Sign up for tax alert emails    GTNU homepage    Tax newsroom    Email document    Print document    Download document

March 8, 2024
2024-0553

German tax authorities revise interpretive letter on tax treatment of wages/salaries under double tax treaties

  • In December 2023, the German tax authorities published a revised interpretative letter on the tax treatment of wages and salaries under double tax treaties.
  • The main changes concern the determination of residence according to the treaties, the definition of the economic employer, and extensive additional documentation requirements.
  • Potentially affected employers should examine the implications of the revisions for themselves and their employees and decide on the necessary measures. For many employers, action will need to be taken concerning the potential for partial double taxation of the employee remuneration and the extensive, detailed documentation requirements.
 

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.

* * * * * * * * * *
Endnotes

1 Art. 15 Model Tax Convention sets the rules for whether the state where the employment is exercised or the state in which the employee is resident according to the treaty can tax the employment income.

2 Art. 23 Model Tax Convention contains the provisions on how the state of treaty residence will prevent income from being double taxed. Germany typically exempts employment income that can be taxed by the other contracting state. Most other countries allow the tax that has been paid in the other state to be deducted from its own tax. This deduction is restricted to the appropriate portion of its own tax.

3 In the Netherlands, the "30% ruling" allows an employer to pay out 30% of certain expats' salaries tax-free.

* * * * * * * * * *
Contact Information

For additional information concerning this Alert, please contact:

EY Tax GmbH, Germany

Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor
 
 

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

 

Copyright © 2024, Ernst & Young LLP.

 

All rights reserved. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP.

 

Any U.S. tax advice contained herein was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

 

"EY" refers to the global organisation, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

 

Privacy  |  Cookies  |  BCR  |  Legal  |  Global Code of Conduct Opt out of all email from EY Global Limited.

 


Cookie Settings

This site uses cookies to provide you with a personalized browsing experience and allows us to understand more about you. More information on the cookies we use can be found here. By clicking 'Yes, I accept' you agree and consent to our use of cookies. More information on what these cookies are and how we use them, including how you can manage them, is outlined in our Privacy Notice. Please note that your decision to decline the use of cookies is limited to this site only, and not in relation to other EY sites or ey.com. Please refer to the privacy notice/policy on these sites for more information.


Yes, I accept         Find out more