Germany: Guidance on royalty deduction limitation rule; application to FDII

German Federal Ministry of Finance issued guidance on the application of the German royalty deduction limitation rule

Application to FDII

The German Federal Ministry of Finance (BMF) in January 2022 issued guidance on the application of the German royalty deduction limitation rule (Lizenzschranke) (Section 4j of the German income tax law (EStG)).

Under the rules of German royalty deduction limitation (Section 4j EStG), expenses for granting of rights on the payor side are not deductible or are only partially deductible if the corresponding income for the foreign recipient is subject to lower taxation deviating from standard taxation (preferential tax regime) and the recipient is a related party of the payor. The deduction limit does not apply if the preferential tax regime applied to the relevant income at the recipient complies with the OECD's nexus approach (i.e., linked to the substantial activity of the taxpayer).

General application issues (BMF circular dated 5 January 2022)

OECD member states undertook to end or amend the rules to comply with the nexus approach by 30 June 2021 at the latest. According to the BMF circular dated 5 January 2022, however, some countries have grandfather rules whereby non-nexus-compliant preferential regimes may (on application) continue to be applied in the transitional phase until 30 June 2021. In these cases, the BMF considers it necessary to check whether the expenses claimed for deduction by the recipient already fell under a nexus-compliant preferential regime or still fell under a preferential regime classified as harmful.

According to the BMF circular, proof that a royalty payment to a foreign recipient is subject to standard taxation and not to harmful preferential tax treatment can generally only be provided through submission of documents from the accounting records of the recipient of royalty expenses and from the foreign tax assessment notice issued for the tax assessment period together with the basis for calculation. Any taxpayer wishing to prove that the income in question fell under a nexus-compliant preferential tax regime must provide proof by submitting a confirmation from the foreign tax authority.

Non-nexus-compliant preferential tax regimes (BMF circular dated 6 January 2022)

The BMF circular dated 6 January 2022 includes guidance in the form of a table with a non-exhaustive list of preferential tax regimes classified as non-nexus-compliant for the assessment periods 2018 to 2020. Any current transitional provisions are also shown in the “period of application” (Anwendungszeitraum) column of the table.

The two recipient countries—Switzerland and the United States—are highly relevant in term of practical application.

  • In respect of Switzerland, there is now clarity that the Swiss holding company privilege in place up to and including the assessment period 2019 is non-nexus-compliant according to the BMF, and the subsequent arrangement (harmonised patent box) applicable for the assessment period from 2020 is a nexus-compliant preferential tax regime.
  • By contrast, there is still no final clarification of whether the existing foreign-derived intangible income (FDII) regime in the United States is harmful or not. In these cases, the BMF circular says that a business expense deduction can initially be claimed.

The relevant tax assessment notices will be kept open in accordance with procedural law.

Read a March 2022 report [PDF 344 KB] prepared by the KPMG member firm in Germany


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