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Withholding tax on royalties for German IP

  • Germany
  • Intellectual property
  • Tax planning and consultancy

03-03-2021

Following much conjecture over the past 12 months, the German Federal Ministry of Finance has now confirmed that non-German companies with registered German intellectual property (IP) are liable to pay a 15.825% withholding tax on gross royalties.

The tax is retrospective from 2013, indicating a pronounced and controversial move away from previous OECD alignment.

Technology and trade mark protection and registration is often made with a global approach, in many cases including Germany, even if the focus of the protection is the entire EU or other parts of the world. Therefore it is commonplace that IP licenses often include German IP as part of a wider IP bundle.

On February 11, 2021, the German Federal Ministry of Finance (GFMF) published a decree (“the Decree”) that needs to be considered for existing and future IP registration, IP protection, IP licensing and tax residence of parties to IP licenses. The GFMF confirmed their position that German withholding tax (at a rate of 15.825%) is due and payable on gross royalties that are payable or that have been paid to a non-German tax resident recipient, even if:

  • the licensee is not tax resident in Germany, and
  • the only nexus to Germany is that the Intellectual Property rights underlying the royalties are entered in a German public register.

The Decree causes practical consequences for companies across the globe licensing German IP.

Affected IP, royalties and capital gain from sale of IP

Royalties from licensing IP rights entered in a German public register payable to a non-German tax resident are subject to German withholding tax. This withholding tax has existed for many years and historically received little to no attention with regard to payments involving only non-German parties. The licensee is primarily responsible for the withholding of tax and the licensor (beneficiary) can be held liable as well. This withholding tax obligation exists irrespective of any tax treaty benefits as long as the parties have not taken action, i.e. applied for and received an exemption certificate from the competent German tax authority on the basis of the treaty benefits.

The capital gain from the sale of IP rights entered in a German public register derived by a non-German tax resident is subject to (corporate) income tax in Germany unless the beneficiary is tax resident in a state with which German has entered into a tax treaty and is eligible for relevant treaty benefits (no withholding tax applies).

IP rights entered into a German public register include any of the following (Registered German IP):

  • German patents, German trademarks, German registered design rights, German utility models and German plant breeders rights
  • according to the Decree, European patents extended on Germany are also affected

IP rights which are not affected include the following:

  • IP rights registered outside of Germany
  • European trade marks
  • know-how
  • software (except for software protected by a relevant patent or utility model)

Any royalty payable for Registered German IP is subject to German withholding tax if the licensee and/or the licensor are not German companies (ie are not tax resident in Germany). This also applies to any IP bundle which includes German Registered IP. For instance, a royalty payable by a Chinese company to a UK company for an IP bundle that includes a German patent, is subject to German withholding tax on that portion of the royalty that is allocated to the German patent.

Tax consequences

Under the Decree, affected taxpayers must come into compliance for prior tax periods before September 30, 2021, and for any royalties that are paid after September 30, 2021. The Decree is applicable retrospectively from undeclared withholding tax which is not time-barred. German tax authorities take the view that this can be withholding taxes not declared for periods since 2013.

To be exempt from the withholding tax, the licensor can apply for exemption certificates with German tax authorities and provide the certificate to the licensee. Upon receipt of a valid exemption certificate, the licensee is not required to withhold German tax on royalties. An exemption certificate can be obtained by a licensor only if the licensor;

  • is tax resident in a state with which German entered into a double tax treaty
  • is eligible for relevant treaty benefits
  • passes the German substance test, and
  • provides relevant documents to German tax authorities.

No exemption certificates will be available for off-shore licensors. In particular IP (holding) companies in the legal form of a Cayman Islands company, BVI company, Bermuda company or Hong Kong company will cause problems unless such companies are tax resident in a treaty state.

For more details on the tax implications, please see our sister briefing, “German withholding tax on royalty payments between non-German parties – German tax authorities confirm position on withholding obligation and set out procedural guidelines for compliance”.

Legal consequences

Besides the need for tax compliance, many legal issues arise such as:

Existing IP licenses

Existing IP licenses should be reviewed if German Registered IP is included. The licensor should (be approached to) apply for an exemption certificate for past tax periods and the current tax period up to September 30, 2021 by December 31 2021 and the licensee needs to verify the likelihood of success of the application in order to properly plan for their own (tax) compliance strategy.

