS

1. Preface

2. Introduction
2.1. Generic example of a tax withholding case:
2.2. Ordinary withholding tax rates
2.3. Reduced tax rate for corporations
2.4. Important administrative aspects

3. Licensing Agreement with Non-Treaty-States
3.1. Example:
3.2. Overview withholding tax cases:

4. Licensing Agreements with Treaty States
4.1. Article 12 - ROYALTIES – reads as follow:
4.2. Special rules for partnerships
4.3. Example (partnership)

5. Relief Procedures
5.1. German (Pre-) Exemption Procedure
5.2. German Refund Procedure
5.3. Deadline for applications

6. Primary European Community Treaty Law

7. The European Community Interest-Royalties Directive (Secondary EC Law)
7.1. Basic Examples for the Application of the EC Interest-Royalties Directive

8. Anti-Treaty-Shopping Rules

9. Value Added Tax

10. Model Tax Clauses
10.1. Alternative 1 (in favour of licensee)
10.2. Alternative 2 (in favour of licensor)

11. Bibliography

12. Photos/ Other Copyrights

13. Tables: Comparison of legal forms of international companies (outside East-Europe) with German companies
13.1. Table: German legal forms
13.2. Table: International legal forms (analogy comparison)

14. Table: Comparison of legal forms of international companies of East-Europe with German companies

15. Appendix: List of German tax treaty rates on Royalties

16. Appendix: Official German Application Form for Refund and/or Exemption

17. Appendix: Tax Payment Certificates

1. Preface

Being into the international tax business for a couple of years, I always found it extremely difficult to deal with cross border cases without having the slightest opinion of what the tax consequences are in the foreign jurisdiction.

Often it was not just to know the tax law – sometimes difficult enough to understand – but to find tax information into the right language and the right format.

The intention of this book is therefore to provide you with an adequate but hardly exhaustive understanding of the tax consequences and also opportunities a foreign licensor could face when receiving payments for royalties out of Germany.

Nowadays tax law is far to complicated to be presented in a compendium without leaving out necessary details. This compendium is therefore a trade off between quality and quantity of information. In case of doubt it is always recommended to ask a tax advisor for further support.

Finally, let me say that I found that most German licensees, especially German companies with internal tax resources, are often willing to support with tax matters of the foreign licensor (of course also in their own interest) as an effort to avoid additional taxes for both foreign licensor and licensee. My recommendation: This opportunity should be sought whenever possible.

Hamburg/Germany, Spring 2008

Rudiger Urbahns

2. Introduction

According to German tax law individuals who have neither residency nor their usual abode in Germany and legal entities which are not effectively managed or resident are liable to tax in Germany only with income generated from certain types of business transaction as listed in section 49 Income Tax Code (ITC).

In cross border cases it is therefore in a first step always necessary to ascertain whether the planed transaction will fall under one of the income categories listed in section 49 (1) No. 1,2,3,6 and 9 ITC. In most of these cases it is necessary that the rights will be exploited or used in Germany.

Germany is not allowed to levy any tax regardless of what is stipulated in any tax conventions and the German licensee may not be held liable in case Germany has no entitlement to levy any tax according to its domestic tax law. The same applies, where the foreign licensor can proof that he is fully liable to tax in Germany.^[1]

However, in case of doubt it is necessary that the German licensee or the foreign licensor clarifies the taxation rights with the local tax office responsible for the tax affairs of the licensee in Germany; the Central Federal Tax Office is not responsible in such cases.^[2] Only in case the local tax office confirms that the foreign licensor is not liable to tax in Germany with the concerned transaction the licensee may be allowed to refrain from deducting any tax otherwise the expectation is always – also in case of doubt – that licensee operates tax deduction. As a rule of thump one should assume that licence fees paid to foreign licensors are subject to limited tax liability in Germany.

Section 50a ITC stipulates that on certain types of income paid to non-residents German tax needs to be deducted at source. Such income subject to withholding tax is according to section 50a ITC:

- Income as a member of a supervisory board (section 50a (1-3) ITC);
- Income generated by artistic or sport performances taking place or exploited in Germany (section 50a (4) No 1 ITC);
- Income generated from the exercise or exploitation of an activity as an artist, professional sportsman, author, journalist or press photographer, including activities for radio or television, e.g. as a foreign correspondent (section 50a (4) No 2 ITC);
- Income from the use of movable property, assignments of use or the right to use rights, especially copyrights and other commercial rights such as author’s rights, film rights, music rights, patents, designs, industrial, commercial and technical work experiences, plans, samples and secret formulas etc. Since 2007 also on the sale of rights subject to section 49 (1) No. 2 lit. f ITC with the exception of European or international tradable CO2 emission rights (section 50a (4) No 3 ITC).

