Year of introduction | States | Favourability of acquired IP?

1973 (discontinued 2010) | Ireland | –

2000 | France | Yes

2003 | Hungary | Yes

2007 | Belgium, Netherlands | No

2008 | Luxembourg,

Spain | Yes (with additional requirements), No

2010 | Malta | Yes

2011 | Lichtenstein, Canton of Nidwalden (Switzerland) | Yes

2012 | Cyprus | Yes

2013 | UK | Yes (with additional requirements)

2014 | Portugal | –

2015 | Italy | –

Useful

· New

· Not obvious according to current knowledge

1st category | 2nd category | 3rd category

patents in the broader sense e.g.

Utility models, intellectual property of plants and genetic material, identification as medicinal products, patent extensions | Copyrighted software | Other intellectual property

+

Other requirements such as:

SEGMENT021 – Reporting obligation

– Sales Limits

Tax burden (g. share) = | 433.333,33 € | x | 5% | = | 21.667 €

Tax burden (not share) = | 566.666,67 € | x | 25% | = | 141.667 €

163.333 €

Surplus licensee = | 1,000,000 €

Surplus license debtor = | 2.000.000 €

Total net profit (Group) = | 3,000,000 €

Tax burden (g. share) = | 1,000,000 € | x | 5% | = | 50,000 €

Tax burden (not part) = | 0.00 € | x | 25% | = | 0 €

Determination of the income of the licence debtor

Current income | 3,000,000 €

– Deductible expenses | – 800,000 €

= Income (licence debtor) | = 2.200.000 €

Surplus licensee = | 1,000,000 €

Surplus license debtor = | 2.000.000 €

Total net profit (Group) = | 3,000,000 €

Current income | 3,000,000 €

– Deductible expenses | – €200,000

= Income (License Debtor) | = 2,800,000 €

Surplus licensee = | 1,000,000,00 €

Surplus license debtor = | 2.000.000,00 €

Total net profit (Group) = | 3.000.000,00 €

Variant | Tax burden Licence debtors in %

License Barrier with Withholding Tax Consideration | 33%

License Barrier Excluding Withholding Tax | 42 %

The license cabinet according to § 4j EStG prevents that license fees abroad can be deducted as operating expenses. Only under certain conditions can you still be deducted as operating expenses. The reason for this is that international corporations use low tax rates abroad to set up patent and license companies there. The companies transfer their intangible assets such as trademarks, patents and copyright to these foreign subsidiaries. Subsequently, the foreign license company leases these rights back to the German operating company. In return, the German company pays license fees abroad, which are only very low or partly not taxed there. This tax model is also favoured by European states, in that the Netherlands and Great Britain, for example, provide 80% of the income from the granting of licences free of tax.

In the video we explain to you how corporations move their profits to low-tax countries by issuing licenses and thereby save considerable taxes.

1st introduction

1.1.

“Only two things in the world are certain: death and the tax”. This famous quote by Benjamin Franklin was certainly still true in his time. However, the fact that this wisdom has lost truth is proven by the current news. In April 2016 it was the Panama Papers, in November 2017 the Paradise Papers. [1] Tax saving models of multinational corporations are always in the focus of publications and above all in criticism. Although these companies generate high added value and high economic profits in many countries, they pay little to no taxes. One of the most prominent cases, Starbucks, reached the zero tax rate by shifting profits to low-tax countries[2]. Control loopholes are exploited in a targeted manner. Particularly popular for shifting profits are expenses paid for the use of intangible assets, e.g. licenses. Companies took advantage of the fact that such intangible assets can be moved relatively easily across borders to countries with a favourable tax rate. From there, rights of use can be granted against payment (license fees). The corporations thus reduce their tax result in countries with a high tax rate and increase their tax result in countries with a low tax rate. They take advantage of the tax gap between states to tax their profits as little as possible[3]. Here, society and the media often appeal to the conscience of companies (management boards)[4]. Transferring profits apparently made in a country abroad by means of legal tax arrangements is seen by society as unconscionable and opportunistic. What is often overlooked is that companies only use opportunities offered by governments of some states (including EU states). We are talking about preferential regulations, also called intellectual property boxes (IP boxes / license boxes). These provide for certain income benefits. Many countries have been competing for years with IP boxes, which offer ever higher discounts. With the aim of attracting companies to their location, the states accept that profits from many neighboring countries are withdrawn. In order to take this circumstance into account, the legislature had restricted the deductibility of interest rates with the corporate tax reform in 2008. Now, on January 1, 2018, a similar provision for license expenses was included in the Income Tax Act. The new § 4j EStG “Expenses for the transfer of rights” is intended to restrict the tax deductibility of licence payments for certain constellations and thus act against profit shifting.

