Both houses of the German parliament have recently passed a bill limiting the tax effects of royalty and licence fees paid to patent boxes. The essence of the new rule is that royalties will not be tax deductible for German businesses if the effective tax rate of such royalties in the hands of the recipient falls below 25%. The lower the tax rate, the higher the non-deductible percentage will be on a sliding scale: 0% rate − royalties completely non-deductible; 5% rate − 80% non-deductible; 10% rate − 60% non-deductible; 15% rate − 40% non-deductible; and so on. Further conditions include the following:
- Royalties include all fees paid for the use of a wide range of intellectual property
- Only intra-group royalties are affected, whereby, branches are deemed to be intra-group
- Intra-group back-to-back or flow-through arrangements are also captured
- Effective date will be January 1, 2018
In line with the “nexus approach” of the OECD’s BEPS Report, however, relief from the limitation will be granted if the IP was predominantly self-developed by the recipient of the royalties. Consequently, acquired IP or IP substantially developed by another group company will not qualify for relief. In addition, licences for the use of trademarks or trade names do not qualify for relief − whether or not developed by the recipient.
It follows that royalty payments to countries that also grant preferential tax rates for acquired – and not only for self-developed – IP will be scrutinized the most. These countries include Hungary, Luxembourg, Malta, Cyprus, Liechtenstein and the Swiss Canton of Nidwalden. Other affected countries may be those that grant tax benefits for IP improvements, partial development, active management or coordination such as Belgium, the Netherlands or the UK.
According to Germany’s own accounts, the additional tax revenue from the bill will total a meager €100 million for the three years 2019 to 2021. To put that into perspective, Germany’s excise tax on sparkling wine rakes in four times as much in one year.
Despite the fact that OECD members and the G20 − which includes Germany − have agreed to grandfather and to abolish non-compliant IP boxes by June 30, 2021, Germany seems to be wary that not all will follow through. Germany has consequently decided to act unilaterally with this bill instead of putting its trust in the member countries’ adherence to international agreements. While this wariness may be understandable under current circumstances, Germany may need to face undesired repercussions for such premature actions. As Germany walks away from its initial undertaking to grandfather existing patent box regimes until 2021 within the BEPS framework, it may lose its authority to claim more important adherence to the BEPS agreements from other member countries – in order to gain a fraction of the revenue generated by a negligible tax as demonstrated above. In other words, in our view, there may well be more lost than gained by premature and unilateral actions such as this bill.