This compendium concentrates in the following only on section 50a (4) No. 3 German Income Tax Code, i.e. on the taxation of royalties.

Although many of the principles in this compendium may also apply to other withholding tax cases of section 50a ITC, they nevertheless partly differ so that further tax advice should always be sought when dealing with such cases.^[3]

Use of movable property: This criterion does not include the sale of property. For lease cases the leased assets need to belong (at least economically) to the foreign licensor.

Sale of rights: The expressed intention of the legislator was to cover only cases of ‘consumptive rights’ (verbrauchende Rechteüberlassung) as a reaction to the FTC decision of 16 May 2001, I R 64/99 (advertisements at sport events).^[4] The legislator has excluded emission rights in 2008 for clarification purposes. The wording is very broad if not to say ambiguous and does cover almost every sale of rights so that one needs to carefully check the further development in this area. Germany’s taxation right on the sale of rights should, however, in most cases be limited according to article 13 (4) OECD-MC.

In the following the main focus is on cases where the remuneration debtor (German licensee), often a company resident in Germany, is obliged to deduct a flat tax on account of the foreign licensor, being not resident in Germany. Problem for the remuneration debtor is that he can be held liable on his own account if he do no operate the appropriate tax withholding. In case of doubt German tax authorities always expect the German licensee to deduct tax. The foreign licensor in turn has the right to claim a reimbursement of the tax so withheld in case he can proof that the tax deducted isn’t correct or too high. The tenor of this somewhat administrative procedure is that otherwise the tax authorities would almost never have the chance to get hold of the foreign licensor (or the relevant information) and to force licensor to pay for his tax obligations in Germany.^[5]

2.1. Generic example of a tax withholding case:

Abbildung in dieser Leseprobe nicht enthalten

2.2. Ordinary withholding tax rates

According to German domestic law the remuneration debtor (licensee) is required to withhold taxes at a rate of 20% plus solidarity surcharge of 5.5% of the tax, in total 21.10%, of the gross remuneration payable to the foreign licensor without any deductions. By law it will be assumed that the foreign licensor is the debtor of the tax so that basically only he is entitled to any later refunds for example due to treaty reliefs.

Usually the German licensee only assumes responsibility in case he does not operate or not at the right rate the tax withholding process. However, if licensee as payment debtor assumes responsibility for the payment of the tax deducted at source, the tax deducted must be projected at 25.35% and the solidarity surcharge at 1.39%. It can be said that in such cases it will be assumed that the tax born by licensee will be deemed as additional licence fee payment. The same shall apply where the licensee is held liable for the failure to deduct tax but in turn can not – for example due to the tax clause in the licence agreement – or will not charge the foreign licensor with this amount. For the licensee the ‘licence fee’ will in such cases be substantially increased by the additional tax charge for which reason it is strongly recommended to deal with the tax issue proactively in the licence agreement. The withholding tax becomes due in the moment the licence fee is paid to the foreign licensor or is otherwise offset against an obligation vis-à-vis the foreign licensor (section 50a (5) sentence 1 ITC).

2.3. Reduced tax rate for corporations

In case the foreign licensor is a corporation the tax has been reduced for licensing cases since 2008 to 15% plus solidarity surcharge, in total 15,825% (section 50a (4) sentence 4 ITC; in case of net agreements: 18.8%). Problem is that the licensee needs to assess whether the foreign licensor is a corporation benefiting from the reduced tax rate or another entity such as a partnership (checked on partner level, see section 4.2) for which the normal tax rate applies. The classification of foreign companies as partnerships or corporations needs to be determined for German taxation purposes only on the grounds of the German tax law by operating a so called ‘analogy comparison’ (Typenvergleich).^[6] The analogy comparison basically requires checking whether the foreign entity by its foreign legal concept and handling is comparable to German corporations (usually a GmbH or AG). The classification according to the common law or tax law of the jurisdiction where the company has its legal seat or has been constituted shall not be decisive.

2.4. Important administrative aspects

German tax authorities can impose the taxes due on licence fees against the foreign licensor in a separate tax assessment (Nachforderungsbescheid), i.e. after the licence fees have been paid without tax deduction, basically only for two different cases (section 50a (5) sentence 6 ITC):

- where licensee has not deducted the tax correctly or
- where the foreign licensor knows that licensee has not deducted the tax correctly and has not immediately notified the tax authorities.

In this assessment process the tax authorities need to consider treaty reliefs.

Otherwise, in case the tax has not been deducted and paid it is more likely that the tax authorities claim, at their discretion, the tax from the German licensee (which then is hold liable as collection debtor), although they are also allowed to charge the foreign licensor (hold liable as tax debtor).

