Germany issues final guidance on classification of cross-border

2 November 2017
Global Tax Alert
Germany issues final
guidance on classification
of cross-border software
and database use
payments for withholding
tax purposes
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Executive summary
On 2 November 2017, the German Federal Ministry of Finance issued final
guidance addressing the question of whether a German (withholding) taxing
right exists on cross-border payments for software, cloud or database use
transactions. The final guidance contains 16 examples and covers situations
where a domestic (German) customer obtains the temporary use right for
software or database applications from a foreign vendor/licensor and uses this
right in its (domestic) business.
Under current German law, a cross-border “payment in consideration for the
temporary use of a right”/“payment for a transfer of know-how” should give
rise to withholding tax (WHT) in a business to business (B2B) situation. Business
to consumer (B2C) transactions should not give rise to WHT. German royalty
WHT amounts to 15% (plus solidarity levy of 5.5% thereon, i.e., effectively
15.825%), or 18.8% in a gross-up scenario.
Unchanged from draft guidance released in May 2017, the overriding principle
that determines whether a software/database transaction leads to a German
WHT obligation for the payer is that if the user is being granted rights to exploit
the software/database that go beyond those rights that are typically granted for
the intended use of the software/database, the transaction should be classified
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Global Tax Alert
as a licensing transaction and hence be subject to WHT. Such
additional rights can be copy, modification, distribution, or
publication rights.
If the nature of the software/database use agreement is
such that the functionality of the software/database and its
intended use in the business is the core of the transaction,
no WHT obligation should arise. In the latter case, no explicit
upfront clearance by the tax authorities shall be necessary in
order to allow the German customer to pay the consideration
to the nonresident without deducting WHT.
It needs to be noted that the guidance states explicitly that it
will only apply to the granting of rights to exploit or use software
and databases. It will not govern other digital transactions
(e.g., sale of image rights/pictures, online streaming, online
gaming or cross-border sale of online advertising space), so
uncertainty remains in these situations.
Detailed discussion
The guidance is a positive development as German
companies and foreign software, cloud, or database
vendors have been hoping for some time for a clarification
surrounding cross-border payments from Germany for the
use of software and databases.
The final guidance provides the following examples:
Example 1: German company receives the copy,
modification, distribution, and publication rights in an image
software from an information technology (IT) company in
Singapore and adapts the software to the German market
(i.e., translates it) and distributes it as part of a software
package. Payments to the Singapore IT company shall be
subject to WHT as the rights granted go beyond the mere
use of the software.
Example 2: Cross-border payment for the use of word
processing software with a right to create 5,000 copies to
be used by employees of the German customer: No WHT
obligation as no rights are granted beyond the intended use
and the copying right is limited to own business.
Example 3: German company purchases (ready to use)
software and adapts it to the specific needs of its business
making use of specific adaptation features already
embedded in the software by the developer for this purpose.
There is no WHT on payment because the rights granted
do not go beyond those needed for the intended use of
the software. Adaptation by the client to the needs of its
business constitutes intended use of the software.
Example 4: German IT-sourcing company purchases license
to use word processing software in the group to which
the sourcing company belongs (via sub-licenses): No WHT
obligation as no rights are granted beyond intended use and
the copying right is limited to own group.
Example 5: Foreign parent allows German subsidiary to
further develop, copy and distribute the parent’s software
products against royalty payments: WHT obligation as rights
are granted that go beyond those needed for the intended
use of the software.
Example 6: German subsidiary of foreign software developer
is a reseller of downloadable software and pays a royalty for
the right to distribute a defined number of software copies. A
predefined number of copies can be physical units (e.g., on a
DVD) or license keys which allow for a download of software.
No right to copy or modify the software is granted. There is
no WHT obligation as this is only a sales transaction. If the
German subsidiary however obtained a copyright, a WHT
obligation would arise.
Example 7: Foreign company provides “infrastructure as a
service” (IaaS)-offering through a German subsidiary, and
together with the right to use the IaaS, grants the German
subsidiary the right to use and modify (for customer use)
archiving software. This should be classified as a split
transaction; the IaaS-related payment would not be subject
to WHT (service, no grant of right), while the right to use and
modify the software should be subject to WHT as rights are
granted that go beyond those needed for the intended use of
the software.
Examples 8 and 11: Cloud-based “software as a service”
(SaaS)/”application service provision” (ASP) transactions
where software remains installed on the service provider’s
server, and beyond the use of software, additional services
are agreed (software maintenance and updates, data
storage, hotline service): No WHT as no rights are granted
beyond intended use.
Example 9: Same as Example 8, but now the foreign cloud
service company interposes a German ASP distributor who
contracts with German customers. Payments by the German
ASP distributor become subject to WHT as rights are granted
that go beyond those needed for the intended use of the
software (distribution rights).
Example 10: Foreign SaaS company distributes in
Germany through a subsidiary, which is being granted copy,
modification, distribution and publication rights to the
Global Tax Alert
software. Payments by the German SaaS distributor become
subject to WHT as rights are granted that go beyond those
needed for the intended use of the software (distribution rights).
•No further clearance from the tax authorities should
be required in order to pay out the remuneration to the
nonresident software provider without deduction of WHT.
Example 12: Payments for access to online scientific journal
(only reading and printing rights): No WHT obligation as no
rights are granted beyond the intended use.
Comprehensive rights are granted
Example 13: Foreign rating agency allows German bank
through end user license to use financial market data online
(access, reading, printing rights): No WHT obligation as no
rights are granted beyond the intended use.
