The tax implications of cloud computing will vary depending on whether the cloud service provider is an unlimited (resident) or a limited (non-resident) taxpayer in Germany.
Where the cloud service provider (CSP) is a resident taxpayer in Germany, the global net income from such business operations would be liable to tax in Germany, unless the income is partially or fully sheltered from German taxation by a double taxation agreement. For corporations, the blended income tax rate is approximately 30 percent (composed of: a corporate income tax rate of 15 percent with an additional, solidarity surcharge of 5.5 percent on this 15 percent; an average trade tax rate of 14 percent). German Trade tax applies only to income generated at the level of a domestic place of business. If a resident CSP has a foreign permanent establishment (PE) due to cloud computing activities, the PE’s income will not be liable to German Trade tax.
For a non-resident CSP there are two ways in which a taxable presence could be created in Germany:
- The CSP has no German PE (or the rendered cloud computing services do not relate to an existing German PE), but the income generated qualifies as domestic income according to German tax law.
- The rendered cloud computing services result in the creation of a German PE.
Characterization of transaction
The German tax implications can only be determined on a case-by-case basis, but in order to avoid adverse German tax effects, the following items should be considered:
Providing infrastructure as a service
For infrastructure as a service (IaaS) to cause a non-resident CSP to suffer taxable income in Germany, the service must correspond to one or more of the items listed in the catalog of activities leading to domestic income. According to this catalogue, leasing movable assets or a group of assets that form an entirety (from an economic perspective) may result in taxable income. Thus, if the service to the client with regard to infrastructure-as-a-service qualifies as a leasing of movable assets (e.g. servers), the CSP may derive taxable income in Germany. For this to apply, the assets need to be physically located in Germany. Furthermore, taxable income should only be generated to the extent that such assets are dedicated to a specific customer, so that the client has a certain level of access and control of the equipment.
Given that, according to domestic German tax law, providing IAAS generates taxable income, Germany may not have the right to tax if there is a double taxation agreement in place between Germany and the home-state of the CSP, where this agreement provides for respective restrictions. According to the provisions of the Organization for Economic and Co-operation and Development (OECD) model agreement, Germany should not have the right to tax income resulting from leasing movable assets to the client. Regardless, equipment located in Germany may result in a German PE of the CSP (see below for details).
Providing software as a service
According to the aforementioned catalogue, compensation to a non-resident CSP for using rights may be considered as taxable income of. Whether the software as a service (SaaS) falls within the scope of such a provision depends primarily upon the type of software. Where the client is granted access to standardized software, the compensation should not qualify as domestic income of the non-resident CSP. In contrast, there may be taxable income if the client has access to customized software.
However, if there is a double taxation agreement between Germany and the CSP’s state of residence, and this agreement corresponds to the OECD model convention, then even if the service qualifies as domestic income from a German tax perspective, it should not be taxed. Regardless, the technical procedure is as follows in such cases: as a first step, Germany will levy withholding tax (WHT) on the respective royalty payments; as a second step, the CSP would have to file for a refund of such WHT with the German tax authorities. However, WHT payments could be avoided if the CSP can produce a German WHT exemption certificate.
A CSP may have a taxable presence in Germany due to a German PE. According to German tax law, a PE is a fixed place of business or facility that serves the business of an enterprise on a temporary or permanent basis, and over which the foreign investor exercises control. This definition does not require human intervention, and therefore the presence of an internet server may constitute a German PE. Thus, if the CSP offers its services via physical equipment located in Germany, it may risk creating a German PE.
Provided that a CSP has physical equipment located in Germany, a client who is non-resident in Germany may under certain circumstances be considered to have a German PE. This is particularly likely if the service is regarded as infrastructure-as-a-service and the client is granted the right to benefit from specific physical equipment located in Germany (e.g. leasing specific hardware).
Additionally, a CSP could have a German PE due to a dependent agent. A dependent agent is an individual that carries out business for the entrepreneur (the CSP) and in doing so is subject to substantive instructions given by the entrepreneur. The authority to conclude contracts on behalf of the entrepreneur (CSP) is a strong indicator for a dependent agent. Therefore, where a CSP uses a person representing a dependent agent to carry out business in Germany, a German PE may come into existence. However, where the business is related to an internet server, it is unlikely to qualify as a permanent agent.
Related party transactions
Once there is a taxable presence in Germany, transfer pricing issues may need to be considered from a German tax perspective, where the cloud services are provided by a group of related entities (at least one of which is resident in Germany) on a cross-border basis.
According to German transfer pricing provisions, intra-group transactions need to be based on the arm’s-length-principle, and prices as well as the terms and conditions must pass the third party test. There are statutory requirements relating to the transfer pricing documentation. If the taxpayer (the CSP) fails to present proper documentation upon request, the German tax authorities may be entitled to estimate the adequate transfer price and to levy additional payments.
As outlined in the previous sections, providers offering cross-border SaaS or IaaS to German customers could be subject to German withholding tax.
Even in a case where a double taxation agreement denies Germany the right to tax the payments, German WHT may still be due. This is due to a technical procedure that requires an initial WHT payment followed by an application for a refund, unless the taxpayer can produce a WHT exemption certificate.
The provision of cloud computing services to individuals and entities in Germany may trigger German Value Added Tax (VAT). German VAT applies to the supply of goods and the rendering of services (e.g. providing software or additional computing capacity). The VAT implications of a specific cloud computing transaction will depend on the type of transaction (supply of goods versus rendering of services) and the nature of the recipient (whether or not the recipient is an entrepreneur from a VAT perspective). The general VAT rate is 19 percent.
Consequently the German VAT implications of cloud computing should be analyzed for a given case or business model. As a rule, services provided for business for business (B2B) purposes are made where the recipient of the service is established. The reverse charge procedure may apply here, in which case liability for VAT is transferred to the recipient of the services. Thus, where cloud computing services are provided to a German entrepreneur, this entrepreneur may have to give assurance that the VAT obligations will be properly fulfilled.
As a rule, the place of supply of services to consumers (Business-to-consumer [B2C] services) is where the business providing the services is established (i.e. where the CSP is domiciled). However, where the supplier is established outside the EU, and electronically supplied B2C services are supplied to customers inside the EU, the place of supply of is the where the customer is resident or domiciled.
E-invoicing has recently been introduced into German VAT law. Thus, it is possible under certain circumstances to invoice customers electronically, e.g. by email. For a CSP this may be relevant in two ways: first, a CSP should in principle be able to invoice its clients electronically; secondly, it should be possible to involve a CSP in producing and electronically storing invoices for German VAT purposes.
Transfer of bookkeeping functions
German tax law provides for the possibility of outsourcing electronic bookkeeping, if certain requirements are met. One of those requirements is that the German tax authorities will accept such a transfer only if the location of the data system is revealed. Furthermore, the German tax authorities usually accept such applications only if there is a double taxation agreement in place between Germany and the envisaged host country, and where this agreement provides for certain mutual assistance clauses. At the same time, using cloud computing may result in bookkeeping data being processed and electronically stored on servers that are located in different countries or are constantly moved between different countries. There is little guidance available on how German tax authorities will react to a request for a transfer of bookkeeping functions relating to cloud computing services.
Transfer of business issues
A transfer of the CSP's business may mean that German income tax is applied to capital gains. However this depends on the specifics of the transaction, with l the following principles applying:
- Asset deal: A transfer of business via an asset deal will mean that capital gains are subject to German income tax. In the hands of the purchaser, the book values of the assets transferred are treated at acquisition cost.
- Share deal: Where shares in a corporation are acquired in a share deal, the book values of the assets and liabilities at the level of the target company (e.g. CSP) remain unchanged. As a general rule, 95 percent of the capital gains from the sale of shares held by a corporation are effectively exempt under domestic law. However, if a banking or finance institute invests in a CSP, such exemption may not be available upon the sale of the shares. Where a double taxation agreement corresponding to the OECD-model convention applies, Germany should not have the right to tax such capital gains. Write-downs to the lower going-concern value of the shares are not tax-deductible for corporate income tax purposes. If the target company (e.g., CSP) has the legal form of a partnership, the acquisition of a partnership interest is treated as a pro-rata acquisition of the partnership's assets. Accordingly, the purchaser steps up the tax basis of the assets of the partnership to the level of its own acquisition cost.
- Reorganizations: Various reorganizations and transactions are tax-privileged in accordance with the EU Merger Directive. The Directive's scope is limited to specific transactions (i.e., certain types of mergers, divisions, transfer of assets and exchanges of shares). In principle, a corporate reorganization may have tax consequences at the level of all entities involved in the reorganization, such as the transferring entity, the receiving corporation and the shareholders.