Should the contractual relationship with the licensor no longer exists and the licensor be unwilling or unable to apply for an exemption certificate for periods prior to and until September 30, 2021, then the licensee who can demonstrate these circumstances is also entitled to apply for such an exemption certificate on its own behalf.

Royalty clauses, tax clauses and other relevant clauses should be reviewed to verify which party bears the withholding tax risk. Subject to the clauses, the parties to the license agreement may have different views on who should bear the costs for the withholding tax given that this was a non-issue before 2020. This becomes a particular issue for the licensee if the licensor refuses to apply for an exemption certificate, or does not fulfil the requirements for an exemption certificate (eg the licensor may be part of a hybrid tax structure which is not apparent to the licensee). This may give raise to arguments about the content of the license agreement, its interpretation and breaches. A specific risk arises for the licensee if they have to pay withholding tax for previously paid royalties (where no deduction for withholding tax was made) and the licensor is entitled to a refund from German tax authorities – is the licensor required to pay the refund to the licensee under all circumstances? 

New IP licenses

The licensee and licensor should identify any Registered German IP in an IP bundle and consider making this Registered German IP subject to a separate license agreement, if practical.

The licensee may not accept the withholding tax costs and include a proper withholding tax clause. The licensee should also consider assessing the withholding tax risk caused by the licensor and request relevant information and contractual obligations to mitigate the risk.

IP registration and holding strategies

De-registration of Registered German IP may be an option to avoid withholding tax in the future. For instance, a German trademark may be replaced by an EU trademark, provided that a similar level of protection can be achieved.

This should be considered if Registered German IP can be owned or held by companies which are registered / tax resident in off-shore jurisdictions, do not have sufficient substance, or are part of a hybrid or otherwise aggressive tax structure which makes it difficult for the licensor to obtain an exemption certificate.

Cash flow impact

If withholding tax has to be paid for periods before 2021, the timing between the payment by the licensee and a refund by the licensor and subsequent repayment to the licensor can have an impact on the cash flow of the licensee.

Profit and loss (P&L) impact and 2020 annual financial statements

Any unpaid withholding tax for periods until 2020 may have to be reflected as an accrual and therefore reduces the 2020 profit. Subject to the applicable accounting standard, a claim for reimbursement against the other party of the license agreement can be reflected to mitigate the P&L effect (subject to the other party’s willingness to make the payment).

Compliance review

Compliance with withholding tax on Registered German IP may become an item for compliance reviews and should in particular be added to due diligence lists.

Risk for managers to commit offences or criminal acts

Managers of a licensee are at risk of committing an offense or criminal act if they deliberately or recklessly choose not make a withholding tax filing, and therefore prevent the licensee from paying the withholding tax when due, or prevent the required accruals for unpaid withholding taxes from being reflected in the annual financial statements.

According to German law tax fraud can be committed by a director or manager of a company who is responsible for dealing with the tax affairs of the company (delegation is not always a defence) and deliberately or recklessly fails to cause the company to pay withholding tax when due. Since the Decree has been published tax authorities may take the view that directors and managers should become aware of their duties within a reasonable period of time from the publication.

Next steps

Global businesses with IP registered in Germany should look now to discuss the tax implications of their existing IP licensing strategy. As well as compliance with the Decree’s retrospective scope, changes may need to be made to ensure future IP is managed appropriately.

Some considerations include:

  • determine what portion of your royalties from an IP bundle with German IP are to be allocated on the German IP
  • get advice to assist in the decision to make a disclosure (including prior five years) and the associated increases in taxes (The tax can apply on each license in a chain of licenses. Such chains may exist within a group of companies or within normal license chains between third parties)
  • review if exemption certificates are available
  • deregister German IP
  • consider if German registered IP is truly necessary for any future IP registrations
  • transfer German IP to companies who are resident in a state with which Germany has entered in to a tax treaty
  • allocate the cost risk to customers by appropriate clauses in agreements

If you would like to discuss this development further, or for assistance in ensuring your business is compliant, please get in touch with our Global tax and IP teams