In a recently published decision, the tax court of Lower Saxony ruled on the German withholding tax on royalties and at the same time commented on the tax treatment of such royalties from an EC law perspective (case reference 6 K 511/06).
The case involved a Dutch entity that granted a German entity the right to set up vending machines in restaurants against a share in the sales of the machines. The Dutch entity had previously acquired this right and thus had royalty expenses of its own. Such payments are generally considered royalty payments for German tax purposes and are subject to withholding tax if paid to a nonresident taxpayer. The withholding tax may be reduced or eliminated under the applicable tax treaty or the interest and royalties directive, this requires, however that the taxpayer has obtained a withholding tax exemption certificate up front. The taxpayer raised several arguments against the withholding tax obligation, which ultimately were rejected by the court. Additionally, the taxpayer contended that the levying of withholding tax constituted an infringement of EC law, at least to the extent the taxpayer had incurred costs in relation to the royalty income earned.
The tax court of Lower Saxony rejected the taxpayer’s EC law arguments. Referring to the ECJ decision in the Scorpio case, the court stated that levying withholding tax on royalties paid to nonresident taxpayers was generally in line with the freedoms of the EC treaty (especially in the years before the directive on the mutual assistance in the collection of taxes was extended to cover income taxes, which was the case between 1995-1997, the years at issue).
The court also rejected the taxpayer’s claim that the royalties paid by the Dutch entity should be considered business expenses that are directly related to the royalty income earned in Germany and that would have to be taken into account in calculating the tax base for withholding tax under the principles of the Scorpio decision.
According to the tax court, the “direct connection” between the royalty income and the royalty expense was absent because the royalty expense was incurred in connection with obtaining the right rather than the actual activity of granting the right to the German entity in Germany. Although the court’s decision not to take into account any personnel and other overhead costs in the Netherlands for determining the withholding tax base in Germany based on previous ECJ jurisprudence, the exclusion of the royalty expense on the grounds that there was no direct connection appears at least doubtful. The case is pending before the BFH (case reference I R 32/10) and it is unclear whether the BFH will uphold this view.
EU/EEA resident taxpayers that have incurred a final withholding tax on royalties in Germany should consider filing protective claims if they incurred significant costs that can be regarded as having a “direct connection” to such royalties.
If you have any questions, please contact the authors of this article at gtln@deloitte.de or your regular Deloitte contact.
