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German Ministry of Finance issues first draft of Annual Tax Act 2022 including provisions regarding extraterritorial taxation of IP — Orbitax Tax News & Alerts

  • The Act proposes to eliminate the nonresident taxation of certain royalty income and capital gains relating to rights solely because these rights are registered in a public German book or register. This is a key development in the debated issue of German extraterritorial taxation of IP.

  • The proposal would abolish extraterritorial taxation of IP to the largest extent as of 2023 and retroactively for transactions between unrelated parties.

  • It is currently unclear whether and when the draft will become actual law, but this proposal should be considered by taxpayers dealing with the issue and assessing next steps.

Executive summary

On 28 July 2022, the German Ministry of Finance (MoF) published the first draft of the Annual Tax Act 2022, proposing several changes concerning different areas of taxation. Among others, the draft proposes changes to the valuation rules for the German real estate, increased amortization rates for residential buildings and several other changes for the benefit of individuals (e.g., increased deductibility for pension contributions and increased lump-sum deduction for capital gains).

Importantly, the MoF proposes to eliminate the nonresident taxation of royalty income and capital gains relating to rights solely because these rights are registered in a public German book or register:

  • Retroactively for transactions between third parties

  • In almost all other cases, as of 1 January 2023. However, the rule shall be maintained for taxpayers (licensors or sellers of German-nexus intellectual property (IP)) resident in a jurisdiction listed on the European Union (EU) List of non-cooperative tax jurisdictions

Detailed discussion

Extraterritorial taxation of IP

The draft proposes to modify Sec. 49 (1) No. 2 f and No. 6 of the Income Tax Act (ITA) to address the so-called “extraterritorial” taxation of IP rights transactions. “Extraterritorial” IP transactions include the licensing or sale of IP rights between, or in the case of a sale by, non-German parties:

  • Based on the wording of the German statute provisions, where a non-German resident person licenses or sells IP that is registered in a German public register (German-nexus IP), Germany can claim a taxing right under domestic law.

  • Under the plain language of the statute, a German taxation right may cover German-nexus IP right licensing or sale transactions which take place solely between, or in the case of a sale by, German nonresident parties. The statute also does not differ between transactions which occur between related and unrelated parties.

For transactions between unrelated parties (generally, a 25% or more shareholding creates related party-status), the current draft proposes to abolish the rule in all open cases, i.e., retroactively. For intercompany transactions, the proposal generally provides that the rule is to be abolished as of 1 January 2023.

As the only exception to this, the draft proposes additional changes to the Act to Combat Tax Avoidance and Unfair Tax Competition to effectively maintain the rule for taxpayers resident in a jurisdiction listed on the EU List of non-cooperative tax jurisdictions (for details regarding this act, see EY Global Tax Alert, German Ministry of Finance publishes working draft of Act to Combat Tax Avoidance and Unfair Tax Competition, dated 17 February 2021).

In the explanatory notes to the proposal, the MoF makes reference to the recently published report on the evaluation of nonresident taxation of royalty income and capital gains relating to rights which are registered in a public German book or registry to the Finance Committee of the German Parliament (for details regarding this act, see EY Global Tax Alert, German Ministry of Finance issues report on extraterritorial taxation of intellectual property to German Parliament, dated 17 June 2022) and reiterates that the main reasons for the proposed changes are that the tax revenues expected to be generated by the rule in the past should generally not carry on in future and that such cases are associated with an immense administrative burden.

It is currently unclear whether and when the draft will become actual law and to what extent further changes will be made within the legislative process. However, the procedure is expected to progress as usual in the case of annual tax acts, meaning discussion within the Government and legislative bodies as well as finalization and enactment should occur within the second half of 2022.

In summary, the proposal concerning extraterritorial taxation of IP is a positive development. However, given that the proposal would abolish the rule only as of 2023 for intercompany cases, filing applications for exemption within the “simplified procedure” in treaty cases (for background, see latest EY Global Tax Alert, German Ministry of Finance extends deadline for applications for retroactive exemption in “clear” treaty cases to 30 June 2023, dated 29 June 2022) would still be required for the past and the period up to the end of the year 2022.

Further proposed changes

The draft law provides for several beneficial changes for individuals and contains rules to increase the exchange of information, and the digitalization of the taxation process in Germany.

Moreover, the draft law provides for a revised valuation of real property to align the current applicable law with the newly issued real estate valuation regulation. These revised rules may also have an effect within the German Real Estate Transfer Tax assessment process.

Further, the draft law provides for certain clarifications to the Tax Haven Defense Act and, e.g., explicitly excludes certain bonds from the withholding tax in accordance with this law in case they are publicly traded.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young GmbH

  • Christian Ehlermann, Munich | christian.ehlermann@de.ey.com
  • Daniel Kaeshammer, Freiburg | daniel.kaeshammer@de.ey.com
  • Stefan Koehler, Frankfurt | stefan.koehler@de.ey.com
  • Michael Schaden, Stuttgart | michael.schaden@de.ey.com
  • Oliver Wehnert, Düsseldorf | oliver.wehnert@de.ey.com

Ernst & Young LLP (United States), German Tax Desk, New York

  • Tobias Appl | tobias.appl2@ey.com
  • Thomas Schmitz | thomas.schmitz@ey.com
  • Jasan Bsharat | jasan.bsharat1@ey.com
  • Matthias Ritter | matthias.ritter1@ey.com
  • Alexander Schega | alexander.schega1@ey.com
  • Janina Kolb | janina.kolb1@ey.com