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The tax-efficient repatriation of German-source profits is subject to recently introduced legislation further tightening the German anti-treaty shopping rules.
The German foreign-to-foreign intellectual property (IP) taxation continues to be a major issue. The German legislator has extended the procedural reliefs, but, despite the constitutional concerns, rather tightened reporting obligations for foreign-to-foreign IP licence and sales transactions regarding IP registered in Germany.
i Tax-efficient repatriation of German-source profits
When it comes to inbound tax planning (i.e., investments by a non-German investor into Germany), one of the major tax planning considerations is usually the tax-efficient repatriation of German-source earnings and profits. Often, such repatriation is structured through the disposal of shares in the German top holding company by the non-German investor, as such capital gains are tax exempt under either German domestic rules (and not even subject to the 5 per cent clawback taxation if the seller does not have a PE in Germany, as recently confirmed by the German Federal Fiscal Court) or an applicable double tax treaty. These capital gains are also not subject to withholding taxes (WHT) in Germany. In addition to the disposal of shares to a third person, this beneficial capital gains treatment can also be achieved by way of share buy-backs, which may often economically substitute a dividend distribution.
Dividend distributions are often not the preferred route for the repatriation of earnings and profits from German inbound investments as these distributions are generally subject to German WHT amounting to 25 per cent, plus solidarity surcharge of 5.5 per cent thereon (i.e., effectively 26.375 per cent). Under domestic provisions, WHT can be reduced to 15 per cent or lower or even to zero under an applicable double tax treaty or the EU Parent–Subsidiary Directive. To tackle abusive tax structuring based on these reductions of WHT (treaty or directive shopping), Section 50d, Paragraph 3 of the German Income Tax Act (GITA) provides for quite harsh anti-abuse and substance requirements. The recently amended provision excludes the reductions from WHT if, among other things, the ultimate parent would not qualify for the treaty or directive benefits and the interposed recipient of the dividend distribution either was not established for sound economic reasons or does not engage in general economic activities with sufficient substance (German substance requirements).
The European Court of Justice (ECJ) held in two decisions that the German substance requirements violate EU law. Both decisions concerned dividend recipients who were resident in an EU Member State and held a controlling stake. In April 2018, the Ministry of Finance (MoF) issued guidelines on the further application of the German substance requirements in light of the first decision of the ECJ (Deister/Juhler) and basically limited the application of the ruling. The guidelines are extensively criticised by commentators, who take the view that the German substance requirements in their current version should in general not be applicable to EU, EEA and third-country investors due to the violation of the freedom of establishment and free movement of capital. It has been emphasised that German tax courts must apply the jurisprudence of the ECJ and can also do so based on the acte clair doctrine in third-country cases. The German legislator was requested to create a permissible regulation.
With effect from 9 June 2021, the German legislator introduced a reform of the German WHT regime also containing a revision of the anti-treaty shopping rules. The new rules apply a two-step approach with a general presumption of treaty abuse under certain circumstances and the possibility of a rebuttal of the presumption by the taxpayer under specific conditions. This new regime results in a significant tightening of the anti-treaty shopping rules, consequently limits the circumstances in which non-resident companies may qualify for WHT relief and even applies in cases where a double tax treaty already includes a specific anti-abuse rule. In many cases in which full WHT relief was available before, relief will be denied under the new anti-treaty shopping rules. One should additionally take into account that further changes to Section 50d, Paragraph 3 GITA and the German WHT regime might be introduced following the EU’s ‘unshell proposal’. In particular, it remains to be seen whether the Member States will consider the substance requirements as set up by the unshell proposal to be missed in cases of intra-group outsourcing and how entities that, by the very nature of their business, require hardly any ‘substance’ would be treated under these new unshell rules.
In the context of a tax-efficient repatriation of German dividends, it should also be noted that the German Federal Fiscal Court held that dividends that are received through a German partnership (which can even be a low substance partnership with deemed trading activity) will be subject to tax assessment, which effectively means that WHTs are refundable at the level of the partnership assessment. This refund by assessment would not be subject to German substance requirements (even if they are still applicable). Although, obviously, this provides for tax planning opportunities, the structures should be carefully planned and monitored as the refund by assessment requires that the shares in the distributing corporation can be attributed to the partnership, which might be challenged in case of a low substance partnership.
