On 20 December 2022, the German Annual Tax Act 2022 entered into force. An essential component of this new legislation is the partial abolition of the limited tax charge on income derived from German registered IP (GRIP). The key practical take-aways for businesses to be aware of following this change in law are summarised below.
By way of reminder, the previous position of the German tax authorities was that transactions between two non-German tax residents triggered a domestic German taxation right where GRIP is involved, for example, on the disposal of GRIP (e.g. due to a sale) or licensing or other forms of making the use of GRIP available (GRIP Transactions). This taxation right may be excluded or restricted under the provisions of an applicable double taxation treaty (DTT). Please refer to our previous blog post here for a detailed discussion on this issue.
The amended rules now:
- limit the German taxation right for GRIP Transactions between related parties to cases where the income recipient has no DTT protection; and
- generally exclude (including on a retroactive basis) taxation on GRIP Transactions between unrelated parties.
However, a German taxation right may nonetheless remain if the income recipient is resident in a “non-cooperative tax jurisdiction”, irrespective of whether this involves a related or third party transaction.
Restrictions regarding related party GRIP Transactions
Payments made for GRIP Transactions between related parties in the period up to 31 December 2022 remain subject to domestic German taxation (and therefore generally still need to be disclosed to the Federal Central Tax Office (FCTO) or in case of IP disposals to the Munich Tax Office).
Tax exemption requests under an applicable DTT can still be submitted to the FCTO under the so-called simplified procedure until 30 June 2023 (for payments made up until that date).
Following the changes to the legislation, payments made between related parties after 1 January 2023 are only taxable if the German taxation right is not precluded by a relevant applicable DTT. In the case of licensing income (as opposed to income from the disposal of IP), this will also require testing the (rather strict) German anti-treaty shopping rules in order to ensure a German withholding tax (WHT) obligation does not arise. Under these rules, DTT eligibility alone is not sufficient to preclude the German taxation right and exemption from German WHT obligations additionally requires one of the following conditions to be satisfied:
- the payment recipient is either (a) a listed company or (b) pursues business activities with appropriate (physical and personal) substance to which the source of income (i.e. the GRIP or a sublicensing right) has a relevant economic connection; or
- if the tests above are not satisfied, it can be demonstrated that the structure was not primarily established for tax reasons.
If the payment recipient itself does not fall into one of these categories, it may also be possible to assess its DTT eligibility based on the status of its shareholder(s).
In cases where no DTT applies, a 15.825% income tax and solidarity surcharge becomes payable (which, in case of license income, is WHT which needs to be withheld, paid and declared to the FCTO by the licensee).
Related parties are broadly assumed to exist where more than 25% ownership between or in two persons exists or where a significant influence on the business decisions can be exerted.
Based on the amended rules and the official reasons given by the German legislature for making these changes, the analysis whether GRIP related payments are subject to a German limited tax liability or not is primarily the responsibility of the taxpayer. On one hand, from a practical perspective, this is a helpful development as the alternative is (in licensing cases where WHT rules generally apply) the application of the FCTO’s review procedure for DTT cases which currently takes between 6 and 12 months even in less complex cases (for example, license payments by German resident licensees without WHT (outside of GRIP transactions) cannot be made unless a final DTT exemption certificate is issued). On the other hand, the assessment of the German taxation right makes it necessary to apply the complex German anti-treaty shopping rules which may create an additional risk of non-compliance other than in clear-cut cases and this may need to be discussed with the German tax authorities at a later stage. In cases of doubt, we recommend involving a local tax lawyer/advisor when completing this analysis. Where there are remaining doubts regarding the DTT eligibility of a payment recipient, it may be worth considering restructuring the arrangements which, depending on the particular circumstances could, for example, include transferring the GRIP to a transferee that is clearly eligible under the relevant DTT.
General abolishment of GRIP taxation for third party transactions
With the enactment of the German Annual Tax Act 2022, the register nexus-based GRIP taxation has been abolished for payments between unrelated third parties for the past and for the future provided that the payment recipient is not resident in a non-cooperative tax jurisdiction (discussed below). In these cases, no German tax obligation exists e.g. to withhold taxes or to make any filings or disclosures. Tax exemption requests already submitted to the FCTO (e.g. under the simplified procedure) have therefore become irrelevant.
Remaining GRIP taxation if recipient is resident in a non-cooperative tax jurisdiction
Payments made to residents of non-cooperative tax jurisdictions remain generally subject to German limited tax liability retroactively as of 1 January 2022 under a new provision included in the so-called Tax Haven Defence Act. In these cases, a 15.825% German tax charge remains (which in the case of licensing income is payable as WHT) on income derived from GRIP. Currently, American Samoa, Anguilla, Bahamas, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, Turks and Caicos Islands, US Virgin Islands and Vanuatu are regarded as non-cooperative tax jurisdictions.
Key take-aways on the taxation of GRIP following enactment of the German Annual Tax Act 2022 are summarised below:
- Related party transactions: GRIP-related payments made before 1 January 2023 remain subject to German tax obligations and tax exemption requests can be submitted to the FCTO until 30 June 2023. Related-party payments made from 1 January 2023 onwards are only taxable if the German taxation right is not precluded by an applicable DTT (which for licensing income includes application of the German anti-treaty shopping rules). The analysis of whether a German tax liability exists is now primarily self-assessed by taxpayers, meaning there is generally no filing obligation if the availability of DTT protection is clear. Where the DTT eligibility is not clear, it may be advisable to make changes to the licensing structure going forward. To the extent a German taxation right still exists notwithstanding the changes to the rules, the allocation of (parts of) the license fee to GRIP may become subject to continued debate with the German tax authorities.
- Third-party transactions: GRIP taxation has generally been abolished retroactively provided that the income recipient is not resident in one of the (currently) 12 non-cooperative tax jurisdictions (in that case, GRIP taxation remains applicable for payments from 1 January 2022 onwards).
- Remaining GRIP taxation rights: In the (limited) cases where German taxation rights remain in place and the recipient is a body corporate, the German tax charge on the relevant GRIP income is 15.825%. For licensing income, the (procedurally stricter) WHT rules remain applicable.
For further discussion or assistance on this topic, please contact our German tax team or your usual Freshfields contact.