From a practical standpoint the tax authorities claim the tax most likely from the German collection debtor (via a liability assessment = Haftungsbescheid) very often as a result of a general tax audit at the premises of the German licensee. It can therefore be said that in licensing cases the German remuneration debtor bears most of the tax risks especially where the tax clause in the licensing agreement shifts the tax burden completely or almost completely to the licensee. However, a liability assessment shall not be possible where licensee has refrained from operating the tax deduction due to a valid pre-exemption certificate and were at a later stage the tax authorities take another position; in such cases it shall not be possible to hold the licensee liable for tax deduction.^[7]

Basically the past perception was that the foreign licensor is as tax debtor entitled – beside the licensee - to file applications as well as objections against the tax returns in which licensee has declared the deducted taxes at source vis-à-vis the German local tax office (Steueranmeldung).^[8] In contrast the Federal Tax Court held in a recent decision^[9] that such objections of the licensor are only possible on the subject if licensee was allowed to deduct taxes but not if the licensor was really taxable with his royalties; this topic needs to be decided by the Central Federal Tax Office in the refund procedure.^[10] It seems therefore that there are only a few exceptional cases where it seems worthwhile for licensor to object the tax declaration of licensee. One needs also to consider the fact that the tax will in such procedures be reimbursed to the licensee and not the licensor;^[11] the licensor, in case he would be successful, therefore needs to claim the tax back from licensee on the grounds of the licensing agreement. The refund procedure seems therefore to be the better way.

In case licensee has been held liable for failed tax deductions the foreign licensor nonetheless has an entitlement for any refunds for example due to the application of treaty relief’s and reduced withholding tax rates in the refund procedure (see section 5). In such cases it seems that the practical side is more problematic: How should the foreign licensor know that licensee has been held liable for failed tax deduction? Why should licensee have an interest to inform foreign licensor when having no outlook for a counter benefit?^[12] My recommendation is to address such issues in the licence agreement (see under section 10) and in a way which is beneficial for both licensee and foreign licensor. Nonetheless, it seems worthwhile for foreign licensor in certain situations to check whether there is entitlement to tax reimbursements.

In case tax on licence fees have been withheld for a period for which later an exemption certificate will be granted, the licensee can file a correction of his tax return and is thus entitled for a refund.^[13] Alternatively the foreign licensor can make an application for refund with the Central Federal Tax Office. To avoid that both licensee and foreign licensor can make competing claims at the same time only the one having the original ‘tax payment certificate’ (see under section 5.2) shall be entitled.^[14] The (qualified) ‘tax payment certificate’ is therefore of some importance for the whole procedure.

3. Licensing Agreement with Non-Treaty-States

In case Germany has not concluded a Double Tax Convention or other bilateral relief agreement with the jurisdiction in which the foreign licensor is resident, the German domestic withholding tax become usually final (section 50 (5) sentence 1 ITC). Double taxation can in such cases only be avoided by unilateral measures in the country of residency of the foreign licensor, e.g. by crediting the tax paid in Germany against the income tax of the foreign licensor in his home jurisdiction according to the domestic tax law in this jurisdiction. Alternatively the licensing income may be exempted from tax.

The tax needs also to be deducted in cases where the foreign licensor has a permanent establishment (PE) in Germany from which he conducts a trade and business activity and to which the licence effectively belongs. However in such cases the withholding tax is not necessarily final. Reason is that the foreign licensor has to submit tax returns for this permanent establishment and that the withholding tax can be credited against the tax assessed for this PE. Under the tax assessment system the foreign licensor is also allowed to deduct all related business expenses effectively connected with the licence income.

In some of these cases it can therefore be advantageous to use a permanent representative in Germany to reach taxation on the net licence fee.^[15] In such cases taxation on the net licence fee may be reached in Germany.

3.1. Example:

Foreign Licensor Ltd. (FL Ltd.), a corporation in a state with which Germany has not concluded a tax treaty, grants an licence to a German enterprise and charges an once off fee of € 100.000.

Under the assumption that FL Ltd. will be recognized as corporation under German law (analogy comparison), the German enterprise needs to deduct withholding taxes of € 15.825 and pays only € 84.175 to FL Ltd. This tax becomes final for FL Ltd. in Germany but may be credited against FL Ltd’s corporation tax charge in its state of residency, depending from the foreign domestic tax legislation.^[16]

In case the German enterprise assumes responsibility of the tax payment due to a net agreement with FL Ltd. the tax would amount to € 18.800. In such case it makes sense to reduce the licence fee accordingly. Otherwise the German licensee may pay a ‘tax premium’ which may nevertheless be creditable against the income tax charge of the foreign licensor (double dip).

