The tax-efficient repatriation of German-source profits is subject to recently introduced legislation further tightening the German anti-treaty shopping rules.
The German foreign-to-foreign intellectual property (IP) taxation continues to be an issue as regards IP transactions prior to and including 2022. Going forward, the German legislator has, however, reacted to the persistent criticism so that foreign-to-foreign IP licence and sales transactions regarding IP registered in Germany will, in the future, only be subject to tax to a very limited extent.i Tax-efficient repatriation of German-source profits
When it comes to inbound tax planning (i.e., investments by a non-German investor into Germany), one of the major tax planning considerations is usually the tax-efficient repatriation of German-source earnings and profits. Often, such repatriation is structured through the disposal of shares in the German top holding company by the non-German investor, as such capital gains are tax exempt under either German domestic rules (and not even subject to the 5 per cent clawback taxation if the seller does not have a PE in Germany, as recently confirmed by the German Federal Fiscal Court) or an applicable double tax treaty. These capital gains are also not subject to WHT in Germany. In addition to the disposal of shares to a third person, this beneficial capital gains treatment can also be achieved by way of share buy-backs, which may often economically substitute a dividend distribution.
Dividend distributions are often not the preferred route for the repatriation of earnings and profits from German inbound investments as these distributions are generally subject to German WHT amounting to 25 per cent, plus solidarity surcharge of 5.5 per cent thereon (i.e., effectively 26.375 per cent). Under domestic provisions, WHT can be reduced to 15 per cent or lower or even to zero under an applicable double tax treaty or the EU Parent–Subsidiary Directive. To tackle abusive tax structuring based on these reductions of WHT (treaty or directive shopping), Section 50d, Paragraph 3 of the German Income Tax Act (GITA) provides for quite harsh anti-abuse and substance requirements. The recently amended provision applies a two-step approach with a general presumption of treaty abuse under certain circumstances and the possibility of a rebuttal of the presumption by the taxpayer under specific conditions. This new regime results in a significant tightening of the anti-treaty shopping rules, consequently limits the circumstances in which non-resident companies may qualify for WHT relief and even applies in cases where a double tax treaty already includes a specific anti-abuse rule. In many cases in which full WHT relief was available before, relief will be denied under the new anti-treaty shopping rules. One should additionally take into account that further changes to Section 50d, Paragraph 3 GITA and the German WHT regime might be introduced following the EU's 'unshell proposal'. In particular, it remains to be seen whether the Member States will consider the substance requirements as set up by the unshell proposal to be missed in cases of intra-group outsourcing and how entities that, by the very nature of their business, require hardly any 'substance' would be treated under these new unshell rules. The EU Member States shall apply the new unshell rules starting from 1 January 2024.
In the context of a tax-efficient repatriation of German dividends, it should also be noted that the German Federal Fiscal Court held that dividends that are received through a German partnership (which can even be a low substance partnership with deemed trading activity) will be subject to tax assessment, which effectively means that WHTs are refundable at the level of the partnership assessment. This refund by assessment would not be subject to German substance requirements (even if they are still applicable). Although, obviously, this provides for tax planning opportunities, the structures should be carefully planned and monitored as the refund by assessment requires that the shares in the distributing corporation can be attributed to the partnership, which might be challenged in case of a low substance partnership.ii German foreign-to-foreign IP taxation
In 2020, many foreign companies had to learn (sometimes the hard way) that they might have fallen within the scope of German non-resident taxation in respect of past IP licence or sale transactions, even if only non-German parties were involved.
As far as foreign-to-foreign intra-group transactions involving IP registered in Germany are concerned, the German Ministry of Finance (MoF) has issued several circulars, sustaining the view that these are subject to German tax and only providing some relief from overly burdensome tax reporting and payment obligations in clearly treaty-protected cases, most recently by circular of 29 June 2022.
According to these circulars, for licence payments that have already been made to the licensor or that will accrue until 1 July 2023, the obligation for the licensee to withhold and pay tax and file a WHT 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 and is entitled to treaty benefits under the applicable double tax treaty and the licence payment is also attributable to the licensor for tax purposes; and
- the licensor (or an authorised licensee) applies for an exemption certificate with the German Federal Tax Office by 30 June 2023, whereby the agreements (including sublicensing relationships) as well as translations of the relevant passages must also be disclosed.
The simplifications described above, however, do not apply if the licensor's treaty entitlement cannot be confirmed or is doubtful. This applies, among other things, to hybrid or dual-resident companies or in other cases of conflicts of qualification. In such cases, the licensees are obligated to file quarterly WHT returns and make payments in non-treaty-protected cases. Even for treaty-protected parties, a 'zero' WHT return may be required.
Regarding foreign-to-foreign third party transactions involving IP registered in Germany, the German legislator has passed changes that retroactively carve out the majority of such transactions from German taxation. The new rules take effect for past and future tax years. However, the German taxation right is upheld for transactions from 1 January 2022 onwards involving counterparties that are tax resident in a jurisdiction deemed as a non-cooperative jurisdiction (NCJ) for the purposes of the German Tax Haven Defense Act. NCJs are based on a blacklist of non-cooperative jurisdictions published by the EU and as updated from time to time,2 and implementations of this blacklist by the German legislator as amended from time to time.3 This requires a careful monitoring of all third party licensing transactions made since 1 January 2022.iii Corporate tax reform
From fiscal years beginning on or after 1 January 2022, partnerships and partnership companies may apply to be taxed similar to a corporation (corporate income tax option). The main intention is to strengthen the international competitiveness of family businesses in the legal form of a limited liability partnership or general partnership. The application required for exercising the option must be submitted before the beginning of the fiscal year in which the partnership wishes to be treated as a corporation. Furthermore, the transition to corporate taxation is considered a change of legal form (which triggers certain lock-up and retention periods under the German Reorganisation Tax Act).
In addition, the German legislator has introduced various regulations to further globalise German reorganisation tax law provided that the contemplated reorganisation has the structural characteristics of a domestic reorganisation and that German taxation rights are not restricted or excluded.iv Return of capital contributions by third country corporations
With effect from 1 January 2023, new rules will apply to returns of capital contributions by corporations that are tax-resident outside the EU. According to German CIT provisions, returns of capital contributions are generally not subject to German income taxation, provided, however, that the contributions (and returns) have been separately assessed following strict procedural rules. In the past, this exemption was only applicable to German and EU entities. For a non-German/non-EU entity, it was quite difficult to meet the procedural requirements. The German legislator has now extended the exemption to third country corporations and provides for a certain procedural simplification.v Covid-19 tax relief and further plans of the new government
The German 'traffic light coalition', which has been in office since December 2021, has introduced further changes to corporate and income taxation. Primarily, certain covid-19 tax reliefs have been extended, especially the rules on loss carry-backs. Although the maximum amount of loss carry-backs for 2020 and 2021 was raised to €10 million in 2021 and a 'provisional carry-back' was introduced valid for 2020 and 2021 with a cap at 30 per cent of the total amount of income. The coalition has extended the rules regarding loss carry-backs to fiscal years 2022 and 2023. Furthermore, the corporate tax reform described above will be reviewed, and transactions involving real estate may be tackled by further changes to the German RETT rules and extended documentation obligations.