Wednesday, 8 February 2017

Germany: Deductibility of royalty payments proposed to be restricted

Germany’s Ministry of Finance (MOF) published a first draft of a law on 19 December 2016 that would limit the deductibility of certain related party royalty payments. Specifically, the draft law would apply to royalty payments that
result in the “low taxation” of the royalty income at the level of the recipient due to the application of an intellectual property (IP) regime (IP box, patent box, license box, etc.), in situations where the IP regime is not based on the “nexus approach” described in action 5 of the OECD’s BEPS project. If approved, the proposed rule would apply to royalty payments that become due after 31 December 2017.
The draft law targets beneficial “non-nexus”-based IP regimes – low taxation (or nontaxation) of royalty income based on the general taxation of the recipient would not be within the scope of the proposed rules. The restriction on
deductibility would apply only to royalty payments between related parties; payments made to unrelated parties would not be affected.
The draft law also targets payments to indirect recipients that benefit from a non-nexus-based IP regime resulting in low taxation. This measure would disallow deductions in back-to-back royalty structures where only an indirect recipient benefits from such a regime.
“Low taxation” for purposes of the draft law generally would mean an effective tax rate of less than 25%. However, low taxation would not automatically result in a full disallowance of the deduction for the royalty payment. The percentage of the disallowed royalty payment would be calculated based on the applicable tax benefit at the level of the recipient (i.e. the difference between the applicable tax rate and a 25% tax rate).
“Nexus-based” preferential tax regimes that would fall outside the scope of the proposed rule include those regimes whose benefits depend on a substantial economic activity. The draft law provides that a substantial economic activity
would not exist where the recipient of the royalty payment did not fully or predominantly develop the underlying IP in its own business operations (e.g. if the IP was developed by related parties or acquired).
The draft law provides an exception from the restrictions for payments regarding trademark rights.
The government is expected to decide whether to move forward with this initiative on 25 January 2017.
Source: Deloitte