Companies moving employees to Germany will welcome a new tax relief system that will enable dual-career couples with children to carry on working.

In April 2006, the German government passed a new tax law, which includes a new regulation regarding the deductibility of child-care expenses, to improve the basic conditions for business development and to stem legal but unwanted tax structuring.

Prior to the new ruling, the lack of a good pre-school child-care system meant that working couples often put off  having children; a pattern which has contributed to Germany's steadily 'greying population'. Through introducing a child-care system to allow dual-career families to keep on working while starting families, the German government hopes to restore the population balance, and to increase contributions to the pensions system.

"Expats are used to having a good child-care system and when they came to Germany the spouse had to stay at home," says Katrin Koehler.  "Now expat spouses can go to work."

Most of the new regulations are retroactively effective already as of 1 January 2006. Individuals are affected in particular by the changes regarding child-care expenses and household help.

Child-care expenses

The new law includes a completely new regulation regarding the deductibility of child-care expenses.

The previous regulation that provided for a deduction as extraordinary personal expenses has been abolished. Instead, the new regulations allow a deduction of child-care expenses for children belonging to the taxpayer's household as business expenses —for income from trade or business, agriculture and forestry and self-employment income, income-related expenses—for employment income, or special personal expenses.

The new regulations are effective as of the assessment period 2006 as far as the underlying child-care services have been provided after 31 December 2005.

The deduction as business expenses/income-related expenses is applicable on child-care expenses for children up to but excluding the age of 14 or for children up to but excluding the age of 27 who are not able to support themselves caused by a physical or mental disability. The taxpayer is allowed to deduct two-thirds of the expenses not exceeding EUR 4,000 per child.

The deduction as income-related expenses is allowed in addition to the lump sum deduction for employees. However, the taxpayer—single parent—is only allowed to deduct child-care expenses as business expenses/income-related expenses if they work.

Parents living together must both work to claim the deduction. If the child is not a permanent resident, the amount to consider as deductible expenses has to be reduced according to the circumstances in the country of residence.

All parents, whether working or not, can deduct two-thirds of child-care expenses but not exceeding EUR 4,000 for children aged between 3 and 6 years as special personal deductions as these costs are not business expenses/income-related expenses. Furthermore, child-care expenses for children up to but excluding the age of 14 or for children up to but excluding the age of 27 are deductible as special personal deductions if the tax payer is still a student, physically or mentally disabled or ill. In this case, either both parents must fulfil one of the required conditions, or the parent who does not fulfil one of the requirements must work.

The taxpayer must provide proof of the expenses incurred by presentation of the invoice and payment on the account of the child-care service provider for both the deduction as business expenses/income-related expenses and as special personal expenses.

Non-resident taxpayers are not allowed to apply for the deduction as business expenses/income-related expenses and as special personal expenses. In case a deduction, according to the above mentioned regulations, is not possible on the merit of child-care services provided in the taxpayer's household, an income tax credit under the terms of the household help regulations may be asserted as described below under 'Household help'.

Household help

In 2003, the German government introduced an income tax credit for individuals who use the services of a legally registered service provider for household activities as a means to prevent an increase of illegal workers in Germany. Starting with the assessment period 2003, a direct deduction from the final income tax liability for such services typically provided around the house can be claimed.
Such typical household services are cooking, baking, sewing, laundry, window-cleaning or gardening. In addition, the German tax authorities have clarified that relocations carried out by shipping companies are household services that have to be considered, a ruling which is clearly beneficial to expatriates.

 For household services provided by a legally registered service provider within the household of the taxpayer, a reduction of 20 percent of the invoice can be claimed on condition that the invoice and a bank statement showing the cashless transfer is provided to the tax office together with the annual income tax return.
According to previous law, the maximum amount per annum was limited to EUR 600. The new regulations increased this amount to EUR 1200 as far as expenses for the care of persons who are in need of care at a certain level, or who qualify for contributions of nursing care insurance, in a private household are concerned.

Also relatives of persons needing nursing and caring are allowed to claim for the tax credit if they pay the costs for these care services and the nursing and caring services are carried out in the household of the needy person or in their own household.

According to the old regulations, the income tax credit for craftwork services in domestic private households could only be claimed for small repair work that could also be carried out by the taxpayer without particular handicraft skills.

Now all invoices for craftwork in connection with self-used real estate can be considered with 20 percent of the expenses per year—maximum EUR 600—irrespective of whether the services provided were for purposes of renovation, conservation or modernisation, for example, decorating services, the modernisation of a bathroom or the changing of windows have to be considered. As before, only labour costs will be taken into consideration, material costs are excluded.

The new regulations are applicable on services and payments after 31 December 2005.

For more information contact tax experts Daniele Sendler (dsendler@deloitte.de) or Katrin Koehler (kkoehler@deloitte.de) at Deloitte's offices in Germany.

June 2006

Subject: Tax in Germany