On 25 January 2017, the German government passed the "Act against harmful tax practices in connection with the transfer of rights". This is intended to prevent multinational companies from shifting profits through licence payments to countries with so-called licence, patent or IP boxes that do not meet the requirements of the OECD and G20 BEPS project.
In 2015, the OECD agreed on a so-called nexus approach in the final report on BEPS action point 5 as part of a "more effective fight against harmful tax practices, taking into account transparency and substance". However, the German tax authorities assume that some countries will continue to use regulations that do not comply with the nexus approach. A large number of German double taxation agreements provide for a zero tax rate on royalty payments. These also include agreements with non-OECD countries that are not bound by the nexus approach. The German tax authorities are now concerned that multinational companies will continue to shift profits through licence payments to countries that do not have a licence box regulation in line with the nexus approach. According to the BEPS requirement, royalty box regulations classified as harmful must be abolished or adapted to the nexus approach by 30 June 2021 at the latest. In addition, the OECD final report stipulates that since 30 June 2016, no new additions to existing preferential regimes that are not in line with the nexus approach are permitted.
With the "Act against Harmful Tax Practices in Connection with the Transfer of Rights", the German legislator is now restricting the tax deductibility of licence payments and other expenses for the transfer of rights to related parties in a new Section 4j of the German Income Tax Act (EStG) if these are not taxed or only taxed at a low rate (i.e. below 25 percent) by the recipient due to a preferential regime that is to be classified as harmful. The law is based on this aforementioned "nexus approach". The requirement of a close relationship within the meaning of Section 1 (2) of the Foreign Tax Act between the debtor and creditor of the payment is intended to ensure that the regulation only covers situations between related parties. In order to prevent avoidance arrangements, the regulation is also applicable to intermediate cases. If the conditions of the regulation are met, the amount of the prohibition on the deduction of business expenses is based on the income tax burden on the creditor of the payment. The higher the tax burden for the creditor, the higher the deductible portion for the debtor. The German legislator is thus pursuing the goal of ensuring an appropriate tax effect for licence expenses at what it considers to be an appropriate rate of 25%.
In order to give companies sufficient time to analyse their business models, the regulation will be applied for the first time to corresponding expenses incurred after 31 December 2017.
We recommend that companies review their existing IP and licence structures promptly for the applicability of this new regulation and, if necessary, realign them in the course of 2017.
Guest article by Carsten Schmid, Transfer Pricing & Friends GmbH, Stuttgart. Further information is available at www.tpa-global.com.
