Amended German IP nexus taxation rules in draft Annual Tax Act 2022

Background of the draft law 

On 28 July 2022, the German Federal Ministry of Finance published the draft Annual Tax Act 2022 (German version | English unofficial translation version). Amongst other provisions, the draft bill proposes changes to the extraterritorial taxation of income and capital gains derived from German-registered IP (GRIP). If enacted as currently drafted, GRIP taxation will not apply to third-party transactions for all open cases with retroactive effect. For revenues received from 1 January 2023, it will not apply unless the payment is received by a person resident in a non-cooperative jurisdiction.

The taxation of GRIP-related income of non-resident taxpayers in Germany is based on provisions introduced in 1925. However, it was nearly 100 years after the introduction of these provisions that the German tax authorities first enforced such taxation (through two circulars dated 6 November 2020 and 11 February 2021).  As a consequence, transactions between two non-resident companies without any physical presence in Germany that include the leasing or transfer of GRIP are taxable. Nevertheless, based on the circulars, these provisions would apply from 2013 onwards, requiring licensees to withhold tax from royalty payments unless the licensor was resident in a jurisdiction with the exclusive right to tax the relevant income under an applicable double taxation treaty (DTT) with Germany. For more background on these circulars, see our previous briefing here. For periods prior to 30 June 2023, parties to these license transactions are still required to notify the German Federal Tax Office in order to dispense with the withholding obligation and, for payments from 1 July 2023 onwards, the licensee will need to be provided with an exemption certificate from the licensor.

Key aspects of the draft bill 

Instead of an outright deletion of the controversial provisions, the draft bill takes a more nuanced approach:

• Royalty income and capital gains related to GRIP rights until 31 December 2022 will only be taxable on payments between related parties as defined under German transfer pricing rules, i.e. entities with an interest of at least 25 per cent of the other person’s profits or liquidation proceeds. Therefore, corresponding payments between unrelated (third) parties will no longer be in scope provided that the respective assessments have not become final.
• From 1 January 2023 onwards, royalty and capital gains derived from GRIP rights will only be taxed if the (related or unrelated) recipient of the payments is resident in a so-called non-cooperative jurisdiction. Non-cooperative countries are tax jurisdictions that do not ensure sufficient transparency in tax matters, engage in unfair tax competition or have not committed to implementing the OECD's BEPS minimum standards against profit shifting and are listed on the EU's so-called blacklist. This list currently comprises American Samoa, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, American Virgin Islands and Vanuatu.

Take-aways and open questions

The draft bill is a positive development given the considerable complexity, uncertainty and practical burden introduced by the circulars. In particular, for third-party license transactions between independent parties in DTT jurisdictions, earlier attempts to “simplify” the exemption procedure have proven difficult in practice. For instance, it was virtually impossible for royalty payors to provide the tax authorities with the required GRIP-specific data in the prescribed format as, invariably, such agreements consist of a broad-ranging bundle of complex IPs (and sometimes other components) which span a large number of jurisdictions. This was also the case regarding information on the licensor, as such information is either not available to the licensee or would require a disproportionate effort to obtain this in respect of prior fiscal years. 

Despite a large number of transactions having been disclosed to the German tax authorities, apparently, no significant additional tax revenue has been collected so far. Going forward, taxation of GRIP-related payments may be facilitated through the introduction of the global effective minimum taxation regime. 

Given the selective, partial abolition of the tax for fiscal years prior to 1 January 2023, it seems at least debatable whether enforcement on related-party transactions for an arbitrary nine year-period between 2013 and 2022 is in line with German constitutional and EU law principles.

In practice, one of the most debated questions is determining a reliable and principled tax base for the purpose of applying the GRIP provisions. Thus far, the guidance provided by the German authorities with respect to the question has been limited. The current law defines (gross) revenues from the licensing or sale of GRIP as taxable income. In most cases, the revenue amount allocated to GRIP has, however, not been determined contractually. The tax authorities have decided to take a “top-down valuation approach” to assess the amount of GRIP-related income. Based on this approach, German income is estimated based on the ratio of gross royalty or capital gain revenues split by the ratio of turnover generated in Germany in relation to turnover generated in all territories covered by the IP agreement. To the extent the relevant transaction comprises a number of IP rights which are not necessarily all registered, this approach may not result in an appropriate amount allocated to GRIP and, correspondingly, an increased tax burden as characteristics of different industries and business models cannot properly be covered by this valuation approach. Due to the fact that the tax authorities refuse to accept alternative valuation approaches, for example common valuation approaches for the examination of transfer prices in Germany, it remains to be seen to what extent these cases will have to be litigated.

Next steps 

The draft bill has been submitted by the German Ministry of Finance for further coordination in the German government and could still be subject to change. A final cabinet decision was initially scheduled to be made by 24 August 2022 and has in the meantime been postponed to 14 September 2022. Following this, the draft bill will be sent to the Federal Parliament and Federal Council before enactment. We expect the legislative process to be completed by the end of the year.