Germany Moves to Close Tax Loopholes on Patents, Licenses

By Jabeen Bhatti

The German Cabinet has approved a bill to close tax loopholes for royalties on patent licenses, in another sign of Germany’s determination to crack down on sophisticated tax planning and harmful tax practices, attorneys say.

The bill, approved Jan. 25, aims to prevent multinationals from shifting profits via royalty payments in countries with preferential tax regimes—such as patent box or other intellectual property regimes—that don’t comply with the Organization for Economic Cooperation and Development’s regulations, said the BMF in a Jan. 25 statement on the bill.

The Federal Ministry of Finance’s (BMF) bill forms part of Germany’s implementation of Action Point 5 of the OECD’s base erosion and profit shifting project.

Taxes should be paid in the country where the “value-added activity” takes places, and not the country that offers the highest tax rebate, added the ministry.

“We will no longer tolerate that international companies shift their licensing revenues to low-tax jurisdictions without there being any research-related activities,” said Federal Finance Minister Wolfgang Schauble.

“We are curbing the transfer of profits via patent boxes for pure tax planning purposes. Countries that encourage such a transfer of products cannot expect that we will support these damaging practices,” the finance minister added.

The bill will now be submitted to both houses of the German parliament for debate and further approval. A date hasn’t been set for the bill to go to parliament, a BMF spokesperson said Jan. 25.

If passed by the parliament and signed by the federal president into law, the bill would apply to royalty payments incurred beginning Dec. 31, 2017.

Cracking Down on Preferential Treatment for R&D

Under BEPS Action 5, which addresses harmful tax practices, a country can only grant a company preferential tax treatment for license boxes if that company has carried out research and development activities and incurred expenses there—known as the Nexus approach, said the BMF in a Jan. 25 statement on the bill.

The bill would apply to companies transferring patents to recipient countries that do not meet these requirements by reducing tax deduction possibilities for companies’ license expenses in Germany if the royalties raised in recipient countries are not taxed or are taxed less than 25 percent, said the BMF.

“In a nutshell, Germany is basically disallowing royalty tax deductions here in Germany if the royalties are only subject to a preferential tax rate below 25 percent in the receiving country,” Thomas Busching, a tax partner at Squire Patton Boggs in Frankfurt, told Bloomberg BNA in a Jan. 25 telephone interview.

He added that German companies paying these royalties will suffer non-deductibility of a certain part of this royalty expense that they are paying to the receiving country. The intention is for companies to change their tax planning practices as a result, attorneys believe.

“Since this bill only applies to inter-company, or inter-group, payments, and the German subsidiary is not entitled to the full deduction of the royalty payments, the German subsidiary will use its influence within the group to change this tax planning scheme,” said Busching.

Bill Applies to Companies in Non-OECD Members

Attorneys said the bill is more evidence that Germany intends to go beyond the OECD’s requirements for targeting tax evasion as the bill also applies to all countries, including those with preferential tax regimes that aren’t member states of the OECD.

“This specific bill needs to be seen in the context of the OECD’s Action Plan,” Mathias Schonhaus, a tax attorney at Hogan Lovells in Dusseldorf, told Bloomberg BNA in a Jan. 25 interview.

“This is a broad law focusing on artificial structures and creating a world where taxes are paid where the substance is on the ground.”

The piece is yet another piece in Germany’s attempt to crack down on various forms of tax planning, said attorneys.

“Germany has always been a proponent of a strict approach toward tax evasion,” said Schonhaus. “Germany is really making an effort here to close all tax loopholes and ensure that the tax base remains in Germany.”

Schonhaus said tax authorities are assuming that 650 cases involving companies in non-OECD countries would be subject to this regulation.

“That’s quite a lot I think. The government expects this will bring in 100 million euros ($107 million) in tax revenue in its first three years,” he said.

But Busching told Bloomberg BNA that he doesn’t expect the bill will raise that much in revenues ultimately.

Still, even if the tax revenues raised by these measures are not that high, the government can point to it as evidence that it takes corporate tax evasion seriously, he added.

“The government can demonstrate to the public that they are not only looking hard at everyday Germans, but also at big corporations even if the revenue is not that much,” Busching said. “That’s where the biggest effect will be probably.”

Burden of Proof on Companies

Attorneys said the BMF shouldn’t find the bill difficult to implement.

“It’s fairly simple to understand and it was constructed with the OECD. And it only applies to German companies, so there is no discrimination involved,” said Busching.

But attorneys cautioned that the bill will likely create a lot of work for companies that still want to deduct these royalty payments going forward.

“If a company pays the license fee in another country to a related party and wants to deduct this from its tax burden in Germany, it would have to prove its counter-party is not benefiting from any preferential tax treatment without having sufficient substance justifying the preferential treatment,” said Schonhaus.

“That’s going to require companies to provide a lot of information to tax authorities,” he added.

Busching said the language contained in the current version of the bill could also create difficulties for companies looking to keep their royalties deductions.

“There are exemptions if the company has ‘substantial business activities’ in the recipient country,” said Busching. “Then the restrictions on tax deductibility would not apply. But there is no exact definition of what ‘substantial business activity’ means. Is it a spending amount or something like that? It’s not really clear how that will be applied.”

To contact the reporter on this story: Jabeen Bhatti in Berlin at correspondents@bna.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bna.com

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