Tax and employment law factors in France, Germany and Luxembourg
This article sets out views from CMS lawyers in France, Germany and Luxembourg. From the perspective of lawyers in those jurisdictions, Brexit has already seen UK-based businesses move part or all of their operations to other EU jurisdictions, particularly those with key strategic financial and commercial centres. As the so-called Brexodus gathers pace, we outline the key tax and employment law considerations for companies looking to set up in France, Germany or Luxembourg – three countries that are proving especially attractive to banking and financial services firms and professionals seeking a new post-Brexit base.
Worker-friendly tax incentives
The French Government is committed to positioning Paris and the wider French financial market as Europe’s key post-Brexit financial centre. New tax incentives are already in place as part of an ambitious reform agenda focused on bolstering the country’s competitiveness.
The 2017 Finance Act extended the “inpatriates tax regime” – a range of specific and generous tax incentives for people who move to France for professional purposes – to cover an eight-year period after a qualifying individual moves to France. In essence, the inpatriation premium received during the employee’s entire stay in France is fully exempt from income tax. Employees directly hired abroad may elect to estimate the inpatriation premium at a flat rate of 30% of their net remuneration.
Passive income from foreign sources – including dividends, interest, capital gains on the sale of shares or life insurance income – may also benefit from a 50% income tax exemption. Inpatriate employees are also exempt from real estate wealth tax regarding their non-French properties for five years after settling in France.
President Macron’s government underlined its commitment to introducing tax incentives in the 2018 Finance Act. Key measures include:
- progressively reducing French Corporate Income Tax to 25%, fully applicable for financial years from 2022
- introducing a flat-rate withholding tax of 30% (including personal income tax and social contribution at aggregate rates of 12.8% and 17.2% respectively) applicable to most investment income and gains – including interest, dividends, and capital gains
- abolishing wealth tax on financial assets and replacing it with a real estate wealth tax (“IFI”) which is only applicable to real estate assets, except for those assigned to a professional activity.
The French Government’s draft Finance Act for 2019 offers a further incentive to foreign employees arriving in France by making them eligible to benefit from the 30% flat-rate tax on carried interest, if certain conditions are met.
Off the record, we understand that the French Government would be receptive to changing aspects of the inpatriate regime that might be a source of difficulties in the context of Brexit. In the same vein, the Government would also support the speeding up of fiscal convergence on corporate taxation in the EU, which should include the possibility of depreciating goodwill for tax purposes.
Fresh start for French employment law
For many years, French employment law had a poor reputation among businesses. Not any longer, thanks to the 2017 Reform, which profoundly renewed French employment law. Reform of the employment law regime is a key part in a wider set of smart measures aimed at enhancing France’s economic attractiveness and competitiveness. These include initiatives taken following the #ChooseFrance summit, held at Versailles in January 2018, which focus on attracting finance and banking companies post-Brexit.
Simplifying and securing dismissal procedures – Following the 2017 Reform, economic dismissals are now easier to implement, especially for global groups. The Reform reviewed the definition of the economic justification required and significantly reduced the scope of the redeployment obligation. It also reduced the time limit for challenging dismissals. This leaves companies much better placed to secure the termination of employment and reduces their exposure to court cases.
Previously, employers were very vocal in denouncing the lack of predictability over the quantum of damages for unfair dismissal that could potentially be awarded to employees, as no cap was applicable. Following the Reform, damages are now capped according to a mandatory pre-set scale depending on the employee’s length of service and the company’s size. With the uncertainty removed, employers can now easily measure risks and make provisions for the maximum amount applicable by law.
Streamlining social dialogue – The Reform provides for the gradual merger of three employee representation bodies: the staff delegates (délégués du personnel), the Works Council (Comité d’entreprise) and the Health and Safety Committee (CHSCT). Companies must set up a new single body – the Social and Economic Committee (SEC) – on or before 1 January 2020 at the latest.
Companies with no trade union delegates are now authorised to negotiate at the company level and even implement overriding company agreements.
Attracting foreign executives – The Government’s business transformation action plan – known as the PACTE Bill, and approved on first reading by the National Assembly in October 2018 – also focuses on simplification, legal security, and attractiveness for business. One significant provision in the context of Brexit is that expatriated executives coming to France would benefit from a six-year exemption of contributions to French pension schemes. This would have a significant impact on labour costs, as the exemption applies both to employers and employees.
Enticing the banking sector – The PACTE Bill provides for overriding rules specially designed for the finance and banking sector. These rules allow employers to recover bonuses paid to risk-takers – as defined in the 604/2014 EU Regulation, working in credit institutions, asset management companies and investment firms – in case of employee non-compliance with their obligations. Employers may also exclude deferred bonuses from the calculation of severance pay and damages awarded by the judge in an unfair dismissal case.
Mainhattan’s headline tax rate not as high as it looks
Frankfurt enjoys a global reputation as Germany's major centre for banking and finance institutions. At first glance, its business profits tax rate of almost 32% looks unattractive. However, the headline rate hides several positive aspects that make Germany a more interesting location.
Most stock corporations, with certain restrictions for banks and financial institutions, qualify for far-reaching tax exemptions for profit from sales of shares and from dividend income. Insurance companies and pension funds may also set up accruals and reserves for future payments. Germany has signed double taxation agreements with numerous countries in the European Union and beyond, which removes the problem for companies relocating their residence to Germany.
