December 02, 2020

German Tax Circular Has Wide-Ranging Implications for IP Transactions and M&A


On November 6, 2020, the German Ministry of Finance (BMF) issued a circular (the “Circular”) interpreting a long-ignored provision of German tax law confirming that German income tax applies to the licensing and transfer of intellectual property that is registered on a German register. The tax applies even where there is no German party or other German connection to the transaction and where the German-registered IP is just one component of a global transaction.

Because the Circular is an interpretation of existing law, it applies to future transactions as well as transactions that took place in prior open tax years, possibly as far back as 2013. Consequently, taxpayers should be taking an inventory of their prior transactions to determine where the tax may apply. Moreover, the impact of the Circular should also be addressed as part of tax due diligence in international M&A transactions.

Recognizing the far-reaching impact of the Circular, on November 20, 2020, the BMF proposed legislation that would significantly limit the impact of the law and bring the taxation of IP transactions more in line with international norms. The proposed legislation has not yet been introduced in the German Parliament and it is not clear whether the legislation will pass if it is introduced. Therefore, the Circular remains the current authoritative position on this issue. Accordingly, taxpayers should understand the potential application of the law to transactions involving intellectual property particularly given the many uncertainties in how the law applies.


For over 70 years, German tax law has contained a provision that imposes German income tax when there has been a license or sale of IP that is registered on a domestic IP register. In essence, the law creates taxable nexus in Germany by virtue of the domestic registration. However, enforcement is difficult where there is no German party to the transaction. Moreover, income tax treaties could potentially apply to mitigate or eliminate the tax. As a result, compliance with the law was negligible.

In recent months, however, taxpayers, their advisors and their external auditors began to focus on the potential application of the law to a wide variety of transactions with particular attention on potential criminal tax exposure for failure to comply. Because of the numerous uncertainties regarding the scope and application of the law, taxpayers have been taking different approaches with respect to compliance, and some have reached out to the German tax authorities for clarification.

The Circular

The Circular clarifies that the current law does in fact apply to transactions involving IP registered on a domestic register. Contrary to the position of various legal commentators, the Circular indicates that no additional nexus or contact with Germany is required for the tax to apply. As a result, the Circular makes clear that tax applies even where there is no German party to the transaction. (The impact of income tax treaties on the law is addressed later in this Legal Update.)

The Circular makes clear that in the case of a license agreement, the licensee is responsible for withholding and remittance of the tax. In the case of a sale or a perpetual license, the seller/perpetual licensor must file a return and pay the tax.

While the Circular confirms that this long ignored provision does in fact apply, numerous questions and uncertainties remain.

Scope of Covered IP

The law is directed at any rights registered on a national German register (“inländisches öffentliches Buch oder Register”). Accordingly, and by way of example, national trademarks and patents registered with the German Patent and Trademark Office (“Deutsches Patent- und Markenamt” or “DPMA”) are within the scope of the law.

The Circular states that patents registered on a domestic register on the basis of an application with the “European Patent and Trademark Office (“Europäische[s] Patent- und Markenamt”) pursuant to the European Patent Convention (EPC) would also be within the scope of the law. However, the EPC does not provide for such a thing as a “European Patent and Trademark Office” (emphasis added). The relevant body established under the EPC (which is an international treaty) is called the “European Patent Office” (EPO). The competent authority for European Union Trademarks is the European Union Intellectual Property Office (EUIPO) which has been established under European Union legal instruments. The competent authority for national German trademarks is the DPMA. While apparently misstating the name of the EPO, the Circular presumably tries to make the point that a German validation of an application filed pursuant to the EPC will be subject to the law, if and when such validation has been registered on the domestic patent register of the DPMA.

The Circular does not address other IP rights such as International Trademarks registered with the World Intellectual Property Organization and designating Germany as one of the covered territories.

Covered Transactions

The Circular notes that the law applies to both licenses and sales of covered IP. Again, because the law imputes German taxable nexus simply because the IP is registered on a national German register, the law can apply even where there is no German party to the transaction. For example, assume a global license of IP that has been registered in several countries around the world, including Germany. The licensee pays a royalty based on the licensee’s global sales. If a portion of those sales arose in Germany, German tax must be withheld by the licensee even if neither the licensee nor licensor are German residents or have a German permanent establishment.

Similarly, assume a global asset sale that includes IP that is registered in Germany. Some portion of the gain on the sale is taxable in Germany and the seller is required to file a tax return in Germany to report and pay over the tax.

Because the law applies simply by virtue of a German registration, there are many other scenarios that can trigger the tax including cost sharing agreements and IP restructuring to comply with BEPS. A capital contribution can also trigger the tax if German-registered IP is part of the assets being contributed for shares in the company. It is an open question whether a capital contribution where no shares are issued (for example, a contribution to additional paid-in capital) triggers the tax.

