German draft law for modernization of withholding taxes relief and new anti-abuse measures

On 20 November 2020, the Federal Ministry of Finance issued the draft for a law on the modernization of the relief from withholding taxes (“Abzugsteuerentlastungsmodernisierungsgesetz – AbzStEntModG”).

Changes have been proposed for the following tax rules in particular:

• procedure to obtain relief from German withholding taxes (“WHT”) on the basis of income tax treaties or EU tax provisions;
• specific anti-abuse rule against treaty shopping;
• limitation of German limited (non-resident) taxation of income from IP being (merely) registered in a domestic register.

In terms of tax policy, multinational enterprises need to know about the following:

Procedure to obtain relief from German withholding taxes

Under the draft law, the provisions regarding the tax withholding relief procedure would be transferred from Sec. 50d of the German Income Tax Act (hereinafter “GITA”) to a new Sec. 50c GITA. Nevertheless, the currently applicable relief procedure would be generally maintained. In principle, for dividends and royalties taxes would still have to be withheld even if they may not be taxed pursuant to an income tax treaty (i.e. pay first, obtain refund later).

As an alternative to this general rule, an exemption from the payment of the withholding taxes exist if an exemption certificate has been issued. Upon request, the Federal Tax Office (“BZSt”) will issue such a certificate if the legal requirements therefore are met. Moreover, exemption certificates for royalties shall be issued even if it is unclear whether a limited (nonresident) income tax liability exists. This would result in more legal certainty for foreign taxpayers.

However, unlike under the currently applicable procedure, exemption certificates would only be issued with prospective effect for a maximum term of 3 years. This would mean an end of the current practice with an earlier effect. Furthermore, the creditor would still have to report “zero” withholding taxes even if no tax must be remitted.

In practice more important is the fully digitized withholding tax relief procedure from 2024. In future, the requests for withholding tax refund/exemption and certificates of foreign tax residency must be transmitted electronically via the electronic interface of the Federal Central Tax Office. The issued exemption certificates and refund notices will also be made available electronically.

Our comments: The digitalization of the withholding tax relief procedure is very welcome, as it is expected to simplify and speed up such procedure in practice.

Specific anti-abuse rule against treaty shopping

Dividends, royalties and interest paid by a German company to a foreign payee are initially subject to German withholding tax of up to 15%/25% plus solidarity surcharge. However, the foreign payee can be entitled to withholding tax benefits on the basis of EU law and/or an income tax treaty. Nevertheless, a foreign company may not be entitled to any relief from German withholding tax under the anti-treaty shopping rule, which is designed to prevent abusive relief from withholding taxes. This currently applicable rule is highly controversial, and the European Court of Justice has found that it conflicts with European law.

Against this background, the Federal Ministry of Finance has proposed that a foreign dividend-/royalties-/interest-receiving company may not be entitled to any relief from German withholding tax, unless

• it has shareholders who would also be entitled to the same treaty relief if they directly received the tax-inducing payment, or
• the source of income has no significant connection with a genuine economic activity of the foreign company, or
• the foreign company provides proof that there are no main purposes for the interposition of the foreign payee to obtain a tax advantage, or
• the main class of shares in the foreign company is traded substantially and regularly on a recognized stock exchange.

The generation of income and its further payment to other persons is deemed to be no genuine economic activity. The same applies if a business activity is carried out without an adequately equipped business premises.

Our comments: Our view on the proposed amendment is mixed. The intended design of the anti-treaty shopping rule in line with EU law is welcomed.

At the same time, however, the new anti-treaty shopping rule should result in a tightening of the anti-treaty shopping rule. For instance, the shareholder(s) of the foreign company should no longer be (hypothetically) entitled to the same treaty relief if they were entitled to treaty relief under a different legal provision (e.g. under another income tax treaty). This shall be given regardless whether both legal provisions stipulate the same amount of treaty relief. Nevertheless, such situation should ease the provision of proof that there are no main purposes for the foreign payee to be involved.

Moreover, according to the legislative explanation the proposed rule shall also apply if the relevant income tax treaty already contains an anti-treaty shopping rule, such as the LOB test as stipulated in Art. 28 of the income tax treaty between Germany and the U.S.

Limitation of German limited (non-resident) Taxation of income from IP

The German tax authorities have taken the view that the foreign licensing or sale of a patent or trademark (merely) registered in a domestic register without any domestic exploitation shall trigger a limited (nonresident) income tax liability for the foreign licensor/seller in Germany. Their – contested – argument is the wording of the law which is almost 100 years old.

Since patents and trademarks are oftentimes registered by multinationals in many countries including Germany to ensure maximum legal protection, this is a very relevant issue in practice. But only in recent months, this issue has been disputed controversially.

Now, just two weeks after the Federal Ministry of Finance issued a circular by which it has stated its view on the currently applicable tax law for the first time, the draft law proposes an amendment of the respective German domestic tax rules. Accordingly, a limited (nonresident) income taxation on the income from the licensing/sale of patents and trademarks can only be triggered, if such IP has been exploited in a German business. Put into other words, the mere registration of patents/trademarks at the German Patent and Trademark Office cannot result in a German tax nexus. Technically, the draft law proposes to eliminate the wording “or registered in a domestic public book or register”, in both Sec. 49(1) no. 2(f) and Sec. 49(1) no. 6 GITA.

The draft proposes that this amendment to be effective for all open, meaning that the changes would have a retroactive effect.

Our comments: The proposed limitation of German non-resident is surprising, but welcomed since Germany often has no right to tax such IP income at all under its income tax treaties with so many other countries. However, obtaining such treaty benefit causes an inappropriate administrative burden for both taxpayers and the tax authorities. Therefore, the proposed limitation would result in a significant administrative relief, and should mitigate the risk of any “retaliatory measures” of foreign countries.

Further proposed changes

Furthermore, the draft law proposes changes for the following tax rules in particular:

• obtaining of withholding tax relief in case of a foreign hybrid entity as the payee e.g. of dividends shall be tightened according to the explanatory note of the draft law;
• usage of tax losses in case of legal reorganizations shall be (further) tightened;
• German debtor of e.g. cross-border royalties shall be still obliged to file a withholding tax return, even if an exemption certificate with full withholding tax relief has been obtained;
• provisions concerning tax certificates in case of withholding taxes on capital income and the exchange of information on tax arrangements using the capital markets.

Our comments: In particular the explanatory note on the proposed changes of withholding tax relief in case of a foreign hybrid entity could have unjustified consequences, for instance in case of a dividend-receiving U.S. LLC whose membership rights are owned by U.S. corporations.

Legislative procedure

The tax policy measures of the Federal Ministry of Finance are still to be approved by the German Parliament. However, it is still open whether the legislative procedure will be swift for all proposed changes. Businesses are therefore advised to carefully keep an eye on the resulting developments.