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In a decision dated 30 April 1997 but published with considerable delay (EFG 1998, 562), the Tax Court of Rheinland-Pfalz has held that the income of a foreign satellite operator from a "transponder usage agreement" with a German provider of television programming was not subject to taxation in Germany. The case involved a contract between the Luxembourg-based operator of the Astra satellite system and a German television provider. Under the contract, the satellite operator agreed to broadcast signals (programming) from an Astra satellite using one of the transponders installed on this satellite. The agreement was phrased in terms of "use of a transponder" by the German television provider during a specified time period for distribution of television programming with a certain guaranteed signal strength to a broadcast area comprising Germany, Austria, and Switzerland. The satellite operator had no permanent establishment or other facility in Germany.

1. Factual background and terms of the contract

The court went to great pains to understand the terms of the contract in light of the technology involved. Essentially, the German television provider was required to deliver its programming signals to a specified ground station in Germany. The satellite operator then was responsible for uplinking to its satellite and beaming the programming back to earth to cover the agreed broadcast area with an agreed downlink signal strength throughout the broadcast territory. In the event of the satellite operator's failure to achieve the guaranteed signal strength, the television provider was entitled to a partial refund and/or to terminate the contract, depending on the duration of the deficiency.

The agreement gave the television provider "exclusive use" of one of the satellites' 16 "transponders" or "transponder channels". A transponder is a virtual combination of multiple electronic circuits used to reinforce and process signals. It is not entirely clear from the statement of facts contained in the decision whether a transponder is a physically distinct unit.

2. Position of the tax authorities

The German tax authorities argued that the agreement involved the grant of a right to use the transponder during a specified period and that the income derived was therefore taxable as rental income under the German income tax code because the right was exploited (in part) inside Germany, where television viewers received the broadcast program. Alternatively, they contended that the income was derived from rental of the transponder itself and hence fell into the category of taxable "other income". Both rental income and "other income" of the sorts allegedly involved are subject to 25 % withholding tax under German domestic tax law, reduced to 5 % under the tax treaty with Luxembourg.

The attempt by the tax authorities to fit the income of the satellite operator into certain technical income categories is a function of the structure of the German income tax code itself. German income tax law defines seven categories of taxable income. The nexus required to tax income derived by non-resident persons is defined in sec. 49 EStG. This nexus differs for each of the seven categories and within these categories for certain sub-categories.

For income from commercial business activity ("business income" - sec. 15 EStG), the basic rule (to which there are a number of exceptions not presented by the case at hand) is that such income is not taxable in Germany unless derived through a German permanent establishment. For "rental income" (sec. 21 EStG), the principal required nexus is that the object rented be physically located in Germany or, in the case of rental income from a grant of rights for a limited period of time, that the rights granted be exploited in a domestic permanent establishment or other domestic facility. Income from the lease or rental of movable objects only constitutes rental income if a number of related objects (e.g. the complete furnishings for a house or room) are rented as a coordinated group. However, the lease of individual movable objects is a category of "other income" (sec. 22 EStG). Non-residents are taxable on such income if the leased object is used in Germany.

The tax authorities thus sought to characterise the income derived by the satellite operator as "rental income" paid for a grant of rights (right to use a transponder) for a limited period of time or as "other income" earned in return for lease of a movable object (the transponder). In the first case, they would also have to show that the right was exploited in a domestic permanent establishment or other domestic facility (i.e. in the establishment of the television provider). In the second, a finding would be necessary that the transponder was used in Germany (e.g. because its signals were received in Germany).

3. Holding of the court

The tax court rejected the arguments of the tax authorities, stating that, as an economic matter, the contract required the Luxembourg satellite operator to render ongoing business services to the German television provider and did not involve a grant of rights or rental of movable property. The court accordingly held the income earned by the satellite operator to constitute "business income". Since the satellite operator had no German permanent establishment, the income escaped German taxation.

The court also rejected attempts by the tax authorities to reach a different result under the complicated doctrine of "isolated analysis" (isolierende Betrachtungsweise - sec. 49 (2) EStG) or under the special rule of sec. 49 (1) no. 9 EStG. Involved in both cases is the interrelationship of the seven basic income categories and the fact that income may fall into more than one category.

In general, income which meets the requirements both for "business income" and for "rental income" or "other income" is placed in the category "business income" (priority of business income over these other two income categories).

However, since the nexus required to tax most sub-categories of business income earned by a non-resident (permanent establishment) is fairly easy to avoid, the general priority of business income over rental income and other income is modified by the doctrine of isolated analysis and by the special rule of sec. 49 (1) no. 9 EStG. We dispense with detailed discussion of these intricate issues, however, because we do not regard them as central to the court's finding that the "transponder usage agreement" did not involve a grant of rights or a lease of a movable object in the first place.

The court left open the question whether the agreement in question constituted a "service contract" (Dienstvertrag) or a "works contract" (Werkvertrag) from the standpoint of German civil law. The basic difference between the two is that the obligor under a service agreement is required to use his best efforts in performing a service, but not to accomplish any particular result, whereas under a works agreement the obligor is required to bring about a particular result.

Because of the required minimum signal strength in the broadcast area, the court was inclined to classify the agreement as a works contract. It left the issue open because it was not dispositive.

4. Appeal to the Federal Tax Court and implications of the decision

The decision has been appealed to the Federal Tax Court (BFH I R 130/97).

Should the judgement be affirmed, this would raise the question, discussed by Strunk in a recent article (IStR 1998, 428), whether its holding can be applied in other contexts, for instance, to contracts by which foreign operators provide German companies with an "electronic shopping mall" to sell goods on the Internet to German customers. Strunk discusses the situation in which a foreign party provides software and the necessary computer space on a server located in another country. The German company interested in selling its goods in a virtual marketplace would presumably use the software to deliver the content which the foreign provider would then display as an Internet website.

Analogising the provider of virtual marketplaces to the satellite operator in the case decided by the Rheinland-Pfalz tax court, Strunk argues that the fees paid by the German company to the provider would escape German taxation because the provision of virtual marketplaces would constitute a single service rendered and should not be broken down into component parts such as the grant of a right to use software.

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