The payment of royalties from a German company to a licensor abroad in this country regularly requires a withholding tax of 15 %. It does not matter whether the license fee is to be paid to an external business partner or whether it is directed to a company abroad – a so-called IP Box – which is self-founded for this purpose. But there are at least two ways to avoid the withholding tax that arises completely.

On the one hand, you can found a GmbH in Germany where the management is located abroad. This ensures that the license first goes to the place of management abroad, which as such constitutes a foreign establishment. Germany cannot therefore impose a withholding tax on it. From there you can then forward the license to the company in Germany, whereby also no tax is incurred.

The second variant requires the establishment of a company in other EU countries as a stopover when transferring the license to the German company. In doing so, the licence fee that the EU company has to pay is charged against that of the German company, with only a small difference remaining as a taxable amount.

For a long time, royalties have been recognized operating expenses on a company’s balance sheet. In this way, they contribute to a reduction in taxable profit. Therefore, it is hardly surprising that entrepreneurs discovered license fees as a potential means of tax design for themselves. Because if the license fee goes to a company with a registered office abroad, where this income causes little or no tax, then you can achieve a considerable tax relief.

But it is also self-evident that the legislature recognized this and took countermeasures. He introduced a set of rules to tax the outflow of potential profits through license payments to foreign companies. Since the Treasury can basically only use the German entrepreneur instead of the foreign licensor to pay the tax effectively, he has designed the tax as a withholding tax.

The legal basis for withholding tax on license fees is integrated into § 50a EStG. In general, this paragraph regulates the taxation of persons subject to limited taxation. For this purpose, § 50a EStG first defines in detail the income for which a limited taxpayer is subject to a tax deduction in this country. Because foreign companies are considered to be subject to limited taxation in connection with the taxation of license payments, they are therefore also affected by this law.

Specifically, this involves a tax deduction of 15% on the gross license fee. A deduction of 5,5 % on the amount of the withholding tax is also added as a solidarity surcharge. After all, this taxation at source has a valid effect, provided that the licensee also fulfils his obligation and duly pays the tax to the tax administration. Of course, this means, in return, that the license fee is contractually fixed with the licensor in such a way that the net amount transferred to the licensor corresponds to the claim actually negotiated.

Our first model with which we can achieve the avoidance of withholding tax begins with the establishment of a GmbH in Germany. Well, admittedly, if you want to avoid the withholding tax, then the establishment of a German GmbH seems at first glance not very effective. Therefore, we arrange this so that in addition to the statutory headquarters of the GmbH in Germany, the management takes place in the country in which the foreign licensor is also based. Because of this, we also establish a company abroad with the location of the management, for example in Spain.

What advantage does this have? Since the foreign licensor now grants the license to the foreign establishment of a German GmbH, there is no withholding tax in Germany. This is because the law only applies withholding tax to a license payment to a limited taxpayer. But the Intermediate GmbH is based in Germany and thus unlimited taxable. Therefore § 50a EStG does not apply to this. And this has avoided the withholding tax in Germany.

Since the design model presented here can of course also be applied to our own foreign IP box, we want to deal with this aspect a little more. Of course, you only save taxes in the amount of the entire license fee if the licensor, i.e. the IP Box, is located in a country that levies no or only a small tax on the income from the transfer of licenses. This requirement is a widespread practice in many tax havens. However, in recent years, in a number of countries, in cooperation with the OECD, this taxation practice has been curbed. For example, Luxembourg partially and Liechtenstein completely abolished the advantages previously granted in the taxation of licence revenues.

In our second model, we take a different approach. Although it is also necessary to set up another company, this time this company should be based in an EU country.

So now we look at the way in which the model presented here allows for the avoidance of withholding tax. First of all, it should be that the licensor, who is located, for example, in a third country, transfers the license to the company established in other EU countries. For example, the license fee should be EUR 100,000. In a second step, the EU company will now hand over the license to the German company. The exemplary license fee should amount to EUR 99,000.

These two amounts could now be offset against each other, whereby the withholding tax would only apply to the difference of EUR 1,000. For other types of income, this is also regulated by law. However, the law does not include license fees as a qualification feature. Therefore, it was previously impossible to make such a set-off for licence fees. However, this exception has already been the subject of negotiations at the European Court of Justice and national courts in the past. The judges found that the German exception – the lack of consideration of license fees – opposes European law in this regard. Consequently, the Federal Ministry of Finance issued a circular with which this offsetting became valid. Thus, the calculation presented here is legitimate.

Of course, it is important that we set up the company we need as an intermediate licensee in an EU country that levies little or no taxes on license revenue. In this case, too, Luxembourg is now leaving for the reasons already mentioned. But maybe a B.V. in the Netherlands or an S.L. in Spain still comes into question.

As you can see, the strategy for avoiding withholding tax is based on the division of the transfer of a license from the licensor based abroad to the German licensee. In both options, it is an intermediate company with which the legal basis for the collection of the withholding tax is elegantly circumvented. This is due on the one hand to a legal loophole in German income tax law and in the second case to an incompatibility of the German law with European law, which was confirmed in the highest court instance.