Germany on its way to an anti-patent-box provision
By Bernhard Schwechel, FACT GmbH
In January 2017, the German Cabinet proposed a new draft bill against harmful practices in connection with transfers of rights and licensing of intellectual property rights (so called licence barrier). It will have a material impact on the tax deductibility of royalties and licence fees owed to related persons.
If the German Parliament passes the bill, it will mean that – in principle – tax relief will be restricted for royalties for the use of IP paid to intra-group entities if the royalties are submitted to "preferential taxation" in the jurisdiction of the licensor. With this restriction, Germany is implementing BEPS Action Point 5 (Countering harmful tax practices more effectively, taking into account transparency and substance) in its tax law.
BEPS Action Point 5 sets out the substantive requirements that so-called patent boxes must fulfil to be granted preferential tax treatment (preferential tax regimes). This means that a state may only grant preferential tax treatment if the intellectual property from which the royalties arise has been created in the applicable state itself (the “nexus approach”). Countries will require a minimum substance level with regard to preferential tax regimes applicable to income generated from IP.
The draft law in Germany stipulates that licence fees or royalty payments made by German taxpayers to related parties are not or are only partially taxdeductible if the payments at the level of the recipient are subject to low taxation (i.e. < 25%) and if the low taxation is based upon a preferential tax regime in the country of the creditor. Substance in the meaning of the nexus approach is the ability to demonstrate that the licensor has created its own R&D expenses during the development of the licensed IP.
As a consequence, only BEPS-conformant patent boxes should generally not be subject to the consequences of the draft law.
This excludes the deductibility of payments to patent boxes that have substantial activity. Substantial activity does not include instances where rights have not been developed by creditors. If the right has been acquired or has been developed by a related party, it would be deemed that there is not sufficient activity.
Obviously Germany is concerned that, despite the OECD measures, other countries will continue to maintain or even recognise tax benefits for income caused from IP. As one example, these fears might be driven by the expected tax policy of the UK due to the Brexit decision. The UK announced that it planned to attract investors by implementing an advantageous tax system, which includes low tax rates as well as special tax schemes such as the Patent Box. Still, before the Brexit vote, the UK agreed on a limitation of its patent box regime that favoured a concessionary tax on incomes created from intellectual property. The UK’s tax regime for intellectual property rights was only 10%, lower than in other EU countries.
Other EU member states supported Germany in opposing this advantageous tax regime. According to them, a UK patent box regime would encourage companies to register their patents in the UK due to its 10% tax rate applied on IP. Germany and other EU member states agreed to the UK patent regime under the condition that it would be limited to certain activities. Therefore, the countries agreed on the favourable tax to be applied to patents in the research and development (R&D) industry that would be carried out in the UK. The agreement states that the patent income will only be subject to a lower tax rate until June 2021.
The agreement is designed to reach a common point of view between OECD and G20 states on the application of the modified nexus approach. Bilateral discussions have been carried out in order to agree on countries’ rights to use favourable tax regimes without abusing them. The agreement aims to implement the modified nexus approach in R&D departments.
Nevertheless, Germany obviously will not (only) rely on mutual agreements with single countries or international organisations, rather it will introduce its own law to reduce the “base erosion and profit-shifting” by using aggressive structures. In the understanding of German tax law makers, this should be sufficient motivation to fight against the ability of multinational companies to shift profits from Germany to tax jurisdictions which have lower tax rates.
It should be noted that the new law includes a so-called “treaty override” provision. This effectively overrides any provision in an applicable double-taxation treaty that is more favourable to the taxpayer. But due to a decision of the Federal Constitutional Court (Bundesverfassungsgericht), treaty override is in accordance with the German constitution. After being passed by the German Parliament, the new law would be scheduled to come into force from 1 January 2018.
As a consequence of this development, it is strongly recommended that multinational companies that make applicable licence payments with German entities or permanent establishments consider the new provisions and decide whether to take action.
Bernhard SchwechelFACT GmbH - Steuerberatungsgesellschaft, Wirtschaftsprüfungsgesellschaft, Kassel, Germany
T: +49 561 316 686 0
FACT GmbH is a tax consultancy, public auditing company and law firm located in Kassel, known as the heart of Germany. FACT provides German and international accountancy and tax services to companies and individuals. The experienced team works on cross-border issues for German clients as well as for foreign clients. FACT works closely with its clients and responds rapidly to their needs.
Bernhard Schwechel is a Managing Partner of FACT. He is experienced in the field of International Taxation. His areas of expertise include Tax and Business Advice for large multinational corporations and mid-sized companies, as well as for internationally-oriented individual clients. He supports his clients in inbound and outbound M&A projects.
Published: March 2017 l Photo: Benjamin ['O°] Zweig - Fotolia.com