If you receive a severance payment as an employee after leaving a company, you usually have to pay tax on it in Germany as well. Fortunately, there are possibilities to have the severance pay paid tax-free abroad after a departure. However, this is only possible under certain conditions. If the severance payment has the characteristic of being an additional, albeit subsequent, payment for services rendered in the past, then the severance payment is taxable in Germany. Even any double taxation agreements have no influence on this. However, if a severance payment is related to restrictions on future professional activity, and thus corresponds to a carceral compensation, then the right of taxation belongs to the state in which the taxpayer is resident at the time of the payment. By the way, this also applies to severance payments with pension character.
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1. Introduction: Paying severance pay tax-free abroad
If an employee leaves an employment relationship and receives a severance payment, this is in principle taxable in Germany. If you consider the restriction according to the place of taxation, i.e. Germany, then it is easy to understand that many people in such a situation think about moving abroad first and only then paying out the severance pay. This is linked to the logically justified hope that the new home state will then tax the severance payment on much better terms than in Germany.
But is this really the case? After all, we know that logical conclusions regarding tax law are quite often the result of an illusion. Therefore, in this post, we’ll take a look at the facts to find out if you can have a severance package paid out tax-free abroad.
2. Paying out severance pay tax-free abroad: legal basis
For this purpose, we must of course be guided by the tax law, specifically with the income tax law on the taxation of income from employment. In this context, the provisions of Section 50d (12) of the German Income Tax Act (EStG) are particularly relevant, which, in connection with any double taxation treaties, governs the taxation of severance payments. The corresponding passage on severance payments in the OECD Model Convention for the Avoidance of Double Taxation, which in most cases forms the contractual basis for agreements with Germany, but also for many other countries, can be found in Article 15 (2) OECD-MA.
Let’s first take a closer look at Article 15 of the OECD-MA. Because embedded in this is the provision that when a severance payment is paid out, the state in which the taxpayer is resident at the time of payment has taxing jurisdiction. On this basis alone, the possibility of having the severance pay paid out tax-free abroad seems to be quite realistic.
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3. Different types of severance pay
Severance pay is usually received when one leaves a company. Normally, such a severance payment can be understood as additional remuneration for services rendered in the course of the employment relationship. On the other hand, there are also severance payments for which a different function is in the foreground. For example, it may be that a temporary ban on working for a competitor company or a non-competition clause from the previous employer should compensate the departing employee monetarily. This severance payment therefore represents a severance payment, the character of which is directed towards future circumstances. In addition, a severance payment may have a pension character. In this case, the payment of the severance pay is recurring and thus corresponds to a retirement salary.
Since there are several types of severance pay, let us now examine the conditions under which severance pay can be paid tax-free abroad.
4. Paying out severance pay tax-free abroad: for services rendered
Let us first create the following initial situation: An employee – we will call him Mr. Strada – leaves the company in which he worked for many years in Germany in the first half of the year. In this case, he is entitled to a severance payment that takes into account the periods during which he worked for the company. Mr. Strada had been planning to move abroad for some time, and now takes his departure from the company as an opportunity to implement this plan immediately. He also thinks that he could possibly have the severance pay paid out tax-free abroad. His former employer agrees.
The country so dear to Mr. Strada’s heart has concluded a double taxation agreement with Germany. This would seem to rule out double taxation of the severance pay already. Fortunately, his new home country does not tax severance payments at all. Nevertheless, some time later, Mr. Strada receives a message from the German tax office, which reminds him of the taxation of the severance payment. How can this be?
In order to understand this, it is necessary to take into account not only Article 15 OECD-MA, but also Section 50d, paragraph 12 EStG. Because this legal norm defines here that such severance pay is considered as retroactive remuneration from the time of the employment relationship. At a time when the right of taxation lay with Germany. Therefore, Germany considers that it has a right to tax the severance pay even after the fact, regardless of the rules provided by the double taxation treaty with regard to the taxpayer’s residency.
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5. Paying out severance pay tax-free abroad: for future renunciations
In contrast, let us now consider what happens if Mr. Strada instead agrees, upon his departure, not to work for a competitor company or as a competitor for a defined period of time (usually two years). If he now receives a severance payment for this, then it has a reference to future actions, even if this basically corresponds to an omission. As a result, Section 50d (12) of the German Income Tax Act does not apply in this case. Therefore, the provisions of the double taxation agreement apply. And that is the taxation in the country where the taxpayer Mr. Strada is resident for tax purposes at the time of payment of the severance pay. Thus, provided that the relevant tax regime with respect to the taxation of severance payments in his new home country is in place, Mr. Strada can have his severance payment paid tax-free abroad.
6. Paying out severance pay tax-free abroad: for retirement salaries
In our third case, we assume that Mr. Strada is to receive a severance payment in the form of a retirement salary after leaving the German company and subsequently moving abroad.
Although a reference back to his previous activity with the company in Germany also applies here, so that, as we have just learned, taxation in Germany is expected in accordance with Section 50d (12) of the German Income Tax Act (EStG). However, retirement salaries, since they are subject to periodic payment, have a pension character. Therefore, this aspect is in the foreground when assessing the application of Section 50d (12) EStG. Consequently, Article 18 OECD-MA instead of Article 15 OECD-MA is applicable in this case. And Article 18 OECD-MA stipulates that the right of taxation for retirement salaries is incumbent on the Contracting State in which the taxpayer is resident.
For this reason, many German pensioners and retirees pay a tax on their pension in their country of residence chosen for old age, for example in Spain, which in Germany would result in either a significantly lower tax or even no tax at all. So, from a tax point of view, let us hope that Mr. Strada receives his regular payment of severance pay in a country where such income does not give rise to taxes.
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Our law firm is particularly specialized in providing advice on international tax law. When it comes to the topic of paying severance pay tax-free abroad, clients value our expertise in the following areas, for example:
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Our tax advisors and attorneys at the Cologne and Bonn offices will be happy to provide you with personal advice on this subject. In addition, we provide advice throughout Germany by telephone and videoconference: