Germany: New Draft of Guidance on Withholding Tax in the Context of Software Licensing

Written on 21 Aug 2017

On 17 May 2017, the German Ministry of Finance released a draft circular aimed at resolving the on-going debate on the application of withholding tax in the context of software and database licensing from foreign entities to German licensees.

Game developers but also publishers outside of Germany grapple with this issue when they use German publishing partners or even their own German subsidiaries to distribute games on a royalty basis, which may be subject to withholding tax.

The new insights gained after an analysis of the new draft circular are crucial to every foreign entity licensing software or databases to or distributing them through German customers or business partners. While the draft does clarify that in many cases, distribution of games is not subject to withholding tax, it suggests that digital distribution may or may not be subject to withholding tax depending on details of the distribution model. It has to be noted that this guidance is still a draft and not yet in force due to the on-going discussion regarding this subject.


Sec. 50a para. 1 no. 3 in connection with sec. 49 para. 1 German Income Tax Act states that a tax of 15% on royalties has to be withheld by the licensee of a software licence if the licensor is a foreign entity with limited tax liability in Germany.

There was a lack of clarity concerning the exact scope of the withholding tax, particularly whether it covers the mere use of software in its intended purpose, sublicensing within the same corporate group, or payments for a sole distribution right. In the past, the distinction was often made between individual software, on which withholding tax was argued to be due, and standard software, on which it was not. The necessity for the licence to be limited in time in order to fit the scope of withholding tax, however, was already sufficiently clarified in the previous circular of 2010.

“Further Commercial Utilisation” as the main criterion

According to the recently released draft guidance, the key characteristic of a software or database licence agreement that constitutes liability to withholding tax is whether the licensee obtains extensive usage rights to further commercial utilisation of the software or database, especially the rights to independent duplication, editing, distribution or publication. Further commercial utilisation in this context is purposeful commercial activity to gain financial profit from the given rights. The lack of extensive usage rights to further commercial utilisation frees the licensee from the obligation to pay withholding tax. The use of software in its intended purpose is not within the scope sec. 50a German Income Tax Act and thus not taxable (no German withholding tax due). If the licensor grants the licensee extensive rights regarding duplication of the software (e.g. copies made by the licensee), German withholding tax would be triggered according to the new draft circular. On the contrary, withholding tax would not be due in Germany if the licensor licenses a certain amount of copies of the software to the licensee. This principle applies to both software and databases.

The following examples clarify this principle:

Intended Use

If a foreign licensor grants a German licensee the use of its software for its intended purpose, the royalties paid are not within the scope of withholding tax, disregarding any mediate financial benefits. Financial benefits achieved through increased economic efficiency with the help of licensed process-optimising software, for example, do not constitute further commercial utilisation, if the software was simply used as intended.

The sublicensing of software by the licensee within his corporate group also constitutes intended use, if the licence was agreed to be a corporate licence and all group members use the software as intended.

While this exception will generally not apply to games as products to be distributed to end customers, it can apply for instance to group licenses to development tools and other software used to create the games in the first place.

Further Commercial Utilisation

Contrary to the use of software in its intended purpose explained above, it would be considered further commercial utilisation if a foreign software developer licenses a game to a German group subsidiary which then further develops it with the ultimate goal of commercial distribution.

In this case, the German entity is granted extensive usage rights, such as the right to duplication, development and editing, and distribution. Due to the extensive usage rights obtained by the licensee, royalties paid to the licensor are subject to withholding tax.

Distribution by Intermediaries

The simple distribution of duplication pieces by a German intermediary following the terms of a distribution agreement, without obtaining extensive usage rights on the software itself, does not constitute further commercial use. A German intermediary thus can handle the distribution of software developed by a foreign developer without an obligation to withholding tax, even digitally, as long as the intermediary does not have extensive reproduction rights. Therefore, German withholding tax would be due if the intermediary has the right to reproduce copies at their discretion.

This exception will often apply in the context of games distribution, whether it is digital or physical, but with digital distribution, it will likely apply only if the number of copies is limited by the licensor in some way.

Mixed Agreements

If an agreement entails not only licences, but also services or other claims, the payment made as performance of the agreement by the licensee will be divided proportionally in order to determine the amount paid as royalties as the basis of assessment for withholding tax. If the agreement lacks a plausible explanation concerning the exact amount paid as royalties, the tax office will assess the amount subject to withholding tax on its best judgment.

It can therefore be helpful to include an express allocation of payments in the agreement. However, the tax authorities will likely not accept artificially low license allocations. If a portion of the payment is allocated to other services, the agreement should describe these services in sufficient detail to make their value clear to the authorities.


The criterion of further commercial utilisation established in the recently published draft circular serves well in estimating whether withholding tax is due in contracts including software or database licenses. The key question in every case is if a license grants extensive usage rights, such as independent duplication, editing, modifying and distribution of the software, aimed at financial benefits with the subject of the licence itself. Again, this new guidance is still a draft version and not in force yet, so further developments remain to be seen.