Employees working cross-border Germany and the Netherlands: where to pay tax on termination payments

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In our January 2016 newsletter we informed you about the new double tax treaty between the Netherlands and Germany (the “2016 Tax Treaty”).  In that article we highlighted an area of uncertainty with regards to the allocation of taxation rights for termination payments where employees work cross-border, which the 2016 Tax Treaty failed to resolve.  Now amended legislation in both countries has resolved the position, providing clarity on this issue.

In this article we summarise:

• the position prior to the 2016 Tax Treaty (as transitional rules apply for the tax year 2016, allowing individuals to choose to apply the former treaty in some circumstances for that tax year);
• the position under the 2016 Tax Treaty, and how this has been resolved.

Treatment under previous Netherlands-Germany double tax treaty (effective through 2015) (the “Previous Tax Treaty”)

The Previous Tax Treaty did not make specific provision for termination payments in the situation where employees worked cross-border.  The result: a difference of approach between the two countries:

• Germany was of the opinion (based on case law) that the country of residence had the right to tax a termination payment since it was a compensation for the loss of a job with consequences for future earnings.
• The Netherlands’ view (based on Dutch case law) was to consider the country(ies) where the employee worked in the past during a reference period of four years in order to determine the allocation of taxation rights.

Since this difference of interpretation could lead to double taxation or no taxation at all, the Dutch and German authorities agreed in 2007 to allocate taxation rights (i.e. between the country(ies) where the employee worked, during the full term of his/her employment) (the “2007 Agreement”).  However, the legitimacy of the 2007 Agreement, which in the Netherlands was implemented via a 2007 Directive, was successfully challenged in both countries.

2016 Tax Treaty

Unfortunately, the countries missed the chance to include a legal agreement on the allocation of taxation rights for termination payments in the new treaty.  Therefore, national rules have to be applied in both countries to resolve the issue of termination payments where employees work cross-border:

• Germany has adopted new legislation (sec. 50d (12) German Income Tax Act) which from 1 January 2017 generally leads to taxation of termination payments in the country(ies) of employment.  However, Germany maintains the right to tax its tax residents if (part of) the termination payment is not taxed at all.
• The Netherlands now applies (as for other OECD-based tax treaties) the interpretation of article 15 of the OECD Model Treaty as published in 2014: in general, allocation of taxation is linked to where the employee worked during the last 12 months of his employment.

This solves the problems arising from the different interpretation in the two countries.  Through 2016, the problem of double taxation can be solved via mutual agreement.

What should you do next?

• When dismissing a Dutch or German employee working cross-border and drafting the termination agreement, carefully check and lay down the tax consequences in both countries, in the interests of both employer and employee.
• Always carefully check whether for the year 2016 invoking the Previous Tax Treaty would be more favourable than applying the 2016 Tax Treaty (and if so apply the Previous Tax Treaty in full and in both countries).  However, the choice should not be dictated by the taxation of termination payments now the 2007 Agreement is no longer justifiable and taxation issues are the same under both treaties.
• If in the past the 2007 Directive was applied in the Netherlands, but applying the 2014 OECD Model treaty Commentary is more favorable, tax payers can appeal against tax bills which are not final yet.
• With respect to German taxation up to the tax year 2016, check carefully whether the jurisdiction of the Federal Finance Court leads to a more advantageous tax position.
• With regards to the most recent German legislation, note that this may still be subject to challenge in the German tax courts.

Further information

For further information or to discuss any of the issues raised, please contact Rina Driece on +31 10 224 6 424, Loyens & Loeff, the Netherlands, or Joachim Menz on +49 892422300, Keller-Menz, Germany.

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