In Germany, employees of a foreign permanent establishment (PE) of a Germany-based company are taxable in Germany from day 1 on their remuneration proportional to their actual working days in Germany – this was clarified by the Federal Ministry of Finance already back in 2015.
The reason is quite simple – in Germany, a PE is not recognised as a legal employer (but only the Germany-based company which has established the PE abroad). Consequently, this Germany-based company is obliged to withhold wage tax for each working day in Germany – even if there is a double tax treaty applicable.
To reduce the high administrative burden, German legislature introduced a flat-rate-tax of 30% of the proportional remuneration as of 1 January 2020. However, the flat-rate tax is only possible if the German working days do not exceed a continuous period of 18 working days.
A big disadvantage is that the flat-rate tax of 30% will be higher than the individual tax rate of the employee in many cases. Therefore, the new flat-rate tax is costly for the employer.
Furthermore, the minimisation of administrative burden will not be achieved, as the collection/monitoring of foreign remuneration and German working days is still required under the new law.
ELStAM system for non-resident employees
The ELStAM system has replaced the old paper-based wages tax card as from 1 January 2013 for resident employees. The ELStAM system uses electronic criteria for wage tax deduction and significantly facilitates communication between employers, employees and tax offices.
As of 1 January 2020, also non-resident employees are integrated into the ELStAM system. Therefore, the employer must retrieve the electronic criteria for wage tax deduction via their payroll system. The prerequisite is a tax ID number for the employee. This must be applied for by the employee or employer.
New 2020 filing obligations for non-resident employees
So far, the German income tax liability for a full-year non-resident employee has generally been settled by the wage tax withholdings and no income tax return had to be filed. As of 2020, a new mandatory filing requirement was introduced for non-resident employees.
It needs to be considered if the employer applied the so-called “One-Fifth Rule” within the wage tax withholding procedure. The “One-Fifth Rule” is a beneficial tax calculation that applies to income for multiple years (e.g. income from long-term incentive plans or sever-ance payments).
Besides the increased administrative effort of filing a tax return, the new law will lead to a significantly higher tax burden for non-resident employees in many cases, as foreign income received during the year will be included for progression purposes when calculat-ing the employee’s personal tax rate.
Extended wage tax withholding obligation for German employers
Each Germany-based employer is obliged to withhold wage tax for its employees. This obligation applies also for employees from abroad who are working for a German employ-er (inbounds). In the past, this obligation was controversial for inbounds for which the German employer did not bear the remuneration costs – rightly or wrongly.
Since 1 January 2020, the German legislature clarified: if a German employer engages an employee from abroad for his Germany-based company, and they do not bear the costs, they still have the obligation to withhold, if they should have borne these costs after taking into account international transfer pricing rules (“arm’s length principle”).
