Extraterritorial taxation of foreign taxpayers - light at the end of the tunnel?

For almost 100 years, German tax law included a regulation that states that non-residents are subject to limited German taxation on the renting out or sale of rights registered in a German book or register, without any further nexus of any of the parties involved being necessary. For almost 100 years as well, this rule was ignored by many. After the German Ministry of Finance (“MoF”) stirred-up the German tax world in November 2020 by stating that it considers the regulation to apply even when no further nexus with Germany exists, a recently proposed change in legislation may bring some light to the end of the tunnel.

Current legislation and Circular of the MoF

Under current law, foreign taxpayers could become subject to German tax (either directly or by means of withholding taxes) on the licensing/sale of rights that are registered in a German register without any other nexus existing. Even though most double tax treaties do not allocate a taxation right to Germany for these situations, taxpayers must go through several formal procedures like filing tax returns, determining license payments that are allocable to the rights registered in Germany, requesting withholding tax exemption certificates and substantiating that the German anti-abuse rules are not applicable. The MoF provided for some simplification procedures for situations in which a double tax treaty clearly prevented Germany from taxing the relevant payments. Nevertheless, the situation was a significant burden for all parties involved.

Initial Proposal for change of legislation (28th of July 2022)

On the 28th of July, the MoF issued its annual proposal for the changes in German tax law for the next year (the ”Initial Proposal”). This includes changes, partly even retroactively, to the extraterritorial. If the proposed amendments are taken over by Parliament and Federal Council and implemented into law as they are drafted in the Initial Proposal, this would bring significant relief. Basically, the proposed amendments can be summarized as follows:

• The licensing and sale of rights between non-related parties without further nexus would, for all payments made in the past and in the future, no longer be subject to German taxation;

• The licensing and sale of rights between related parties without further nexus would, for all payments made after 31 December 2022, no longer be subject to German taxation.

The proposed amendments would not influence

• The licensing and sale of rights between related parties without further nexus for all payments made in the past and until 31 December 2022;

• The taxation of rights as mentioned in Sec 21 para. 1 sentence 1 Income Tax Act, being rights in relation to real estate, rights that are registered in a shipping register and rights that must be registered in the land register;

• The taxation of the sale / licensing of rights to the extent the licensor / payment recipient is resident in a EU-black listed country (currently American-Samoa, Fiji, Guam, Palau, Panama, Samoa, Trinidad and Tobago, US Virgin Islands, Vanuatu);

• The taxation of the sale / licensing of rights to the extent licensor or licensee has a tax residency / PE / other type of business activity or nexus in Germany.

At this stage, the Initial Proposal is just a proposal and still needs to go through Parliament (Bundestag) and Federal Council (Bundesrat). However, it does seem like there is some light at the end of the tunnel!

Update with Draft Bill of 14 September 2022

On the 14th of September 2022, the German Federal Government issued the adapted version of the Initial Proposal (the “Draft Bill”). Where it concerns the changes proposed by the MoF on the 28th of July 2022 in relation to the extraterritorial taxation of rights registered in a German book or register without further nexus, the Draft Bill almost fully includes the proposed amendments mentioned above. The Draft Bill now also specifies that, for sales of rights between related parties, the existing legislation is cancelled for sales that take place after 31 December 2022.