German international tax law
Foreign income in the German income tax system
Individuals subject to unlimited German income tax liability generally must also include foreign-source income in the German tax analysis. Whether that income is actually taxed in Germany, exempt under a double tax treaty or taxed with a credit for foreign tax depends on the type of income, the source country and the treaty rules that apply.
Starting point
Unlimited German tax liability generally means worldwide income
An individual who is subject to unlimited German income tax liability is generally taxed on both German and foreign income. The fact that a payment originates abroad does not by itself make it exempt from German tax.
After the income has been classified under German income tax law, it must be determined whether an applicable double tax treaty allows Germany to tax the income or requires Germany to exempt it. If no treaty applies, or if the treaty uses the credit method, Sections 34c and 34d EStG may become relevant.
The result therefore commonly depends on three levels: German domestic tax law, the foreign country's tax law and, where applicable, the double tax treaty between the two countries.
Section 34d EStG
What counts as foreign income under German tax law?
Section 34d EStG contains a specific catalogue for purposes of foreign tax relief. It is not enough that money is paid from abroad. The relevant question is where the income source is located under the statutory sourcing rules.
Foreign agricultural business
Income can qualify as foreign income where the agricultural or forestry activity is carried on abroad or the relevant business establishment is located there.
Foreign permanent establishment
For business income, it is often decisive whether the income is attributable to a foreign permanent establishment or to business activities conducted through a foreign place of business.
Activities or fixed base abroad
For professional and other self-employed activities, the analysis may depend on where the services are performed and whether a fixed base or permanent establishment is involved.
Work performed abroad
For employment income, the place where the work is actually performed is usually highly relevant. Employer state, residence state and work state can differ.
Dividends, interest and other investment returns
For investment income, the source classification can depend on factors such as the debtor, issuer or company paying the income and the applicable statutory sourcing rule.
Location of the property
Rental income from real estate located abroad is a typical category of foreign income. Under many treaties, the location of the property is also central to the allocation of taxing rights.
Double tax treaties
Exemption method or credit method
Double tax treaties do not eliminate double taxation in the same way for every type of income. Depending on the treaty and income category, Germany commonly uses either the exemption method or the credit method.
Germany removes the income from the German tax base
- The relevant foreign income is generally not taxed directly in Germany.
- It may nevertheless affect the German tax rate under the progression clause.
- Whether the progression clause applies depends on both the treaty and Section 32b EStG.
- Typical examples can include foreign permanent establishments and foreign real estate.
Germany taxes the income and credits foreign tax
- The foreign income remains part of the German tax base.
- Foreign tax can be credited against German tax within the statutory limits.
- The credit is capped and may not fully eliminate double taxation in every case.
- This method is common for many dividends and interest payments.
Section 34c EStG
Foreign income tax and withholding tax credits
Where foreign tax is imposed on income that is also taxed in Germany, Section 34c EStG can provide a foreign tax credit or, in certain circumstances, a deduction. The credit is neither automatic nor unlimited.
Foreign tax must generally be assessed and paid
The credit analysis focuses on the foreign tax that was actually assessed and paid.
A substantive link to the income is required
Only foreign tax attributable to the relevant foreign income included in the German assessment can generally be credited.
Credit limitation
The German foreign tax credit is limited. A high foreign tax burden therefore does not automatically lead to full relief in Germany.
Withholding tax and final assessment are different issues
Dividends, interest and other investment income may first be subject to withholding tax. Treaty reduction, source-country refund and German credit treatment must be analysed separately.
Section 32b EStG
Tax-exempt foreign income can increase the German tax rate
Foreign income that is exempt from German tax under a treaty can still be relevant for the German progression clause. It may not increase the German tax base itself, but it can increase the tax rate applied to other taxable income.
A higher German tax rate may result
Positive exempt foreign income can increase the average tax rate applied to income that remains taxable in Germany.
No automatic negative progression effect
Foreign losses do not automatically reduce the German tax rate. Restrictions under German domestic law, including Section 2a EStG, can prevent such losses from being taken into account.
Treaty permission alone is not enough
Even where a treaty allows Germany to apply a progression clause, the actual domestic-law basis is Section 32b EStG.
Year of arrival or departure
Foreign income during a year with only partial German tax residence
In the year of moving into or out of Germany, the tax year often has to be separated into periods with and without unlimited German tax liability. Income earned outside the period of unlimited German tax liability can still be relevant for the progression clause.
Moving to Germany
Foreign income earned before arrival can be relevant to the German tax rate in the year of arrival even though it is not part of the worldwide income taxed during the later period of unlimited German tax liability.
Leaving Germany
Foreign income earned after unlimited German tax liability ends can likewise be relevant to the progression clause in the departure year.
German-source income after departure
Certain German-source income can remain subject to limited German tax liability after the move.
Treaty residence is a separate question
Domestic tax liability and treaty residence are different levels of analysis. Where a person maintains homes in two countries, the treaty tie-breaker can become decisive.
Federal Fiscal Court case law
Important BFH decisions on foreign income
BFH case law shows that foreign tax credits, progression and treaty exemption each have their own statutory requirements. German tax treatment therefore cannot be derived solely from the foreign tax return.
Foreign tax credit under Section 34c EStG
The BFH emphasized that the foreign tax credit is limited both in time and by subject matter. Only foreign tax attributable to the foreign income included in the relevant German tax assessment can generally be credited.
Where the foreign tax base includes other income as well, an allocation of the foreign tax can be required.
No negative progression effect for non-deductible foreign losses
In a case involving losses from foreign real property, the BFH held that negative foreign income excluded under Section 2a EStG could not reduce the German tax rate through a negative progression effect.
The court also clarified that a treaty may permit a progression clause, but its concrete application requires a domestic-law basis in Section 32b EStG.
Not all treaty-exempt foreign income is subject to progression
The BFH considered income from agricultural land extending across the German- Dutch border. The decision illustrates that statutory exclusions in Section 32b EStG must be checked in addition to the treaty exemption itself.
Practical documentation
Which documents are typically needed for foreign income?
Foreign tax return and tax assessment
These documents show which income was taxed by the source country and which foreign tax was assessed.
Proof of foreign tax payment
Evidence of actual payment can be required for a German foreign tax credit.
Income-specific documents
Depending on the income category, employment contracts, brokerage statements, rental statements, company records or permanent-establishment documentation may be needed.
Treaty and residence documentation
In dual-residence or multi-country work situations, the actual residence, presence and work patterns may also need to be documented.
Further reading
Related German tax topics
Some detailed German-law pages are currently available only in German. Those links are identified below.
International tax advice
Do you receive income from outside Germany?
We review the German tax classification, the applicable double tax treaty, exemption or foreign tax credit, progression effects and the correct reporting in the German income tax return.
Arrange an initial consultation