The aim of this scientific work is to check the new license barrier according to § 4j EStG for its suitability to prevent the profit shift of multinational corporations. In this context, the standard will also be examined with regard to related regulations, such as the additional taxation (§ 10 AStG) and the withholding tax (§ 50a EStG). The aim is to establish whether the interplay of these rules may result in an unjustifiable additional tax burden. If this were to be accepted, the provision would have prevented a shift in profits, but it would not be appropriate because of the excessive burden on taxpayers.

1.3. procedure

The contribution is divided into 1st introduction, 2nd basic part, 3rd license barrier § 4j EStG, 4. Critical analysis of legislation and 5th conclusion.

In the basic part, the IP box is first discussed. The reader is introduced here to the functioning and also the problem. Combined with the historical evolution of IP box regimes, it highlights the motivations of governments that led to the introduction of such perks. In the sub-capital 2.2 of the basic section, the author will deal with Action Point 5 of the BEPS Action Plan (BEPS = base erosion and profit shifting). In particular, attention is paid to the Nexus approach, which is the core of the action point. However, the explanation of the definition of a harmful preferential regime and the increase in transparency, which can also be found in chapters 3 and 5 of the Action Point, will be omitted in this elaboration. These criteria are not necessary for assessing the licensing barrier and should therefore not be the subject of the contribution. The basic part concludes with the presentation of the taxation system until the time of the introduction of the license barrier, the status quo as of 31 December 2017. The basic part is intended to provide the reader with the necessary basic knowledge as well as to explain the problem of profit shifting in order to subsequently understand the legislative motivation and the importance of the license barrier in the third chapter of License Barrier § 4j EStG. Chapter 3 deals with the licensing barrier according to § 4j EStG and thus forms the core of the elaboration. First of all, the importance of the new regulation in connection with the BEPS measures is presented and the intention of the legislators with the introduction. Afterwards, both the factual requirements and the legal consequences of the standard are explained and analyzed. Due to the complexity of the factual requirements, a division is made into sub-chapter 3.2.1. Objective scope, 3.2.2. Personal scope, 3.2.3. The Nexus approach as a negative precondition and 3.2.4. priority of additional taxation. Subsequently, the legal consequences of fulfilling all the criteria are explained. Chapter 3 License barrier according to § 4j EStG concludes with a test scheme for the license barrier and a comparison with the interest rate barrier according to § 4h EStG. By means of the comparison of the two provisions, the examination of the “compatibility with higher-ranking law” (chapter 4.1.) should show whether the case-law on § 4h EStG is applicable to the license barrier. If it turns out that both Norman are comparable, this could possibly allow conclusions to be drawn about the constitutionality of the license barrier. In the 5th capital is the critical analysis of legislation. Here, in the first step, it is checked whether the license barrier is possibly in conflict with higher-ranking law. A review of constitutional law, EU law and agreement law should therefore take place. However, this should explicitly not be a check of legality, but only show potential conflicts. In subchapter 4.2. of the analysis part, the license barrier is to be evaluated economically. Finally, the main points of criticism are summarized in the conclusion.

The elaboration focuses only on the income tax assessment of the license barrier and related legal regulations. All other types of tax are to be excluded here.

2nd basic part

The following chapters deal on the one hand with current IP box regimes and their origin, functioning and impact on taxation

(1st sub-chapter) and Action point 5 of the BEPS project is explained (2nd sub-chapter). In particular, attention is paid to the Nexus approach. This is an essential part of the aforementioned action point and is directly mentioned in the legal norm of § 4j EStG (licensing barrier) as a prerequisite. In addition, in the third sub-chapter, the author deals with how license income and license expenses were treated in German tax law until the introduction of the license barrier on 01.01.2018. In this chapter, it also becomes clear which legal system makes the transfer of profits abroad (via license fees) possible and why IP boxes function as a design variant.

The knowledge gained through IP box regime, the Nexus approach and the previous taxation system will serve in the later part of the elaboration for the analysis of the license barrier.

2.1. IP boxes

2.1.1. Functionality

An IP box is a (preferential) special tax regime of a state that exists alongside the current tax system. It is characterized in most cases by generous tax exemptions from income from intangible assets (patents, trademarks and other legally protected assets[5]). [6] As a result of the benefits, the effective tax burden is far lower than the regular taxation in the State concerned. Similar to tax laws, IP boxes can be designed differently by each state[7]. Accordingly, the advantages can also be present in a wide variety of forms. In general, the preferential arrangements include a reduction in the tax rate, the tax base or special conditions for the payment or repayment of taxes. [8] Governments introducing IP boxes in their state are basically pursuing the goal of achieving productivity growth in the promising sector of the economy through investment incentives in intellectual property (IP).