Example 14: Facts as in Example 13, but now the German
bank also has the right to grant its customers access to
the database: WHT obligation as rights are granted that go
beyond those needed for the intended use of the database
(sub-licensing right).
Example 15: Facts as in Example 13, but now the bank
also has the right to grant its customers access to data
generated from the database (although not access to the
database itself). There is no WHT obligation as no rights are
granted beyond the intended use. The bank does not have
the right to publish or copy material parts or the whole of the
database content.
Example 16: A German university uses a database of US
provider. On its premises, the university is entitled to grant
free use of the database to employees and students and
grant third parties access to the database against a costbased, nominal consideration. There is no WHT obligation
because the university does not economically exploit the
rights granted because it offers database access for free or
only a nominal consideration.
Navigating practical difficulties
From a procedural perspective, it will be important to
distinguish between the following situations in the future:
Only right to intended use in the business is granted
•If the nature of the software/database use agreement is
such that the functionality of the software/database and its
intended use in the business is the core of the transaction,
the remuneration should not give rise to taxable German
source income (in absence of a German permanent
establishment or a dependent agent of the nonresident
software provider). Therefore, no WHT should be due under
domestic law.
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•If the user is being granted rights to exploit the software/
database that go beyond those rights that are typically
granted for the intended use of the software/database, the
transaction should be classified as a licensing transaction
and as German source income which is subject to WHT.
•Under German law, a customer cannot directly rely on the
existence of a tax treaty/directive that gives the exclusive
right to tax royalties to the country of the licensor’s
residency; the customer may only refrain from levying
withholding taxes (or withhold at a lower treaty/directive
rate) if a transaction has been cleared with the Federal
Tax Office (FTO) upfront and the vendor has presented
a valid WHT exemption certificate issued by the FTO
before payment is made. Otherwise the customer of the
nonresident vendor can be held secondarily liable for
withholding taxes if a tax auditor successfully argues that a
payment should give rise to WHT.
•Such WHT exemption certificates are specific to the contract
under which the remuneration is paid and to the counterparty to the contract. Essentially, this means that a WHT
exemption certificate has to be obtained for each contractual
relationship that triggers withholding tax. In situations where
a nonresident digital business has a large number of clients
in Germany, obtaining WHT exemption certificates can be
challenging from a purely practical perspective.
Implications
It is expected that the principles set out in the guidance
shall make the cross-border distribution of software to endusers in B2B transactions much easier. The guidance sets
forth clear – and relatively easy to follow – criteria when
WHT would need to be levied on cross-border payments.
It can therefore be expected that in B2B transactions,
German resident end-users will better understand when
not to withhold tax in situations corresponding to the
examples covered in the guidance so that no WHT exemption
certificate from the German tax authorities should be
needed in these cases.
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Global Tax Alert
Uncertainties may arise in the case of combined contracts.
According to the guidance, the full remuneration should be
subject to WHT where the granting of the comprehensive
rights is the prevailing element of the agreement and a split of
the remuneration is not possible. Based on the wording of the
guidance, this should always be the case where comprehensive
rights are granted to the customer and the software is adapted
or developed for the customer by the software provider. No
WHT has to be withheld where the rights granted account for
10% or less of the total remuneration.
In cases of doubt or disagreement between the software
provider and the customer on whether the principles of their
specific arrangement would be covered by the guidance or
whether a portion of the remuneration would trigger WHT, it
may still be possible to obtain a WHT exemption certificate to
reduce the uncertainty.
As noted above, the guidance will only apply to remuneration
for software and databases. Therefore, uncertainty remains
e.g., for the cross-border sale of image rights/pictures in B2B
transactions which customers may use for their business
(e.g., for display in brochures, on webpages or similar).
If, in these cases, WHT exemption certificates are not an
option – e.g., because of the number of German customers –
nonresident vendors should review whether they could take
other measures to address the uncertainty resulting from
the classification of payments received from their German
customers. In very exceptional cases, it may be possible to
discuss with the FTO the possibility of a blanket WHT exemption
certificate (typically any such agreement would require the
consent of the Federal Ministry of Finance). If this is not an
option, vendors may consider contractual agreements shifting
the financial risk to their customers to limit their own exposure
– or serving the German market through a German resident
distribution entity and thus avoiding the WHT obligation on
customer payments completely.
Moreover, the guidance does not address other forms of
digital transactions, e.g., sale of online advertising space,
content streaming or online gaming so uncertainties can be
expected to remain in these areas.
Nevertheless, the official guidance should be welcomed by
taxpayers as it addresses the technical uncertainties in a
pragmatic way. For the cases not covered by the guidance,
however, the existing procedural difficulties remain.
Elimination of these procedural difficulties is likely to require
a change in law to fundamentally improve this process and
make it easier to apply in cases where a nonresident has a
large number of customers in Germany.
For additional information with respect to this Alert, please contact the following:
Ernst & Young GmbH, München
• Christian Ehlermann
• Katja Nakhai
christian.ehlermann@de.ey.com
katja.nakhai@de.ey.com
Ernst & Young LLP, German Tax Desk, New York
•
•
•
•
•
•
Tobias Appl Thomas Eckhardt Markus Schweizer Nicolai Huschke Valeska Schierle
Ivo Schmohl tobias.appl2@ey.com
thomas.eckhardt@ey.com
markus.schweizer1@ey.com
nicolai.huschke1@ey.com
valeska.schierle1@ey.com
ivo.schmohl1@ey.com
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