Globalization has led to increasing cross-border secondments of management and other employees. Cross-border assignments help companies and groups of companies to understand and develop deeper connections with foreign cultures and markets as well as their own foreign business. Companies also endeavour to benefit from their existing employees' skills and experience when expanding abroad by seconding them to new offices.
From a legal point of view, such assignments usually trigger the following types of issues: employment, civil, company, social security, administrative law and, of course, tax law. The tax considerations differ depending on whether a secondment is (i) into Germany ("inbound") or (ii) out of Germany ("outbound").
Secondments into Germany
Companies and entrepreneurs expanding their business activities to Germany are often faced with several German tax law issues.
If members of the key management team are seconded, the employing company will want to avoid any risk of an unrestricted (corporate) income tax liability in Germany on its worldwide income. Even if the company's "statutory place of business" is not in Germany, if an "effective place of management" is in Germany then an unrestricted German tax liability may be triggered. In light of this companies must be aware that seconding senior executives to Germany could be deemed to establish an "effective place of management" in Germany. This will be the case if day-to-day management decisions are effectively made in Germany.
Companies and investors will also aim to avoid creating a "permanent establishment" in Germany, as the creation of such an establishment will trigger not only a tax burden, but also tax compliance issues in Germany. A "permanent establishment" is any fixed place of business or facility that serves the business of an enterprise. The term "permanent establishment" also includes a place of management. Numerous German tax court decisions deal with the issue of seconded managers' "home offices" potentially constituting "permanent establishments". In this context, it should be noted that seconded employees who are deemed to be "permanent representatives" may trigger a "permanent establishment" as well. A "permanent representative" is a person who carries out business transactions for an enterprise on an ongoing basis and, in so doing, is subject to its substantive instructions. This includes, in particular, persons who, on an ongoing basis, enter into or solicit contracts, obtain orders, or maintain a stock of goods or merchandise and make deliveries from this stock. Finally, it should be noted that applicable double tax treaties define the term "permanent establishment" differently, and the local German tax authority may not be aware of this in each specific case.
Creating a "permanent establishment" may also have VAT implications for the seconding company. However, given that today's VAT laws are harmonised by EU legislation as interpreted by the European Court of Justice, the permanent establishment rules for VAT registration and VAT liability are different from the rules for (corporate) income tax and trade tax liability.
Moreover, in virtually all cases where a permanent establishment is created, the personal income tax situation of the seconded employee is affected, which also potentially creates a wage tax liability for the seconding company. As a general rule, maintaining a residence or usual abode in Germany will subject the employee's worldwide income to German tax, unless the individual is protected by the rules of an applicable double tax treaty. In some cases, the secondment can be structured in a way to avoid the employee being subject to an unrestricted income tax liability. It should be kept in mind that inbound secondees who are not aware of the German principle of taxation of worldwide income risk being investigated for tax fraud, and being subjected to subsequent penalty payments, for many years into the future.
In some cases, issues relating to the taxation of equity incentives may arise. If, for instance, an employee seconded to several countries in succession realizes a taxable profit from the exercise of a stock option granted many years earlier, it may not be clear which country has a right to tax such profit.
Secondments from Germany
The Federal German Ministry of Finance has issued a circular defining "employee secondment" for tax purposes. Pursuant to this guidance, an "employee secondment" requires the employee to maintain his employment with his employer or the employer's group of companies either by switching his original contractual employment relationship to an employment relationship with the group company to which he is seconded or, alternatively, ensuring that the group company to which he is seconded is regarded, in economic terms, as his employer. The guidance stipulates that no secondment occurs if the employee simply performs an obligation, which is owed to his original employer, for the group company abroad to which he is seconded. In such cases, the German Ministry of Finance's guidance on secondments do not apply.
Outbound employee assignments typically trigger the following tax issues for the employer:
- the wages tax consequences of the assignment need to be clarified;
- a salary being paid for or on behalf of an employee assigned abroad might not be fully tax deductible from the employer's corporate income tax liability;
- the seconded employee may trigger a "permanent establishment" for the employer abroad (please see above for the implications of this);
- the employer is often faced with income allocation issues in terms of base salary, contributions to pension schemes or other allowances between the affiliated companies involved. The German Ministry of Finance has established criteria for income and cost allocation in cases of secondments which should be observed. In general, secondments must comply with the arm's length principle; and
- in some cases the assignment may affect the taxation of stock options or similar equity incentive schemes for both the employee and the employer.
