New German lump-sum taxation regime for wages of employees with limited tax liability

On November 22, 2019 the German Bundesrat approved Germany’s Third Bureaucracy Relief Act (Drittes Bürokratieentlastungsgesetz 2019). With this act, the legislature added a subsection 7 to Sec. 40a of the German Income Tax Act (ITA), which allows lump-sum taxation of wage payments to employees with limited tax liability at a rate of 30% from 2020 on. The new Sec. 40a(7) ITA allows the lump-sum taxation of wage payments received by employees assigned to foreign permanent establishments of a domestic parent during short-term assignments in Germany.

Background to the new lump-sum taxation regime

The wording of the provision alone does not reveal the background to the new legislation. Section 40a(7) ITA essentially concerns the allocation of the right to tax wage payments of employees resident abroad under a double taxation treaty. The situation is as follows:

When employees assigned to a foreign permanent establishment of a domestic parent work in Germany, the question arises as to whether Germany is entitled to tax wage payments attributable to the employees’ domestic working days – even for short-term assignments such as meetings or further training.

Under domestic law, employees are (indisputably) subject to limited income tax liability for wage payments attributable to work performed in Germany pursuant to Sec. 49(2) no. 4a ITA. The German tax authorities are of the opinion that Germany also has the right to tax wage payments under the DTT (see guidance issued by the Federal Ministry of Finance on May 3, 2018, Federal Tax Gazette Part I 2018, p. 643, para. 186).

The tax authorities justify this by stating that for the application of Art. 15 (2)(b) OECD-MC the domestic parent is to be classified as a domestic employer resident in the state in which the work is carried out (Germany). The foreign permanent establishment, however, does not meet the requirements of an employer under treaty law. For the allocation of the right to tax under the DTT, neither the duration of the employee’s activity in Germany nor who bears or should have borne the expenses for the employee working in Germany is relevant.

The consequence of the administrative interpretation is that the domestic parent is obliged under Sec. 38(1) ITA to withhold and pay income tax in Germany (the parent is also an employer under civil law). For the domestic parent, domestic business trips by employees of a foreign permanent establishment may therefore result in a wage tax liability.

Disputed administrative opinion

The administrative opinion is disputed with respect to the fiction of autonomy and independence of permanent establishments for the purpose of determining taxable profits within the Authorised OECD Approach. The background is that in economic terms the remuneration for domestic activities is borne by the permanent establishment in the employee’s country of residence. If the permanent establishment is classified as an employer, Germany has no right to tax. In this case, there is an employer that is not resident in the state in which the work is carried out and that would bear the remuneration. However, it corresponds to an (older) decision by the Federal Tax Court that legally dependent permanent establishments cannot be employers within the meaning of the DTT.

As a result, domestic business trips by employees of a permanent establishment result in considerable processing costs. Even for a single working day physically spent in Germany, the pro rata taxable wage in Germany must be determined and taxed. Especially for companies in the banking and insurance sectors, which often structure their foreign business using permanent establishments, business trips to Germany result in considerable administrative expenses. As a rule, the parent will (have to) pay wage tax on the German working days (at their expense), which triggers an additional wage-taxable benefit.

Lump-sum taxation aims to simplify

The objective of Sec. 40a(7) ITA is to simplify the withholding and payment of wage tax by the German parent as the employer. However, on the basis of the taxation issue addressed by the provision, the new statutory regulation also confirms the administrative opinion set out by the Federal Ministry of Finance on May 3, 2018 (para. 186).

Requirements for lump-sum taxation

According to Sec. 40a(7) ITA, a domestic parent (domestic employer) may exercise the option of lump-sum taxation of wage payments at a rate of 30% for employees of foreign permanent establishments who havxxxe limited tax liability. The option of lump-sum taxation is not limited in terms of amount.

It is also intended to simplify the assumption of tax by the employer; however, the lump-sum taxation then excludes the recognition of any income-related expenses of the employee. The parent may not switch at will between lump-sum taxation and standard taxation within a calendar year.

Lump-sum taxation is permissible only for short-term activities in Germany. Activities in Germany that do not exceed 18 consecutive working days are covered; otherwise standard taxation applies.

Conclusion

Sec. 40a(7) ITA is based on the legislature’s objective of simplifying the taxation of domestic business trips of employees assigned to foreign permanent establishments. However, lump-sum taxation still requires a time-consuming determination of the pro-rata wage payments attributable to the working days performed in Germany. It should also be noted that the 18-day limit creates additional recording obligations. The simplification effect aimed at by the legislature will therefore be very limited.