Non-German resident companies might beneficially own and receive royalty payments for intellectual property (IP) exploited, used or merely registered in Germany. These entities might be liable for German withholding tax (“WHT”) on royalties paid in respect of the use of that IP in circumstances where the royalty payor is also a non-German resident company. The German Finance Ministry issued guidance in respect of this tax on 6 November 2020. Entities with this fact pattern should estimate their potential tax exposure in line with this guidance, which might result in the recognition of a tax liability.
What is the issue?
Under German tax law, non-German resident companies that beneficially own and receive royalty payments for intellectual property (IP) registered, exploited or used in Germany, may be liable for German withholding tax (“WHT”) on royalties paid in respect of the use of that IP in circumstances where the royalty payor is also a non-German resident company. Furthermore, a taxable transfer of such IP can give rise to German capital gains tax.
This law applies to certain types of arrangements relating to IP rights where those rights have been registered in a German register, whether or not they are exploited within Germany. The exposure relates to non-German resident taxpayers who should have submitted tax declarations or tax returns even where both payor and payee are resident outside Germany. In the absence of an applicable tax treaty, withholding taxes of 15.825% are due on income arising from the rights. If tax treaties exist between Germany and the relevant country where the non-German resident taxpayers are based, this could have the effect of reducing the effective tax rate to 0%. However, under existing German laws, taxpayers subject to such a treaty will be required to remit WHT and then file a claim for a refund in the absence of advance clearance from the German government.
A sale of IP registered in Germany can also give rise to capital gains tax under the same law.
The German Finance Ministry issued guidance in respect of this on 6 November 2020. On 20 November 2020, the German Finance ministry published a draft bill that reduces the scope of the tax provisions retroactively for all open cases such that a non-resident tax liability will only arise where the IP is exploited in Germany (rather than simply registered). However, the timetable for this draft law becoming substantively enacted is not yet clear.
The main impact of the existing legislation is in respect of structures where there is an IP holding company that is not resident in Germany but for which the IP has been registered in Germany. It appears that such structures are more common amongst US multinationals but there are other structures or jurisdictions that might be affected. For example, where a business model has been implemented creating royalty flows to an IP company or where there’s been a transfer of IP (following acquisition, internal restructuring or the like).
Assessing the exposure
- Capital gains tax
Any exposure will be based on an assessment of the specific facts and circumstances of the relevant structure, including whether there are German tax treaties with the relevant territory that provide relief.
The German statute of limitations is 7 years and hence it is unlikely that material exposures exist for transactions prior to that point.
In terms of quantifying the potential exposure, entities would need to estimate the size of the royalties paid since 2013 (7 years from 2020) and determine the appropriate amount to apportion to German nexus IP (using transfer pricing principles). This amount should have the 15.825% WHT rate applied to it. Entities should then determine if there is a double tax treaty that applies between the IP country (licensor jurisdiction) and Germany as to whether the WHT is recoverable. In respect of IAS 12, entities would apply a probable (more likely than not) threshold to recognise both liability and receivable. For under-reported tax, entities should assess penalties and interest based on current German regulations.
To the extent that there has been any transfer of IP since 2013 to which capital gains tax should have been applied, entities should analyse whether the transfer qualifies as a “sale” of IP (as under certain conditions specific transfer transactions as contributions/ dividends may not qualify as a “sale” of IP). They should determine the value of IP transferred since 2013 and any associated gain and determine the appropriate amount to apportion to the German IP (applying transfer pricing principles). Capital gains taxation of 15.825% would apply on applicable capital gain (based on fair market value less book value for German tax purposes). Finally, entities should determine if a double tax treaty applies between IP country (transferor jurisdiction) and Germany to ascertain whether the capital gain is tax exempt. For under-reported tax payable on capital gains, entities should also assess penalties and interest based on current German regulations.
Given this background, there are a number of relevant accounting questions in respect of the law as it stands:
1. Is the tax an income tax within the scope of IAS 12?
Yes. The guidance requires that judgement is applied to determine whether a withholding tax is an income tax. Many withholding taxes are paid in lieu of an income tax and are therefore accounted for as income taxes. In this case, the tax is being levied on the income from using the intellectual property in Germany. If the tax is not withheld, the holder of the IP is required to file a tax return in Germany and that return would include income and allocated expenses, which implies the notion of a net profit. The tax is charged at the corporate tax rate. Payment of the withholding tax would give rise to foreign tax credit that could be offset against income tax (which it is in the US) and the same might be true in other jurisdictions. These factors suggest that the tax is an income tax.
Any capital gains tax consequences of selling the intellectual property will also be in the scope of IAS 12.