Research funding is basically divided into two types in literature. On the one hand, input-oriented (or direct) and on the other hand, output-oriented (or indirect) research funding[9]. The main difference is the stage at which companies are granted benefits. With the input-oriented system, companies can already expect benefits during the research and development phase. These can be granted in the form of research allowances, research premiums or by reducing the tax base through special depreciation and investment allowances[10]. The input-oriented research funding is thus granted regardless of whether revenue is actually generated from the IP created. This particularly favours investments in risky but potentially innovative projects. Also in the event that no revenue can be generated from the IP, research and development expenditure will be favoured.

This is contrasted by output-oriented research funding. It is only at the IP revenue stage that benefits are granted in the form of reduced tax rates on these revenues. Revenue is completely decoupled from research and development expenditure. The expenditure has no relevance for the benefits. IP boxes can be classified in this output-oriented (indirect) research funding. It is questionable whether such output-oriented funding actually encourages companies to invest in innovative projects. After all, there is a risk for companies that research projects will fail economically and no revenue can be generated from them. Benefits are then not to be expected through IP boxes, which only promote income.

The following figure shows once again the previously described differences between input-oriented and output-oriented research funding:

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Figure 1: Promoting R&D input and output

Source: Spengel, C., Patent Boxes. Innovation and tax policy implications, 2015, o.

Basically, all governments with the introduction of preferential regimes (IP box regimes) pursue the overarching goal of making their location more attractive for companies. Facilitating the development of intangible assets will stimulate the development of such assets. However, there is a significant difference among the IP box regimes. This is the treatment of acquired intangible assets (IP). Many regimes do not differentiate between IP created by research and development (R&D activities) and IP acquired by another group company. The basic economic idea behind IP boxes of establishing an incentive system for R&D through targeted tax benefits is undermined by such undifferentiated IP box regimes. If no R&D activity (corporate substance) is necessary for the use of the IP boxes, corporations can use the regime for pure tax optimization. Intangible assets are simply relocated to the country with the cheapest IP box regime and from there are required royalties from IP-using subsidiaries. IP boxes are thus a prime example of harmful taxation practices. [11] Studies to date also indicate that IP boxes have little relevance for the territorial linking of R&D. They are thus less suitable for funding R&D than input-oriented research funding in the development phase[12].

It should be noted that Germany, Estonia, Latvia and Sweden do not grant IP support via IP boxes. In Germany, the introduction of an IP box was under discussion a few years ago, but was ultimately not implemented. It is still limited to project funding in the development phase, i.e. input-oriented research funding.

2.1.2. Historical development

The first IP box was introduced by Ireland in 1973. These tax-free licence revenues from Irish patents[13]. With the turn of the millennium, France followed and in 2003 Hungary. However, the real “rush” on IP boxes began only in 2007, when the Netherlands and Belgium also introduced IP-favoring regimes. In the following years, nine countries did the same. Among them seven member states of the European Union.[14] The following table gives an overview of currently existing IP boxes. In addition, it is shown which IP box also favors acquired intangible values.

Table 1: Years of introduction of IP box regimens

Source: Based on comparison of BT pressure. 18/1238, Response Federal Government, 2014, p. 2; Heidecke, B. & Holst, R., Lizenzaufausen, 2017, p. 129 f.

The increase in preferential (favourable) regulations is due on the one hand to the gain in importance of intangible assets as well as the increasing tax competition between EU member states. The trend shows that today, intangible assets are mostly the market value of a company. This is evident, among other things, in the market values of the 500 largest listed American companies, which are determined by the rating agency Standard & Poor’s (S&P 500). Whereas in 1975 intangibles accounted for 17 % of the market value, in 1995 they accounted for 68 %, in 2005 they accounted for 80 % and finally in 2015 they accounted for 87 % of the market value. [15] It is clear that companies, especially in this area of assets, have an interest in receiving benefits.

