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Working abroad - Tax equalisation and tax protection in the new ‘183-day circular’

During a period of working abroad, employers and employees normally conclude tax equalisation agreements. The usual methods here are tax equalisation and tax protection. One of the tax equalisation methods that underlies the posting of employees will ensue from the employer’s general posting guideline. In addition, individually applicable arrangements under the contract of employment have to be taken into account.

In this connection, the Federal Ministry of Finance (Bundesministerium der Finanzen, BMF) recently compiled the principles that have to be observed in a circular of 12.12.2023 (reference: IV B 2 - S 1300/21/10024 :005).

Alternative methods

In the case of tax equalisation, employees should be made liable to taxation in the amount equivalent to the one that would have to have been paid if they had remained in their home countries irrespective of the tax rates applicable in the host state. By contrast, in the case of tax protection, employers only compensate the tax disadvantages in the host country. Accordingly, an employer would assume the additional tax charges in the event that the taxes in the host state are higher than those in the home country. However, if the tax rate in the host country is lower than in the home country then the benefit would go not to the employer but instead to the employee. 

Hypothetical tax withholding and actual tax payments

Both methods can result in hypothetical tax (hypotax) being withheld from employees within the scope of salary accounting. In return, employers assume the actual taxes that are incurred (in the host state). Hypotax does not constitute the tax that is actually paid in the home country or host state, but rather a fictitiously calculated quantity within the scope of the internal relationship between the employee and employer. Hypotax reduces an employee’s gross salary. If an employer withholds a hypotax then this would be a salary deduction and the employee would not receive the equivalent amount as salary.

Please note: The full amount of income tax that has actually been paid by the employer for the employee has to be classified as the employee’s salary in the respective state (state of domicile or the state where the work was performed) where it was incurred.

Special features of net pay agreements

In cases where employees work across borders, it is first necessary to check whether gross pay agreements or net pay agreements have been made. Under a net pay agreement, the employer pays the employee a fixed net salary. The employer likewise undertakes to bear the cost of all or specific levies (tax and social security contributions) for the employee.

If a domestic (German) employer pays a net salary then this value has to be ‘grossed up’ for the respective remuneration payment period. If the employer assumes the responsibility for making the employee’s additional income tax payments, then, on the date of the payment, this would result in a further inflow of remuneration for the employee that would, in turn, have to be ‘grossed up’. Adding together the grossed-up salaries for the individual remuneration payment periods (consisting of regular salary payments and other compensation) results in the employee’s total grossed-up annual salary. This grossed-up amount should be shown on the electronic certificate of payroll tax deductions as taxable gross salary or as the employee’s tax-free salary under a double taxation agreement.

If the employer is not obliged to deduct payroll tax in Germany and the salary payment to the employee is made on the basis of a net pay agreement then, in the assessment, only the net salary that was paid out in the respective calendar year has to be included. It is only when the foreign employer subsequently compensates the accrued tax amounts that this compensated amount has to be taxed once again within the scope of the income tax assessment. In these cases, the amount is not grossed up.

Financial support for prepayments

If, in exceptional cases, an employee receives financial support from the employer during the calendar year already so that the employee is able to make the prepayments that become due to the tax office then, to this extent, this would also constitute remuneration that had already accrued. The same would apply if the employer were to transfer the prepayments directly to the tax authority responsible for the employee’s assessment. Here, too, the amount would not need to be grossed up.

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