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The German parliament has approved a bill that closes tax loopholes for royalty payments on patent licenses and forms part of Germany’s wider crackdown on harmful tax practices.
The bill, approved April 27 by the lower house of the German parliament, the Bundestag, shows that Germany is determined to go further than OECD guidelines in its implementation of Action 5 of the OECD’s project to combat base erosion and profiting shifting, said attorneys.
“Germany’s proposal here is stricter than what the OECD proposed,” Bodo Bender, a partner at White & Case in Frankfurt, told Bloomberg BNA in an April 26 telephone interview.
“This is now a unilateral approach by the German legislator that tries to limit royalty expenses if they are low-taxed in a foreign jurisdiction on the basis of a preferential tax regime.”
BEPS Action 5 holds that a country can only grant companies preferential tax treatment for license boxes if research and development activities and expenses were actually incurred there—the so-called Nexus Approach, wrote lawmakers in their justification for the bill.
But the bill would target companies that transfer patents to countries that fall outside the so-called Nexus approach with preferential tax regimes—defined as a country where royalties aren’t taxed or are taxed at less than 25 percent—by reducing tax deduction possibilities for companies’ license expenses in Germany, said lawmakers.
The Federal Cabinet, the executive arm of the German government, adopted the bill Jan. 25. It was drafted by the country’s Federal Finance Ministry (BMF) under Finance Minister Wolfgang Schaeuble.
The bill will now be submitted to the upper house of the German parliament, the Bundesrat, for approval. If passed and signed by the federal president into law, the bill would apply to royalty payments incurred after Dec. 31, 2017.
With the bill, lawmakers have struck a fair compromise between the interests of tax authorities in Germany—where patent boxes are nonexistent and opposition to their introduction stiff—and companies that legitimately use these devices for R&D purposes, attorneys said.
“I think it’s a fair approach, because many countries have opted to endorse research,” Oliver von Schweinitz, a partner at GGV in Frankfurt, told Bloomberg BNA in an April 24 telephone interview. “But Germany has been trying to reduce the impact of what we perceive as unfair tax competition by other countries—in particular places like Gibraltar—where nothing is going on.”
The BMF’s bill acknowledges this by introducing provisions permitting the use of patent boxes under certain conditions, said attorneys.
“To reach a compromise, [the BMF] agreed on something that would allow patent boxes in other countries as long as the research connected to the patent box was actually conducted in the place where earnings would accrue,” added von Schweinitz.
The bill isn’t likely to result in a huge increase in tax income, however, said attorneys.
Lawmakers estimate that these changes will lead to a total increase of 10 million euros in tax revenue in 2019, 50 million euros in 2020 and 40 million in 2021.
“It’s an increase between 30 and 50 million euros a year,” Bender said. “But on the other hand, this will also entail increased administration, and tax authorities will have to verify these IP structures, which can be quite complicated.”
As a result, it’s still unclear what the bill’s ultimate impact on tax revenues will be, he added.
And while the bill adequately balances the interests of parties involved, companies affected will likely find these changes burdensome, said attorneys.
“These rules are very complicated,” said von Schweinitz. “From a purely technical perspective, it will be difficult to compute profits, for example.”
Critics say the bill itself contains loopholes because it focuses solely on patent boxes that conflict with the guidelines of the OECD’s nexus approach.
“That already exempts all sorts of patent boxes which can be very easily manipulated and exploited and abused,” Markus Meinzer, a senior analyst with the U.K.-based Tax Justice Network, told Bloomberg BNA April 24.
“As long as the OECD ticks off the box, it can still result in a zero-percent taxation,” added Meinzer.
And others already caution that the bill may be found to conflict with EU law.
“Some authors have said this may not be in line with the German constitution or EU law since it clearly targets the taxation of IP holdings of non-residents and other jurisdictions,” Bender said. “But this is something that further procedures will clear up as they develop.”
But overall, the changes introduced by the bill should be welcomed, said attorneys.
“Germany doesn’t want Gibraltar—without any research occurring there—to further unfair competition vis-a-vis Germany and then make business more difficult here,” said von Schweinitz. “So I think it’s a fair rule.”
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