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Worldwide income: which income is taxed in which country?

Anyone who has worldwide income is subject to tax. The question is, in which country do you have to pay the taxes?

Table of Contents

Importance of domicile and residence

Anyone who has a residence in Germany or stays here for a longer period of time and has a worldwide income is also liable to tax on their worldwide income. This is the same in most other countries. This is called unlimited tax liability. Some countries, such as the USA, link unlimited tax liability to nationality. Therefore, US citizens are always subject to tax in the USA, even if they do not have residency there. At the same time, however, they are subject to unlimited tax liability in the country in which they live.

 

There are people who live in different countries. They are then subject to unlimited taxation in all of these countries and would therefore theoretically have to pay tax on their entire global income several times. In cases where a DTA exists at all, the so-called residency is determined in advance. In tax and social security law, this is where you have your center of vital interests. To put it simply, the center of life's interests is where the heart beats. This is usually where the family lives. But leisure activities and hobbies are also connecting points. If you cannot clearly assign your life interests to a country, you will be asked about sources of income and the location of your property interests. If all else fails, nationality decides.

Clarified residence

However, once your residency has been clarified, this does not mean that you will have to pay tax on your entire income there. Residence does not displace parallel unlimited or limited tax liability in several states. However, within the meaning of the DBA, residency determines how the DBA is to be read and understood in the separate articles for each type of income.

 

For example:

  • Regardless of their origin, interest and dividends are taxable in the country of residence of the recipient.
  • Income from employee activity in one country is taxable where the activity is carried out, despite residency in the other country. For cross-border commuters or managing directors, however, residency plays a role again.
  • Income from the rental of property is taxable in the country in which the property is located. Residence doesn't matter

 

Income from abroad

You can also have a source of income in a country without living there. most countries then tax income from this source. In these cases one speaks of limited tax liability. As a result, you can have unlimited tax liability in several countries at the same time and limited tax liability in other countries at the same time. But international cooperation wouldn't work that way.

Avoidance of double taxation – DTA

That is why many countries have concluded bilateral agreements to avoid double taxation (DTA). There are two ways to avoid double taxation in the DTA. With the so-called exemption method, one of the countries involved waives the exercise of its taxation rights. If Germany has to waive according to the wording of the DTA, proof will be required that the other country has taxed the corresponding income or was at least aware of its right to tax. Because you want to avoid non-taxation of income.

 

With the imputation method, both countries assign the corresponding income (unlimited or limited). However, the tax paid in the other country and no longer subject to a refund will be offset against the national tax burden. With this method you are always stuck with the higher of the two taxes. The problem here is that you may fail to assert any claim for reimbursement abroad. If the foreign state wrongly believes that it is allowed to tax the income and therefore imposes taxes, a refund application must be filed and enforced. Otherwise these taxes cannot be credited in the other country.

Example Germany-Switzerland

A person living in Germany receives interest or dividends from Switzerland. This is global income. According to the DTA, Switzerland is entitled to withhold 35% withholding tax from such income. However, 20% will be reimbursed for residents of Germany upon request. The entire gross income from interest and dividends is taxed in Germany; only the 15% that rightly remains in Switzerland is offset against the German tax burden. Anyone who fails to submit an application in Switzerland on time is out of luck and will pay taxes twice.

How does a double taxation agreement (DTA) work?

DTAs are international agreements that two states conclude bilaterally with each other to avoid double taxation of income, assets, gifts and inheritances. In short: The DTA ensures that worldwide income is not taxed twice. However, there are no internationally valid DTAs. There is no DTA at all for sales taxes, so double taxation is possible here. If double taxation occurs with sales tax, there is no mechanism to eliminate this.

DBA = bilateral agreement

Since these are bilateral agreements, no two agreements are the same. This is because the DTAs are written in both national languages, with both language versions having equal rights. But it is impossible to translate a text in such a way that the same thing is meant or understood in the same way on both sides. We are currently conducting proceedings before the tax court in a German-French case in which the taxpayer relies on the French language version before the German tax court. To do this, the judge must first have a good enough command of the French language or find an officially appointed translator who also has an in-depth knowledge of tax law. The DBA therefore demands a lot from even the scholars.

 

Once the language hurdle has been overcome, there is not necessarily a technical agreement about what is written in the DBA. It is true that most states follow the model contract and the interpretation of the OECD when negotiating and interpreting it. However, the OECD's interpretation is not binding, so in the end each country presents its own point of view.

Different interpretations of terms

So is e.g. For example, the term “income from employment” in the DTA is not synonymous with the term “income from employment” in the German Income Tax Act. In the DTA this refers to income (worldwide income) that comes from the physical performance of an activity. These are

  • the remuneration for the activity carried out, typical of this is the current salary
  • Pro-rata performance-related compensation, including bonuses, royalties and options
  • Compensation for lost income in the form of one-off payments, income as a result of previous employment, pensions and pension payments
  • Remuneration for taking on responsibility, this applies to the supervisory board and the administrative board
  • public service, benefits from public funds
  • Flight attendants

 

From the perspective of the German tax authorities, this type of income also includes compensation for the loss of a job, i.e. severance pay. However, France does not classify severance pay as this type of income, but treats it as other income. And Germany is only examining Article 13 of the DTA, while France is assessing the matter according to Article 18. In this respect, one speaks of a qualification conflict that can only be resolved at the state level in a usually lengthy mutual agreement procedure.

DBA - worldwide income: The most important regulations are outlined below:

  • Employment: Taxation at the place where the work is physically carried out. If the work is carried out in several countries, e.g. in the home office, then the taxation right is divided between the countries on a pro rata basis.

 

  • In some countries there are special regulations for cross-border commuters. Despite carrying out their work in the other country, they are then taxed where they live or are resident.

 

  • There are also separate regulations for managing directors, board members and other management bodies in some DTAs, for example Germany-Switzerland. The salary is then taxed in the country in which the company is based. Caution: the tax residence of the company is not necessarily where the company is registered.

 

  • Supervisory/Administrative Board: Taxation takes place at the company's registered office.

 

  • Pensions, pensions: taxation at the place of residence, but does not apply to pensions from public funds (DRV, AHV), then usually the “cash state principle”.

 

  • Rental real estate: taxation in the country in which the property is located.

 

  • Corporate profits: Taxation at the company's registered office, unless there is a DBA permanent establishment in another country

 

  • Interest, dividends: Residence of the beneficiary, but in some countries withholding tax, which is partially refunded upon request.
  •  

All of the taxpayer's income must be stated in an income tax return, regardless of where it is taxable based on national laws and the DTA. In the case of exemption, the income taxed abroad is included in the calculation of the tax percentage, whereby the percentage is only applied to the income subject to tax at home. This is called progression reservation or rate-determining income.

It should be noted that due to the allocation of income to different countries, it can happen that you pay taxes in one country, while tax losses are declared in the other country, but these cannot be offset against positive income across the border. An exception are the so-called final losses, see the separate article.

 

The complexity of national tax laws is further increased by the DTA. This results in a number of problems, as incorrect non-declaration of income is punished in every country. But this also gives rise to design possibilities. The banker and founder of the house Mayer Amschel Rothschild, who was born in Frankfurt in 1744, already knew this. The quote comes from him: “Ignorance of tax laws does not exempt you from paying taxes.
But the knowledge often”.

Jürgen Bächle
Jurgen Bachle

has been working as an independent tax consultant and expert in international tax law since 1989 and has been a member of the board of the German Association of Tax Consultants Baden-Württemberg, DSTVBW, for over 20 years.

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