Deloitte & Touche report on Germany's new administrative rule relating to the tax treatment of employment income and respective business expenses under net salary arrangements.

When an employer and employee enter into a net salary agreement, it is the employer's responsibility to pay the host country tax liability. The agreement protects the employee from paying a higher tax burden when on assignment than they otherwise would have done should they have remained in their home country.

Benefit-in-kind

Since the employee would have paid home country taxes if they had not accepted the assignment, included in the assignment package is that the employer withholds a 'hypothetical tax' on the employee's normal compensation. This hypothetical tax is withheld by the employer via the payroll, either in the home or in the host country. In turn, the employer pays the host country taxes.

Since the assignment arrangements require the employer to pay the employee's German tax liability, this payment is also considered a 'benefit-in-kind' which must be grossed-up in the German payroll. However, this significantly increases the employee's taxable compensation and the assignment cost to the employer. Therefore, it is crucial to take advantage of the employee's individual tax return and for the employer to structure the reimbursement of expenses wherever possible and in this way reduce the German tax burden.

Two significant changes stemming from the new administrative ruling affect tax preparation fees and moving expenses.

The ruling also clarifies previously confusing areas of expat taxation.

Tax preparation fees, which are related to the employee's individual income tax return and which are paid by the employer, are taxable income. Therefore, the employer must include the fee paid for both the home and host country tax returns in taxable compensation.

Prior to 2006, German income tax law allowed for a deduction of tax preparation fees which were taxed via the payroll – or for the tax preparation fees the employee paid themselves and which were not reimbursed. This deduction was abolished as of 1 January 2006.

Conditions for tax-free moving expenses

In general business-related moving expenses are treated as a deductible expense or reimbursed tax-free, according to German income tax law. Actual moving expenses can be reimbursed tax-free if the amounts reimbursed are supported by invoices and do not exceed the invoiced amount.

Direct payment from the employer to a third-party vendor is also possible. Amounts which can be reimbursed tax-free are – provided, the reimbursement or the payment is based on invoices – for example:

• Transportation of household goods and personnel effects,
• Travel for the employee and their family.

In addition to the tax-free reimbursement of actual moving expenses, German income tax law also allows for a standard deduction in the assignee's German income tax return for moving expenses.

The standard deduction is intended to cover all moving expenses which typically occur, but for which the individual does typically not receive an invoice, such as the tip for the moving company's personnel.

The new ruling clarifies that moving expenses for repatriation to the home country are only deductible as a business expense if the assignment to Germany was set for a limited period at the beginning of the assignment.

When the centre of vital interest shifts

A 'centre of vital interest' for an expatriate is the country in which they have the strongest family ties. For example, if the expatriate is married with children, and the children remain in the home country along with the spouse, the centre of vital interest will remain the home country. For a single expat with strong family ties in the home country this still applies. Usually the longer the assignment the more likely it is that the centre of vital interest will shift to the host country.

Employee's whose centre of vital interest switched from their home country to Germany, and switched due to the German assignment, will receive 80 percent of the standard moving deduction amount when moving back to their home country.

However, if the employee's home country principle residence was maintained but their centre of vital interests was switched from their home country to Germany, they will receive 60 percent if married and jointly filing, and 40 percent if single, of the standard moving deduction amount when repatriating.

Case study

Let us take the example of a married taxpayer with two dependent children on a three-year assignment to Germany, whose centre of vital interest transferred to Germany and whose home was maintained in the home country.

Standard moving deduction for the move back to the home country:

When a 'double household' applies

The standard moving deduction will only be granted if the individual's centre of vital interest does not remain in the home country.

If it remains in the home country, then the individual will have a 'double household' according to German income tax law and they will be allowed to deduct the actual costs for the second household established due to the German assignment, to receive German taxable income from employment. Actual moving costs will still be deducted as a business expense in the German return, but – as previously mentioned – a standard moving deduction would not be allowed.

The new administrative rule has also amended the tax treatment for Japanese relocating to Germany with regards to double-residency, according to the existing treaty between Germany and Japan.

February 2006

Katrin Köhler is Senior Manager International Assignment Services at Deloitte & Touche GmbH, Düsseldorf.

Subject: Expat tax in Germany, relocating to Germany