Foreign source income and German income tax
von Peter Scheller
Foreign source income is in general not subject to German income taxation if a person is not resident in Germany. However, in years where a person enters or leaves Germany this sort of income might affect the progressive German income tax rate on taxable income in Germany. In these cases the tax rate will be calculated on the basis of the world-wide income except the income on capital investments and capital gains of the same. Capital income is taxed at a flat rate of 25% plus a solidarity surplus charge (combined tax rate about 26,375 %).
Foreign source income will have an effect on German income taxation if the following situations arise:
- The person is subject to German income taxation for part(s) of the calendar year.
- The person receives income while being a tax resident in Germany which is taxable in Germany.
- The before mentioned income does not result in an income taxation at the maximum rate (combined tax rate inclusive solidarity surplus charge: 47,48 %)
If the before mentioned applies, foreign source income not being taxable in Germany will increase the German income tax rate. Consequently the tax burden in Germany will increase.
Example: The US citizen A is living in Germany and works for a German employer. On 1 of July his employer sends him abroad for 24 months on an assignment contract. A gives up his tax residency in Germany and relocates himself to the work destination. A receives a gross salary of € 70,000 for the first half of the year which results in a taxable income of € 50,000 after deductions and allowances. A receives a gross income for the rest of the year of € 90,000. In the second half of the year he has work related expenses such as relocation expenses, costs of telecommunication, travelling costs and working materials of € 20,000. The income tax on an income of € 50,000 for a single person would be € 13,483 (tax rate: 26.97%), but A’s income tax rate will be calculated on the basis of € 120,000 (income taxable in Germany of € 50,000 + foreign source income of € 70,000). The tax rate on € 120,000 is 37.06%. The German income tax is € 18,530 (€ 50,000 * 37.06%). The increase in German income tax of about € 4,000 is caused by the increase of the tax rate.
The example shows the following:
- Foreign source income which is not taxable in Germany may have a considerable effect on German income tax. This is especially the case if a person moves to Germany or leaves Germany within a calendar year.
- It also shows that work related costs caused by foreign activities have a decreasing effect on the German income tax rate. If for example A would not declare his work related costs of € 20,000 in his German income tax return the tax rate would be calculated on an income of € 140,000 which would result in a tax rate of 38,10% and an income tax of € 19,053. Through declaring the work related expenses on his foreign activities he reduces his German income tax burden by about € 500.
(1) Above mentioned circumstances given, income which is not taxable in Germany has to be declared in the German income tax return.
(2) Expenses related to income which is not taxable in Germany can be deducted and decrease the German income tax rate.
(3) Foreign source income has to be calculated in accordance with German tax regulations. This means that special deductions and allowances can be deducted. A good example would be relocation expenses. Not only direct costs like travelling costs, removal expenses etc. are deductible but also standard amounts for other expenses. These amounts can be deducted without any proof.
(4) Foreign source losses such as those from rental activities may also have a reducing effect on the German income tax rate.
Author: Peter Scheller, German Tax Adviser – Master of International Taxation