Executive summary

On 12 December 2023, the Federal Ministry of Finance published a revised interpretative letter on the tax treatment of wages and salaries under double tax treaties (DTTs). Comprising 427 paragraphs (previously 372), the letter is now significantly more extensive and contains numerous editorial changes in addition to new content. It also integrates explanations from other Federal Ministry of Finance interpretative letters. Some of the material changes are likely to pose significant challenges for affected employers and other parties involved.

Detailed discussion

Significance and effective date

In the letter, the Finance Ministry explains its view of the tax treatment of income from employment in accordance with the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention. In places, it also deals specifically with DTTs concluded by Germany. The new interpretative letter supersedes letters dated 3 May 2018 and 22 April 2020 (tax advisory fees assumed by the employer). It applies to all open cases (e.g., to matters from 2023).

Major changes

Some of the new guidance reflects current administrative practice and interpretations. However, a number of points also indicate new approaches/positions and in some places an about-face in the guidance (e.g., due to recent rulings by the Federal Finance Court concerning income from the exercise of stock options after a change in treaty residence). The following changes are particularly noteworthy:

• The letter contains additional comments on the determination of residence, including new examples that indicate the German tax authorities will assume a change of residence less frequently than is customary in an international context (marginal no. 7 et seq.). This could lead to double taxation in many circumstances. In addition, the new examples do not reflect typical real-life cases and therefore offer little assistance for the required case-by-case assessment for determining residence.
• The Federal Ministry of Finance clarifies that the "subject-to-tax" clauses in the DTTs and under Sec. 50d (8) and (9) EStG ("Einkommensteuergesetz": German Income Tax Act) also apply if the exemption of the income results from the allocation rule¹ and not the relief method article.²
• There are extensive new comments on the economic employer with an exemplary list of suitable evidence. Moreover, the criteria for profit allocation (transfer pricing) were broadly adopted. This suggests significantly increased documentation requirements down to the employee level.
• The required breakdown and allocation of the cross-charged salary components in secondment cases has been explained in more detail and the obligation to provide the individual employees with the corresponding documentation has been added.
• It stresses that for the criterion of residence (Art. 4 OECD MTC), the date on which the income is received is always relevant (based on the Federal Finance Court's judgment of 21 December 2022, I R 11/20 on determining which country has the right to levy tax on income from stock options in the event of a change of residence).
• It explains that:
• A signing bonus must be allocated over the expected actual working days during the term of the contract or until it becomes vested (Federal Finance Court's judgment of 11 April 2018, I R 5/16).
• The country of residence generally has the right to tax if the signing bonus is not repayable in the event of premature termination of the employment relationship.
• The comments on share-based payment models have been supplemented in particular by comments on virtual share-based remuneration (phantom stock) and a note to clarify that, depending on the circumstances of the individual case, there may initially be no receipt of income when restricted shares are granted.
• The Federal Ministry of Finance has added an example that indicates the subject-to-tax clause of the DTT with the Netherlands (Art. 22 (1) (a) Sentence 1) should be applied insofar as the Netherlands' 30% ruling applies.³ This may be relevant for DTTs with other countries that include a subject-to-tax clause and offer similar Expat Tax Regimes.

Conclusion

Change of residence will be assumed less frequently

According to the principles explained in the Federal Ministry of Finance's interpretative letter, in many cases, the German tax authorities will not assume a change of residence while the other contracting state will. In the case of secondments to Germany, none of the contracting states would then tax the pro-rata income for working days in third countries. However, in this case, Sec. 50d (9) Sentence 1 No. 1 EStG applies and Germany taxes it. In the case of secondments from Germany, on the other hand, there is pro-rata double taxation.

Relevant residence for stock options

The same double-taxation issue arises when, for example, in the case of stock options, Germany bases the assessment of residence on the date of receipt while the foreign country bases it on residence during the vesting period. According to the feedback received from local tax specialists, a significant proportion of the other countries (including some of the most populous ones) do not agree with and are unable to follow this approach, meaning that some degree of double taxation will be unavoidable or may only be resolved in lengthy mutual agreement procedures.

Increased documentation requirements

Another (potential) challenge for employers is the evident increase in documentation requirements imposed by tax authorities in connection with the determination of the economic employer and the assumption of costs. Currently, employers and employees do not normally provide the relevant information and evidence in such detail.

Date of receipt when shares with restricted transferability are granted

As before, restrictions on disposal under the law of obligations do not prevent receipt. It remains to be seen how the tax authorities will treat this if the company is required to consent to the employee's sale of the shares. The date of receipt for shares with restricted transferability has already been hotly debated (Federal Finance Court's judgments of 30 June 2011, VI R 37/09 and of 1 September 2016, VI R 16/15). Under civil law, ownership including ownership rights is generally transferred to the employee upon acquisition. In addition, the company's consent to the transfer to the employee is implied, which indicates that the income is received when the shares are granted. If the German tax authorities do not deem the income to have been received or consider the date of receipt to be later, this could lead to international distortions and render ineffective the provisions of treaty law for the avoidance of double taxation.

Netherlands expat tax regime

The Netherlands' expat tax regime (the 30% ruling) is intended to make the Netherlands a more attractive work destination. However, the legal opinion set out in the Federal Ministry of Finance's 12 December 2023 interpretive letter largely renders this rule ineffective if the employee retains their residence in Germany.

Overall, the specifications of the Federal Ministry of Finance lead to a considerable additional workload for employers and other parties involved (including the tax authorities) and increase the likelihood that certain remuneration components will be taxed twice in some cases.

Next Steps

Employers who send their employees on international assignments should determine what adjustments are required in light of the new interpretative letter and consider implementing these as soon as possible. This concerns, for example, not only the tax treatment of severance payments and share-based payments, but also the implementation of the extended documentation requirements for determining the economic employer, if applicable. It is also advisable to clarify the extent to which the risk of double taxation can be reduced if it can be assumed that the other contracting state will treat the employee as resident abroad and Germany will treat the employee as resident in Germany.

If the tax authorities levy tax on remuneration components in Germany on the strength of the Netherlands expat tax regime (or a similar regime in another country), the taxpayer may want to review whether an appeal can be filed. The Federal Finance Court has yet to clarify whether the right of taxation actually reverts to Germany in this case. Corresponding proceedings are pending before the court under ref. I R 51/22. Another alternative could be to consider whether the actual income-related expenses can be deducted, as this does not trigger any subsequent taxation in Germany.