Register cases: Tax regulation with international controversy

In today's dynamic and interconnected global economy, multinational companies are faced with the challenge of finding their way through a complex web of tax regulations. One particularly relevant regulation concerns the so-called "register cases" in Germany. This concerns the limited tax liability for income from the transfer of rights entered in a domestic register in accordance with Section 49 (1) no. 2 letter f of the German Income Tax Act (EStG).

This provision was originally introduced in 1925 to ensure that Germany received an appropriate share of the income from rights registered in Germany. Until 2020, however, in practice only royalty payments and capital gains from domestic licensees or sellers were actually recognised for tax purposes, while transactions between foreign parties were disregarded. This practice was also not criticised by the German tax authorities, and legal disputes mainly concerned payments made by residents.

In 2020, the German tax authorities took a stand for the first time in a letter from the Federal Ministry of Finance (BMF) and made it clear that royalty payments and capital gains from beneficiaries resident abroad are also subject to limited tax liability and that foreign licensees are obliged to pay withholding tax. This change to the previous practice led to considerable protest from the companies concerned as well as a lack of understanding on the part of foreign governments and tax authorities. Taxation solely on the basis of a domestic register entry was considered excessive and possibly contrary to international law.

This regulation has developed into a complex issue for companies, with both legal and economic implications for companies operating internationally. In a globalised economy in which intellectual property is often used and licensed across borders, the question arises as to what extent Germany may tax licensing and sales transactions whose only connection to Germany is the registration of the right. Many cases are currently being discussed with the tax authorities, the main issue being the determination of the tax base (see below). The question of the extent to which the new interpretation of Section 49 para. 1 no. 2 letter f EStG by the German tax authorities is lawful will very likely be the subject of future case law.

In a letter dated 11 February 2021, the Federal Ministry of Finance (BMF) specified the "top-down approach" for determining the appropriate remuneration within the meaning of Section 49 para. 1 no. 2 letter f EStG. This approach is based on the total gross remuneration and requires an appropriate apportionment, particularly if contracts cover several rights or the rights are registered in different countries. The allocation is made in proportion to the turnover generated in the territories concerned. A valuation approach based on registration costs or a "bottom-up" approach is not considered appropriate as it does not take sufficient account of economic reality.

Important aspects of the assessment basis:

1. Share of licence fees for trademarks and patents registered in Germany: licences are often paid for comprehensive packages of intellectual property. A detailed assessment of individual IP components is difficult, so determining the share for "naked" trade marks, for example, is controversial. Companies must carefully examine how they determine the licence fees for certain shares of intangible assets in order to minimise tax risks.
2. Territoriality principle: The territoriality principle states that the protection of intellectual property is only enforceable in the country in which it was registered. Intellectual property registered in Germany is only relevant if it is used on German territory. If there is limited use, for example because no production takes place in Germany, the German share of the licence payments relevant for withholding tax purposes should reflect this limited use.
3. EU trademarks and publicly recognised trademarks: Income from the licensing or sale of rights that are entered in a German register is subject to limited tax liability in Germany in accordance with Section 49 (1) no. 2 letter f EStG. Trade marks that are registered both with the German Patent and Trade Mark Office and as an EU trade mark often have no additional protective effect and should be taken into account as a reduction when determining the proportion of licence payments attributable to Germany.

Determining the tax base for licence payments and disposals in an international context is complex, particularly in the case of trademarks and patents registered in Germany. It is important to consider these aspects carefully in order to minimise tax risks.

Your direct contact at KPMG AG Wirtschaftsprüfungsgesellschaft will be happy to answer any questions you may have.