In case FL Ltd. would have had a (deemed) permanent establishment in Germany with which the licence is effectively connected, the German enterprise would also have needed to withhold taxes at the same rate. However, this tax would be credited (or reimbursed) against FL Ltd’s German tax which becomes due on the profits (i.e. the net result which is made up by the licence income less related expenses).^[17] However, it needs to be determined in more detail in relation to the tax law of FL Ltd’s home jurisdiction if this result is more favourable for FL Ltd.

3.2. Overview withholding tax cases:

illustration not visible in this excerpt

4. Licensing Agreements with Treaty States

According to article 12 (1) OECD Model Tax Convention royalties shall only be taxable in the resident state of the foreign licensor with no withholding tax at source.^[18] However, as this is only a non-binding model one has always to rely on the wording of the relevant bilateral tax treaties for the assessment where royalty payments are taxable respectively how the taxation rights are allocated. German tax treaties very often do not follow the OECD model but the UN model and Germany is therefore in many cases allowed to levy taxes at source of 5 to 15%. Also the definition of licences in paragraph 2 can differ from the OECD model so that one needs to carefully assess whether Germany is allowed to levy any tax at source. However, in case Germany reduces in a bilateral Double Tax Convention the withholding tax to zero, it is recommended to simply follow the pre-exemption procedure. For existing bilateral tax treaties and the applicable withholding tax rates compare the table in section 15.

4.1. Article 12 - ROYALTIES – reads as follow:

1. Royalties arising in a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in that other State.
2. The term "royalties" as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience.
3. The provisions of paragraph 1 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise through a permanent establishment situated therein and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment. In such case the provisions of Article 7 shall apply.
4. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the royalties, having regard to the use, right or information for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case, the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of this Convention.

[...]

^[1] This is explicitly stipulated in this sense in section 73e sentence 5 ITPC, i.e. no obligation to withhold any tax. Usually such result can be reached where the foreign licensor establishes a German corporation, such as a GmbH, which grants the right instead of the foreign licensor and which is fully taxable in Germany.

^[2] German tax authorities provide binding rulings for which they, however, charge fees. In certain cases it may be sufficient to reach non-binding confirmation from the local tax office.

^[3] One of the main differences, among others, is that Germany allows that buiness expenses are deducted in the withholding tax procedure under certain conditions. However, this procedure is cirticized by the European Commission, see reasoned opinion (IP/08/144) of 31 Jannuary 2008 “Direct taxation: Commission requests Germany to end discriminatory rules applied to non-resdent taxpayers (mainly artists, sportsmen and journalists).”

^[4] The legislation change was introduced in 2007(StÄndG).

^[5] This procedure was confirmed by Federal Tax Court (Bundesfinanzhof) decision of 05 November 1992, I R 41/92, BStBl 1993 II, 407. Tenor: “The tax exemption of licence fees according to article 12 (1) DTC Germany – Switzerland does not exclude the levy of withholding taxes according to section 50a (4) No 4 ITC.”

^[6] The Federal Tax Administration Guideline, dating 24 December 1999, Appendix I Table 1 and 2, Federal Gazette I, 1076 (Permanent Establishment Guideline), contains a ‘official’ list where foreign entities have been compared to German corporations. Compare also the general principles for an analogy comparison in Section IV of the Federal Tax Administration Guideline of 19 March 2004, FG I, 411, regarding the classification of an US LLC. This list is attached as appendix to this compendium in section 13.

^[7] FTC conclusion of 26.07.1995, I B 200/94

^[8] General rule outlined in FTC decision of 12 October 1995, I R 39/95, BStBl 1996 II S.87 for salary tax deductions. Tax returns need to be filed quarterly.

^[9] Federal Tax Court decision of 7 November 2007, I R 19/04

^[10] See more in section 5.

^[11] Federal Tax Court decision 13 August 1997, I B 30/97

^[12] Remember the refund procedure requires that the ‘Tax Payment Certificate’ will be attached which can only be issued by the licensee.

^[13] This concerns especially cases where between application and granting of the pre-exemption certificate licence fees have been paid which have been subject to withholding taxes.

^[14] Form of the tax exemption certificate can be found in section 17.

^[15] The same applies for treaty cases but without creating agency permanent establishments in the sense of a tax treaty. In this sense also: Pöllath in Vogel/Lehner, DBA Kommentar, Munich 2003, sec. 31; reason is that the domestic definition in section 13 General Tax Code is much broader than the definition contained in tax treaties, compare Kruse in Tipke/Kruse, AO Kommentar, § 13, Tz. 9.

^[16] Alternatively the licence income may be exempted from tax with then no credit of the foreign tax.

^[17] Section 50 (5) sentence 2 ITC

^[18] Article 12 is addressed to the source state and the assessment of his tax position; the tax position of the state of the licensor is usually addressed in the method article 23. The resident state does exempt the licence income or credit the source tax against the income tax of the licensor in his home jurisdiction.