In 2020, many foreign companies were taken by surprise when they learnt that they might have fallen within the scope of German non-resident taxation with respect to past IP licence or sale transactions, even where only non-German parties were involved in such transactions. Due to the uncertainty regarding the tax treatment of German registered IP, many companies – after intensive internal tax investigations of the past seven years or more – filed notifications with the German tax authorities to inform them about their licensing and sales transactions with regard to IP registered in Germany.

The hope that the German legislator would retroactively abolish its alleged taxation right with respect to all licensing and sales transactions involving German registered patents and trademarks proved to be short-lived. Instead the German Federal Ministry of Finance has issued a circular that provides for merely some relief from overly burdensome tax reporting and payment obligations in case of clearly treaty protected cases. In more detail:

Foreign-to-foreign licensing transactions with regard to IP registered in Germany

For license payments that have already been made to the licensor or will accrue until September 30th, 2021, the obligation for the licensee to withhold and pay taxes and file a withholding tax return has been suspended, if and to the extent the following requirements are fulfilled:

• the licensee is not tax-resident in Germany;
• the licensor is tax-resident in a treaty protected country, entitled to treaty benefits under the applicable double taxation treaty and the license payment is also attributable to the licensor for tax purposes;
• the licensor (or an authorized licensee) applies for an exemption certificate with the German Federal Tax Office by 31 December 2021, whereby the agreements (including sublicensing relationships) as well as translations of the relevant passages must also be disclosed.

The simplifications described above do not, however, apply if the licensor`s treaty entitlement is doubtful. This applies, among other things, to hybrid or dual-resident companies or in other cases of conflicts of qualification, i.e., the licensees are obligated to file quarterly withholding tax returns and make such tax payments in non-treaty-protected cases. The circular does not, however, contain an explicit statement with regard to the deadline for such filing requirements with regard to old cases.

If the application for an exemption certificate is rejected by the German Federal Tax Office, the licensee will also be obligated to file quarterly withholding tax returns and make such tax payments within one month after the rejection.

With regard to the determination of the tax base in licensing transactions containing a bundle of German and non-German registered IP the circular indicates how to calculate the amount attributable to German registered IP. According to the German tax authorities, the total license payments shall be apportioned by a top-down approach considering the principles of causation, i.e., a revenue based approach shall apply.

The applicable procedure for license payments that will accrue after 30 September 2021 depends on the status of the draft law which we reported about in our tax blog in January 2021. The view taken in the circular on the determination of the tax base determination is not limited to cases until 30 September 2021 and will therefore most likely also apply to cases after September 2021. In all likelihood, however, it will come down to the fact that if you have an exemption certificate with effect from this date at the latest, at best no tax will have to be withheld at all.

The circular does not in general distinguish between license transactions with third parties and intra-group license transactions. Even though there are considerable arguments speaking in favor of a different treatment of third party license transaction, a preferential treatment is currently not foreseen. The licensee is in certain cases - even without being authorized by the licensor - entitled to file an application for the exemption certificate. This signals that the German tax authorities are aware at least of certain of the practical problems which licensees especially will be facing in case of an inclusion of third party license transactions. However, the circular does not deal with further issues connected to such third party licenses, such as the fact that in many third party transactions it is practically impossible for licensees to identify the existence of any German registered IP and the amount of the royalties allocable to such IP.

Foreign-to-foreign IP sales transactions with regard to IP registered in Germany

According to the circular, the seller of a foreign-to-foreign IP sales transaction is obligated to file a tax return if German registered IP is involved.

In case the seller is tax-resident in a treaty-protected country at the time of the sale and the applicable 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 also disclose the IP sales transaction agreement (including sublicensing relationships) as well as translations of the relevant passages.

In case the seller is not tax-resident in a treaty-protected country at the time of the sale, further information on the determination of the tax base (based on the top-down approach as described above) needs to be disclosed.

Implication for practice

On the one hand, the new circular brings more clarity to the process. It is particularly helpful that a procedural simplification is in general foreseen for the settlement of treaty protected cases (even though a lot of partly burdensome documentation will still be required to document such treaty protection). On the other hand, there are still some uncertainties remaining especially with regard to deadlines for filing requirements with regard to (withholding) tax returns for non-treaty protected cases as well as the practical handling of third party licenses. And, in the end, it seems as if the tax courts will have to ultimately decide if the mere German registration provides a sufficient nexus in order to validly establish a German taxation with respect to purely foreign-to-foreign transactions.

As it seems that the German taxation regulations with regard to foreign-to-foreign licensing or IP sales transactions involving German registered IP will remain unchanged, it is recommended to carefully review and process old cases and in addition, take precautions for future cases. Such precautionary measures should in particular consist of the preparation of application for exemption certificates. It furthermore can be helpful to thoroughly review the relevant agreements and, if necessary, adjust them with proper tax clauses with regard to the withholding obligation of the licensee and document the calculation of the tax base with regard to German registered IP. In this context, it might also be helpful to discuss with IP lawyers whether the registration of IP in Germany can be dispensed with in favour of registration only in the EU.