ii German foreign-to-foreign IP taxation
In 2020, many foreign companies had to learn (sometimes the hard way) that they might have fallen within the scope of German non-resident taxation in respect of past IP licence or sale transactions, even if only non-German parties were involved. Although the MoF has provided for some relief in cases of licensors that are tax resident in a treaty-protected country, new legislation consolidates German tax claims on foreign-to-foreign IP transactions. Despite the constitutional concerns, the MoF issued circulars on 6 November 2020, 11 February 2021 and 14 July 2021, sustaining the view that these foreign-to-foreign IP transactions regarding IP registered in Germany are subject to German tax. The circulars of 11 February 2021 and 14 July 2021 (the Circulars) provide merely for some relief from overly burdensome tax reporting and payment obligations in cases of clearly treaty-protected cases. There is, however, no relief with regard to non-treaty-protected cases. The Circulars also do not in general distinguish between licence transactions with third parties and intra-group licence transactions (i.e., a preferential treatment is currently not foreseen).
According to the Circulars, for licence payments that have already been made to the licensor or that will accrue until 1 July 2022, the obligation for the licensee to withhold and pay tax and file a WHT return has been suspended, if and to the extent that the following requirements are fulfilled:
- the licensee is not tax resident in Germany;
- the licensor is tax resident in a treaty-protected country and is entitled to treaty benefits under the applicable double taxation treaty and the licence payment is also attributable to the licensor for tax purposes; and
- the licensor (or an authorised licensee) applies for an exemption certificate with the German Federal Tax Office by 30 June 2022, whereby the agreements (including sublicensing relationships) as well as translations of the relevant passages must also be disclosed.
The simplifications described above, however, do not apply if the licensor’s treaty entitlement cannot be confirmed or is doubtful. This applies, among other things, to hybrid or dual-resident companies or in other cases of conflicts of qualification. In such cases, the licensees are obligated to file quarterly WHT returns and make payments in non-treaty-protected cases.
The applicable procedure for licence payments that will accrue after 1 July 2022 is subject to the slightly amended and even stricter rules pursuant to the Deduction Tax Relief Modernisation Act. Pursuant to the new law, the German taxation of foreign-to-foreign IP transactions will continue. The new law even tightens the reporting obligations for foreign taxpayers in cases that, under treaty law, are exempt from German taxation. The German WHT payment obligations for IP transactions can be avoided only in treaty-protected cases by applying for an exemption certificate in advance. In addition, starting in 2022, licensees in treaty-protected cases will not be required to withhold WHT from royalty payments if the annual royalties do not exceed €5,000. Irrespective of any WHT payment obligation, the new provision, however, further states that licensees will still be required to file WHT returns. This will even apply to the exemption described above, albeit, according to special regulations, a ‘zero’ WHT return will be sufficient.
Furthermore, the seller of a foreign-to-foreign IP sales transaction is obligated to file a tax return if German-registered IP is involved. If the seller is tax resident in a treaty-protected country at the time of the sale and the applicable double tax treaty (at the time of the sale) assigns the right to tax capital gains resulting from the IP sales transaction to the country of residence, a zero tax return may be filed. Even if a treaty-protected seller does not have to provide further information on the determination of the tax base, it is required to disclose the IP sales transaction agreement (including sublicensing relationships) as well as translations of the relevant passages.
iii Corporate tax reform
On 25 June 2021, the German Parliament passed legislation to modernise corporate income taxation taking effect from fiscal years beginning on or after 1 January 2022. The core element is the introduction of a corporate income tax option, allowing partnerships and partnership companies to be taxed similar to a corporation. The main intention is to strengthen the international competitiveness of family businesses in the legal form of a limited liability partnership or general partnership. The application required for exercising the option must be submitted before the beginning of the fiscal year in which the partnership wishes to be treated as a corporation. Furthermore, the transition to corporate taxation is considered a change of legal form (which triggers certain lock-up and retention periods under the German
Reorganisation Tax Act).
In addition, the legislation includes various regulations to further globalise German reorganisation tax law provided that the contemplated reorganisation has the structural characteristics of a domestic reorganisation and that German taxation rights are not restricted or excluded.
iv Covid-19 tax relief and further plans of the new government
The new German government, the ‘traffic light coalition’, which has been in office since December 2021, plans to introduce further changes to corporate and income taxation. Primarily, certain covid-19 tax relief will be extended, especially the rules on loss carry-backs. Although the maximum amount of loss carry-backs for 2020 and 2021 was raised to €10 million in 2021 and a ‘provisional carry-back’ was introduced for 2021 with a cap at 30 per cent of the total amount of income, the new coalition has proposed to extend these rules to fiscal years 2022 and 2023. Furthermore, the corporate tax reform described above will be reviewed and transactions involving real estate tackled by further changes to the German RETT rules and extended documentation obligations.