In terms of the income tax implications for the employee, it is necessary to determine whether the employee maintains accommodation (e.g. an apartment) in Germany. In this case double taxation issues are definitely triggered, as both Germany and the country to which he or she is seconded may claim a right to tax salary or potentially even worldwide income. Furthermore, it is necessary to determine whether a double tax treaty exists between Germany and the other country. Employees seconded from Germany may benefit from a tax exemption under specific administrative guidance (Auslandstätigkeitserlass) even if no double tax treaty exists. If, however, the employee gives up any German residence he could remain liable to restricted German income tax on any sources of income arising in Germany (e.g. income from renting out real estate). In addition, in certain cases the German Foreign Transaction Tax Act (Außensteuergesetz) may trigger additional income tax liabilities. It should also be noted that there are special regimes for cross-border commuters in most double tax treaties.
Tax structuring of secondments
The planning of employee secondments should take into account the employer's as well as the employee's tax situation. As a starting point a few basic German tax rules should be considered:
- German income tax law distinguishes between business travel and employee assignment. Business travel rules may apply for short term assignments of up to three months. Business travel tax rules differ, inter alia, in terms of tax deductible expenses for the employer as well as the taxation of reimbursement of travel expenses for the employee.
The 183 day rule will have to be taken into account. In this regard, the following guidelines usually apply:
- Salaries, wages and similar remuneration derived by a foreign expatriate from employment shall be taxable in the country to which he/she has been seconded if, and to the extent to which, the employment is exercised there.
- However, many double tax treaties set out that remuneration derived by an expatriate in respect of employment exercised in the other country shall be taxable only in the home state of residence if: (i) the employee is present in the country of secondment for periods not exceeding, in aggregate, 183 days in the fiscal year concerned, and (ii) the remuneration is paid by, or on behalf of, an employer who is not a resident of the country of secondment, and (iii) the remuneration is not borne by a "permanent establishment" in that country. If the employment is so exercised, such remuneration may be taxed only in the home state of residence.
- Please note that individual double tax treaties vary when defining the specifics of the 183 day rule. Special rules also apply for the first and the last year of the assignment.
- If the requirements under the 183 day rule cannot be met, the expatriate will be taxed in all countries in which he actually performs his employment. This may trigger, in general, an obligation to file several tax returns in different jurisdictions.
In a number of countries special beneficial regimes may apply for expatriates. In each case the applicable double tax treaty must be thoroughly considered.
Secondments also trigger social security contributions. Social security is not treated as a tax law issue in Germany, unlike in other countries.
The basic position is that social security contributions are paid in the country where the employment is carried out. However, there are exceptions to this general rule under German law (the "Ein- und Ausstrahlung") and the law of the European Union (and also if other countries are involved) in cases where inter-governmental agreements regarding social security matters exist between the home and host country.
In the European Union a specific Regulation (EU No. 883/2004 since 01.5.2010) applies which deals with the coordination of social security systems in Europe and is, therefore, relevant to secondments. If a seconded employee intends to return to his home country at the end of the secondment, it is possible to remain in the home country's social security system for a certain amount of time during the secondment (in the European Union this is usually 24 months).
In relation to inbound secondments from non-European Union countries, where no specific inter-governmental agreements exist, German law provides for potential exemptions from the obligation to pay social security in Germany. As for outbound secondments, it is often possible to remain in the German social security system despite being seconded out of Germany (and out of the European Union).
Prior to a secondment the social security implications should be clarified with the social security authorities involved in both the home and host country. When employees are seconded abroad from Germany, the social security implications of the secondment, in particular application for a secondment certificate (Entsendebescheinigung "E 101" or "A 1"), and other potential exemptions, must be coordinated with the statutory health insurances' head office beforehand.
Social security implications also have to be considered in situations where employees work at the same time in different countries. Within the European Union, where the employment activities are substantially performed in the home country, the application of social security law is not determined by the "nationality" of the labor contract, but exclusively by the residence of the employee.
A cross-border secondment may trigger aspects from fields of law such as employment, immigration, commercial and corporate. However, tax and social security aspects at the level of both the employer and the employee are some of the most sensitive legal implications and should be considered carefully in advance.