Penalties and interest based on current German regulations are not in the scope of IAS 12.
2. What are the implications for accounting for periods before 2020 if the structure has been in place for many years?
The tax law and related structures existed at previous reporting dates. Paragraph 5 of IAS 8 states that a change in accounting estimate arises from new information and new developments. The same paragraph states that an error arises from a failure to use reliable information that was available or could reasonably have been expected to have been obtained and taken into account when the financial statements were approved. IFRIC 23 requires that the accounting for a tax uncertainty is revised only when circumstances change.
The entities that implemented these structures typically undertook appropriate due diligence, received professional advice before implementation and consulted tax, legal and other professional specialists. It appears that no-one was aware of the link between the legislation in question and the structures being implemented. There is no legal precedent and a great deal of complex analysis has been required to determine that in some cases there might be a material liability to be recognised. Unanswered questions remain. This suggests that management could not reasonably have been expected to take into account the potential requirement to pay withholding tax at reporting dates before 2020.
A change in estimate arises from new information and new developments or more experience. The detailed analysis completed by a wide range of deep technical experts has resulted in something that may be reasonably categorised as a new development that provides more information about the potential tax consequences of the affected tax structure. This results in a change in estimate with any charge arising in the current year rather than treating adjustments as the correction of a prior period error.
3. Can any amounts paid and amounts recoverable be shown net?
It appears that some territories have a tax treaty with Germany which means the rate applied to the transactions should have been nil. However, the entity that owns the IP should have filed a tax return in Germany and obtained a certificate before making royalty payments. In the absence of a law change, entities subject to a tax rate of nil will have to pay the tax at 15.825% and then subsequently claim a refund. The payment and receipt will not happen simultaneously, which creates a presentation question - there is a current tax payment and a current tax receivable that cannot be offset legally and will not be paid simultaneously. On this basis, amounts should be grossed up. In order to recognise an asset, IAS12 requires that recovery is probable and, given the complexity of the German tax law, the specific facts and circumstances that apply to the entity will need to be considered in arriving at this assessment.
4. How should any post year end change in German tax law be treated?
IAS 12 requires tax to be based on tax laws that are substantively enacted at the balance sheet date. Any change in substantively enacted laws post balance sheet is treated as a non-adjusting post balance sheet event. However, the impact of such non-adjusting events should be disclosed, if material.
As an expert in international taxation and cross-border transactions, I have a deep understanding of the complex issues surrounding withholding taxes, intellectual property (IP) taxation, and the associated regulations in Germany. My expertise is grounded in practical knowledge gained through extensive research, professional experience, and a proven track record in providing strategic advice to multinational corporations.
Now, let's delve into the concepts discussed in the article about non-German resident companies and their potential liability for German withholding tax on royalties related to intellectual property:
German Withholding Tax (WHT) on Royalties:
- Non-German resident companies receiving royalty payments for IP registered, exploited, or used in Germany may be subject to German WHT.
- The WHT applies even if both the royalty payer and payee are non-German resident companies.
- The German Finance Ministry issued guidance on this matter on 6 November 2020.
Scope of German Tax Law:
- German tax law applies to certain types of arrangements related to IP rights, especially when those rights are registered in a German register, regardless of their exploitation within Germany.
- Exposure exists for non-German resident taxpayers, requiring them to submit tax declarations or tax returns, and in the absence of a tax treaty, a 15.825% WHT is applicable.
Capital Gains Tax on IP Transfers:
- A taxable transfer of IP can trigger German capital gains tax.
- The draft bill published on 20 November 2020 aims to retroactively reduce the scope of tax provisions, focusing on non-resident tax liability only when the IP is exploited in Germany.
- Assessing exposure involves considering specific facts and circumstances, German tax treaties, and estimating royalties paid since 2013.
- For capital gains tax, entities must analyze IP transfers since 2013 and determine the applicable capital gain, considering transfer pricing principles.
Accounting Questions and Implications:
- The article raises accounting questions under IAS 12 regarding the nature of the tax as income tax, implications for periods before 2020, and whether amounts paid and recoverable can be shown net.
- It suggests that withholding tax is an income tax under IAS 12, and capital gains tax consequences fall within its scope.
Post Year-End Changes in German Tax Law:
- IAS 12 requires tax to be based on laws substantively enacted at the balance sheet date.
- Any post-year-end changes in German tax law are considered non-adjusting post-balance sheet events, and their impact should be disclosed if material.
In conclusion, the article emphasizes the importance of assessing potential tax exposure, understanding the implications of existing and draft legislation, and navigating the complex landscape of German taxation, particularly concerning intellectual property and withholding taxes.