Allocating Value to the German IP

One of the biggest challenges with the application of the law is allocating value to the German-registered IP. In the global license example above, where the royalty is based on global sales, it may be argued that the portion associated with the German IP is based on the ratio of German sales to total sales. However, if the royalty is a fixed royalty or is based on some other factors not attributable to the German market, it would be increasingly challenging to determine the appropriate amount of withholding tax.

Similarly, as in the case of the global asset sale example above, some portion of the gain needs to be allocated to the German-registered IP. While purchase price allocations are used in asset sale transactions to allocate value to asset classes, rarely are they specific enough to determine the value attributable to a specific IP registration.

Legal vs. Economic Ownership

In many IP holding structures—and, in particular, cost sharing arrangements—one party holds the economic and beneficial ownership to certain geographic rights to the IP while another party holds the economic and beneficial ownership to other geographic rights as well as legal ownership of the IP around the world. It is not clear under which circumstances German tax filing and withholding requirements apply to a party holding only economic ownership.

Chain Royalties

A further question arises with respect to licenses and sub-licenses and at which level or levels withholding is required. For example, if a license including German-registered IP is licensed to a licensee that then sub-licenses the IP to a downstream licensee, the question arises as to which licensee is required to withhold. The Circular does not address this question. Under certain circumstances, German law provides that, if a downstream licensee has already withheld tax on the royalty, no further withholding on the upstream licenses should be required. On the other hand, withholding by an upstream licensee will not satisfy the withholding requirements for licensees further down the chain.

Application of Income Tax Treaties

The application of the law as interpreted by the Circular is extraterritorial. Tax is being imposed notwithstanding residency or a permanent establishment. Income tax treaties can limit the application of the German domestic law. For example, an income tax treaty may reduce or eliminate withholding tax on royalties. Similarly, an income tax treaty may require an actual permanent establishment in Germany before tax can be imposed on a sale of assets rather than taxable nexus being created simply by virtue of a German registration.

As regards German withholding tax, treaty protection does not automatically apply. Where a transaction has not yet occurred, it is possible to obtain advance treaty clearance to reduce or eliminate the tax. However, as noted above, the Circular does not include a grandfathering rule. In the absence of a withholding tax exemption certificate, where a treaty would apply to a prior transaction, the licensee is generally still required to withhold the tax and then the licensor may apply for a refund of the tax based on the application of the treaty. The tax refund procedure can be quite time-consuming, particularly where eligibility for treaty benefits is not entirely clear.


As noted above, the Circular makes clear that the law applies retroactively to all open tax years. Therefore, the law could generally apply as far back as 2013. Taxpayers should be taking an inventory of their prior transactions to determine where the tax may apply. The Circular provides that for tax years up through December 31, 2013, any withholding tax returns should be filed with the taxpayer’s regular competent tax office. For filings for years after December 31, 2013, the filing must be made with the Federal Central Tax Office.

When taxpayers became aware of the potential application of the law, some taxpayers simply filed holding statements with the local or federal tax office. These statements were designed to acknowledge the potential application of the tax to prior transactions and assert that the law did not apply, was unconstitutional, was extraterritorial or was otherwise unenforceable. The purpose of the statements was to mitigate penalty exposure and potential criminal prosecution. The Circular makes clear that the law does in fact apply and taxpayers taking this position must now reconsider their approach.

Impact on M&A Transactions

The retroactive nature of the tax has implications for international M&A tax due diligence. A purchaser acquiring shares of a non-German company owning or having obtained a license for German-registered IP should take the law and Circular into account as part of the purchaser’s tax due diligence and investigate how the target company has dealt with this issue.

Proposed Legislation

In an apparent about-face, on November 20, only two weeks after issuing the Circular, the BMF proposed legislation that would significantly reduce the application of the law. Under the proposed legislation, German tax on transactions involving German-registered IP would only apply if the IP is exploited in Germany through a German permanent establishment or facility of the licensee. Mere registration of the IP on a German register would no longer be sufficient nexus to trigger the tax.

If enacted, the law would retroactively apply to all open tax years. This is a surprising development considering the Ministry had only recently issued its Circular, on November 6, confirming the application of the tax. That said, the Ministry did not withdraw the Circular which remains the current authoritative position.

The proposed legislation was included along with other important changes to German anti-treaty shopping rules that Germany is required to enact to remain compliant with EU rules. As a result, it is possible that the legislation may progress quickly. However, the timetable is still open.

As noted, if enacted, Germany’s taxing right would be excluded retroactively. Accordingly, taxpayers who have already filed for prior years should take the necessary steps to keep open all relevant tax periods, for example, by filing an appeal with respect to the application of the tax.

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