Draft aims to clarify an area of uncertainty
On May 17, 2017, Germany’s Ministry of Finance (MoF) issued the first draft of long-awaited guidance regarding the German withholding tax (WHT) treatment of payments made to nonresidents under software, cloud and/or database licensing arrangements. The draft, which is now open for comment until June 23, 2017, provides useful guidance and numerous relevant examples.
German domestic tax law generally imposes WHT at the rate of 15.825% (which includes the solidarity surcharge) on royalty payments made to nonresidents, unless a reduced rate or an exemption applies under a tax treaty or relief from withholding tax is granted under the EU interest and royalties directive. Payments made to nonresidents that are properly classified as payments for services or for sales proceeds, on the other hand, generally are not subject to WHT in Germany.
For treaty or EU directive-protected payments, the recipient is required to obtain a royalty WHT exemption certificate from the German federal tax authorities before the payment is made to be able to benefit from a reduced WHT rate/exemption under a treaty or the directive. The process required to obtain the exemption certificate can be protracted and burdensome. The uncertainty and lack of guidance in this area has led to situations where German customers/recipients of software-based services have asked for royalty WHT exemption certificates even in situations where no WHT should be due, in order to mitigate their risk of bearing a secondary liability for the WHT.
The draft decree, which is divided into two parts – one part on software and the other on databases – aims to provide more clarity and certainty to taxpayers.
The draft decree provides that outbound payments for the use of software are royalties subject to German WHT only in cases where the user obtains a comprehensive right to economically exploit the software under the arrangement. Under the draft guidance, this comprehensive right would include the right to reproduce, modify, distribute or publish the software. The draft clarifies that the simple right to use a software program, without the right to further exploit or commercialize the software, would not be considered a royalty (and, therefore, should not create a WHT obligation in Germany); it is irrelevant for these purposes whether the software is provided via a physical data storage device or electronically by download or via a third-party server.
It also clarifies that German WHT should not be triggered if the arrangement for which the payment is made focuses only on the designated or intended use of the software (i.e. the installation of the software, the download of the software into the user memory, the application of the software and, if applicable, duplication activities that are required to run the software).
The draft decree states that German WHT should not arise if only the result produced from using a software program is commercially exploited by the user. To illustrate this point, the draft decree includes examples of (i) the use of slides that were created by a presentation software program during a commercial presentation; and (ii) the sale of calendars that were created by means of an image processing software, neither of which generally would trigger a German WHT obligation.
The draft decree then provides nine examples that describe circumstances where payments for the use of software would and would not be subject to German WHT:
The second part of the draft decree looks at the tax treatment of licenses to use databases. Similar to payments for the use of software, German WHT would apply to payments made to nonresidents for the use of databases and database content only in cases where, as part of the arrangement, the user receives a comprehensive right to economically exploit the database, regardless of whether the right applies with respect to the entire database or is limited to specific content. German WHT would not apply where the rights of the payer are limited to typical rights of a database user, e.g. access, reading and printing rights.
The draft guidance provides four more examples that illustrate the government’s view of the tax treatment of payments for the use of databases:
The draft guidance is a welcome clarification regarding the WHT treatment of outbound payments for the use of software and databases, and should help to provide for more certainty in this area. If approved, the guidance hopefully will allow taxpayers to avoid the lengthy and burdensome process that is required to obtain a WHT exemption certificate where it is unnecessary, by making clear in which situations German WHT will apply to software and database usage payments. It currently is unclear when the draft decree will be finalized.
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