Another reason for tax optimization using intangible assets is the mobility of these. Once created, it is usually without significance for the group which group company holds the values in its operating assets. [16] Moreover, the transfer of such assets is possible without high transaction costs. Only when it comes to taxation is caution required. If, for the first time, high royalties were collected for use, the assets are to be valued accordingly for tax purposes. A later (functional) shift, i.e. Removal from a German company, for example, would entail a taxation of derailment according to § 4 Abs. 1 sentence 3 EStG i.V.m. § 6 para. 1 no. 4 EStG. Furthermore, in the case of the transfer of functions to an affiliated company pursuant to § 1 para. 3 p. 9 AStG in the absence of a value by means of a hypothetical arm's length comparison (§ 1 (3) p. 5 AStG) to determine a value for the asset. However, it should be noted that due to the wide variety and uniqueness of intangibles, it will be difficult to establish an adequate transfer price. [17] Accordingly, companies have room for manoeuvre here. For companies, it should be noted that a correct pricing of the asset to be moved reduces or reduces the subsequent tax advantage through IP boxes. As good as cancel[18]. Too low a price, which does not take into account future revenues, is therefore effective for companies, but harmful for the state from which the asset is taken.

2.2. BEPS – Action point 5

The following chapter will deal with Action Point 5 of the BEPS project of the OECD and G-20 countries. Understanding the approach developed by the OECD to combat profit shifting is essential for understanding the functioning of the license barrier according to § 4j EStG. In particular, the Nexus approach is examined as the core of the action point 5 and the license barrier. Action point 5 is part of a comprehensive action plan against the erosion of the tax base and profit shifting (BEPS). A total of 15 action points[19] are intended to implement and achieve the common goal of the OECD and the G20 states[20]. IT companies in particular are the focus of the package of measures. Until now, they have been able to take advantage of legal loopholes due to the variety of products and services across borders and leave their income partially untaxed. [21] With its project, the OECD represents governments of a total of 44 countries, which together account for 90% of the world economy[22]. This highlights the importance of the BEPS project. In 1998, the OECD published the report “Harmful Tax Competition: An Emerging Global Issue”. In this, measures have already been developed to counter harmful tax practices of companies but also by states. In particular, the focus was already on assets that can be easily moved across national borders, i.e. intangible assets. The report is now the cornerstone of the new OECD action plan.

Action point 5 ‘Effective fight against harmful tax practices taking into account transparency and substance’ deals in particular with the definition of preferential arrangements, the requirement of a material business activity (substance) and the increase of transparency in advance tax commitments (Tax Ruling)[23]. The Nexus approach is the core of the action point. As part of the elaboration, the OECD comes to the conclusion that IP-intensive business areas are an essential factor for sustainable growth and employment[24]. Accordingly, the States are granted the right to promote these activities by means of tax incentives[25]. Nevertheless, the tax benefits should be granted only to the extent that companies are actually active in the States, i.e. carry out a substantial business activity. This essential business activity is given the name of the substance by the OECD. The requirement of substance should therefore become one of the key criteria for granting tax advantages.

2.2.1. Determination of tax-advantaged revenue (Nexus approach)

From three possible approaches that should implement this goal, the Nexus approach was finally selected. The Nexus approach can be used to determine a ratio (nexus ratio) at which income can be tax-deferred. The expenditure of the taxable person acts as an auxiliary variable. Only insofar as the taxable person spends on research and development can his revenue be favoured. At the Nexus approach are after the transition period until 30. June 2021 all states are bound and committed to this[26]. Within the transitional period, all IP box regimes are to be adapted to the Nexus approach.

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Figure 2: Nexus Formula

Source: OECD, 2016 paragraph 30.

The Nexus approach correlates the qualified expenses that companies have actually spent on intellectual property development with total expenditure on development. According to OECD guidelines, only those costs which are directly attributable to the development of an intangible object and which are attributable to the development under own direction are to be regarded as qualified.[27] Ancillary costs incurred during the development period, such as interest payments, construction costs and other costs which are not directly attributable to a single asset, are not considered as development costs[28]. So they are not included in the qualifying expenses nor in the total expenses in the Nexus ratio.

For the calculation of the Nexus approach, it is important over which period of time expenditure and revenue are taken into account. Here, there is a difference between the Nexus quotient (ratio), which is the front part of the Nexus formula, and the revenue to be multiplied. The Nexus quotient uses the cumulative expenses incurred over the lifetime of an intellectual property item. If, for example, IP is developed over a period of four years (investment periods), all issues relating to this IP are included in the Nexus quotient every four years. The resulting ratio thus represents an average of the proportionate qualified expenditure. However, the final calculation of tax-advantaged income is different. As usual, the income is determined anew with each investment period. However, it should be noted that it is here, similar to a profit determination according to § 4 Abs. 3 EStG, on which payment receipt and payment outflow is important. For the purpose of calculating the tax-advantaged revenue, the current year’s licensing revenue is multiplied by the nexus ratio established over previous years (see Figure 2).

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Figure 3: Nexus ratio

Source: Own presentation

In its final report on Action Point 5, the OECD defines four spending terms that are relevant for determining the Nexus ratio: