In the first of a special series of articles, Thomas Kausch of PricewaterhouseCoopers gets to grips with the fundamentals of the German taxation system.

This article is a general background to the German tax and social security system. Tax law and practice in Germany as of 1 January 2001 is reflected. This is not a comprehensive guide, so we advise the reader against making decisions without taking professional advice. Understanding basic principles The scope of German taxation Anyone taking up residence in Germany or who has his/her customary place of abode there will become subject to unlimited tax liability on his worldwide income. Any person not residing in Germany or staying for less than six months is subject to limited income tax liability, restricted to income from German sources. The source of employment income is considered to be where the employment is carried out and not from where the salary is paid. EU nationals who are non-residents may apply to be treated as residents under certain conditions (mainly that at least 90 percent of their total income is from a German source). The tax year

After 31 December 2001 only half of dividend income is taxable and corporate tax will not be credited any more. Only 50 percent of foreign tax will be credited then. Capital gains tax As a rule, capital gains are taxable in Germany (at individual progressive rates), only if the sale is within one year (for movable assets, e.g., shares, so-called short-term capital gains) or ten years (for real property) after the purchase date. Special rules apply where a taxpayer has an interest of 1 % or more in a corporation. After 31 December 2001 only 50 percent of short-term capital gains are taxable. Double taxation agreements German national income tax law has been modified and superseded by various tax treaties with foreign countries to ensure that income is not taxed by more than one country. The existing treaties with Germany and those under negotiation are shown in Appendix C. Obviously, the tax conventions do not apply if both residence and source of income are located in the same country. This is the case if the employee gives up his/her former residence, moves (together with his/her family) to Germany and establishes residence in Germany. Generally, he/she is taxed abroad only until departure, and taxed in Germany from the date of arrival in Germany. Therefore tax treaties are only relevant if the employee is resident in country A, but exercises activities in country B, or if he/she maintains residences in more than one country. In general, the salary of an employee is taxed in the country in which he/she physically performs his/her duties; the location where the results of the activity are put into practice is irrelevant. As a general rule, a person residing in Germany and working in another country is taxed in that country. Germany will exempt the salary from tax, even if the individual is not actually taxed in the country where the work is carried out. This rule does not apply for some countries, e.g., France, Italy, Canada, Sweden and the USA. Germany will take exempted income into account when calculating progressive tax rates for taxable income. In spite of the above principles the right to tax the salary of an employee remains with country A, if the person keeps his/her residence in A and: is present in country B for less than 183 days (not only working days) within country B's fiscal year (or with respect to some countries: within a period of twelve months); and the salary is paid (borne) by or on behalf of an employer not resident in country B; and the salary is not borne by a permanent establishment which the employer has in country B. If the stay, or the total of several stays, in country B amount to more than 183 days, the salary for that period is taxable in country B. A bonus for the whole year may have to be broken down. Where an international assignee has a residence in two or more countries, (for instance when his/her family has remained in the home country), the employee is deemed, for application of the treaty, to be a resident of the contracting state in which he/she has his/her centre of vital (personal and economical) interest. As a rule, on a temporary assignment, the centre of vital interest remains in the home country. If the employer is located in a third country, the double taxation treaty will allow salary earned while on trips to Austria, Norway, Pakistan and India to be exempt from German taxation. Special tax relief Employment income connected to special construction, engineering or consulting work outside Germany lasting at least three months is exempt if: the employee works abroad for a German employer; and there is no Tax Treaty with the foreign country (see Appendix C). Social security contributions In principle, all employees working in Germany are subject to the German Social Security System, which covers statutory pension funds, unemployment insurance, contributions to the statutory care scheme (nursing at home), health insurance and work accident insurance. Current rates are shown in Appendix F. Contributions are paid half by the employer and half by the employee. For accident insurance, only the employer is obliged to pay. Employer's contributions are, in general, mostly tax-free to the individual. Employee contributions are deductible within certain limits. The following are exceptions to the general rule: Employees on secondment German social security does not apply to individuals seconded to Germany for a limited period to work on behalf of a foreign (non-German) employer on his/her payroll and account, subject to special conditions. The decision as to whether the provisions for a secondment are met is made by the local Health Department. European Community (EU) law EU rules apply if the secondee is an EU national and assigned to Germany by his/her employer for whom the employee normally works within the territory of an EU member state. Where the assignment to Germany is for less than 12 months and the secondee is not replacing an employee whose assignment in Germany has come to an end, he/she may remain in his/her home country social security scheme. In this case a certificate by the relevant foreign authority (form E 101) should be obtained confirming that he/she is covered by his/her home country scheme. In cases where EU rules apply, German health services are provided if he/she presents form E 128 or E 106 issued by his/her home country health insurance authority. An extension of the certificate for up to a further 12 months may be granted if his/her assignment is unexpectedly prolonged. An application must be made with the relevant foreign (host) authority. If none of these rules is relevant, he/she may still apply to pay his/her home country's social security tax instead of German social security tax during his/her employment in Germany. A request must be filed with the competent authority in his/her home country. (Article 17 EC Regulation 1408/71). Social security treaties Treaties have been concluded with Canada (Quebec), Chile, Israel, Japan, Morocco, Poland, Switzerland, Tunisia, Turkey, USA, Bulgaria, Croatia, Slovenia and former Yugoslavia. In these cases the rules of the treaty apply. The treaty with Hungary has been signed, but has not been enacted yet. If one is assigned to work in Germany for a firm located in one of these countries, he or she may be exempted from German social security in total or in part subject to the treaty rules on application.