For these reasons, along with several other exceptions in the German taxation system, the high business tax rate may only apply to a small portion of a company’s profit – depending on the structure of the company and the complexity of the relationships. Companies from the UK looking to move to Germany should therefore check the details of their specific situation to assess the precise implications of German taxation for their business model.
The UK’s concept of “capital allowances” is unknown in Germany. Although there are several exceptions, determining income for tax purposes is, to a large extent, linked to German commercial accounting regulations. In Germany the tax base is generally reduced through write-downs, including goodwill which is must be written off over 15 years.
Following a company move from the UK to Germany, the company's assets will most likely become subject to taxation in Germany – e.g. for future sales. This also applies to intangible assets such as rights and brands. The valuation of these assets for tax purposes has a major bearing on future taxation in Germany, as valuation is linked to future deductions for business expenditures.
Companies only partially relocating to Germany will only be partially taxed in Germany, for example through a “permanent establishment”. In these circumstances, determining the methodology for allocating profits for this permanent establishment is key. The German tax authorities have issued quite detailed guidelines for banks and insurance companies in this respect, so the basis for taxation of permanent establishments may be more “established” in Germany than elsewhere.
Moving an entire business to Germany is treated as a non-taxable event for value added tax purposes, so should not result in German VAT liability.
High standard tax rates, but much lower fixed rate for financial income – Germany’s tax rates for employees are relatively high, with a progressively increasing tax rate that tops off at around 47.5% (including the solidarity surcharge). The average tax rate varies according to the level of income and can be much lower in certain circumstances. High earners also benefit from a basic tax allowance and the progressive increase in tax rates. If a natural person lives in Germany permanently, tax is due on all income, including interest or dividends. Income from capital investments is taxed at a fixed rate of around 26.4%.
Key aspects under German employment law
The German employment law regime is considered to be employee-friendly and -protective, which is why employers may be hesitant moving to Germany. However, if companies deal more closely with their options for employment conditions etc. and seek appropriate advice, they can live with the regulations – as do Citigroup, Morgan Stanley, Goldman Sachs and several major Japanese banks who are among the numerous banks moving their European headquarters to Frankfurt in preparation for Brexit.
Unfair dismissal – One key aspect of German employment law is the Protection Against Unfair Dismissal Act, which gives strong protection against dismissal to employees with more than six months’ continuous service with an employer that employs more than ten employees in Germany. While this places a burden on employers, it may also be a selling point for employees to relocate. Dismissals must be justified on three key grounds: business-related (e.g. business closure); conduct-related (e.g. theft) or person-related (e.g. health). Statutory notice periods of four weeks to seven months, depending on the length of employment, must be observed. The legal consequence of dismissal without sufficient justification is reinstatement. However, most litigations end with a settlement agreement including a severance payment (usually 0.5 monthly salaries per year of employment – the factor depends on the chances of success of the claim).
The Protection Against Unfair Dismissal Act applies even if the parties agree that the employment contract is subject to British law, unless British employees commute to Germany while their main place of work remains in the UK – flights between Frankfurt and London run several times a day.
Employee representation – There may also be reservations among British employers about works councils. Employees in German businesses with more than five employees may elect a works council which has the right to be involved (co-determination right) in issues such as working hours, wage structure and projected staffing requirements. It must be properly informed prior to the appointment, transfer or dismissal of an employee. In the event of restructurings or collective redundancies, the employer must negotiate with the works council to reach a reconciliation of interests (Interessenausgleich), which is usually combined with a social compensation plan (Sozialplan). While these rules can restrict a company, a constructive works council can help implement changes in a uniform manner and promote the acceptance of company decisions among the staff.
Social security – The German social security system includes health insurance, long-term care insurance, pension insurance, accident insurance and unemployment insurance. Contributions are shared by the employee and employer, each bearing around 20% of the employee’s gross salary (capped at an annual income of EUR 53,100 for health and long-term care insurance and at an annual income of EUR 78,000 for pension and unemployment insurance). In the event of a hard Brexit, UK employees commuting to Frankfurt can remain in the British social security system for up to 12 months – but only if they keep their habitual residence in the UK. If the UK joins the European Economic Area (EEA), employees can also remain in the British social security system in the event of a secondment of up to 12 months.
Immigration – After Brexit, UK citizens will need to apply for a work permit before taking up work in Frankfurt. Most bankers, however, will be entitled to an EU Blue Card, which allows them to work in other European countries as well.
Luxembourg’s well-established reputation as a leading financial centre makes it a natural candidate for financial companies weighing their Brexit relocation options. The jurisdiction offers advantageous tax measures to financial companies and their employees.
Low tax regime for financial companies
Corporate income tax – Financial companies established in Luxembourg city are subject to corporate income tax at a global rate of 26.01%. There are exemptions and tax deductions specifically for financial companies. These include the deduction of provisions booked by financial institutions to cover the risk of default on certain categories of assets or against loans where no specific or foreseeable risk, other than normal credit risk, is involved. Contributions made by financial institutions in the deposit guarantee scheme, dividends and capital gains are also deductible.
Significantly, Luxembourg decided to exclude financial institutions and insurance companies from the scope of the rule limiting interest deductibility following transposition into Luxembourg law of the EU Anti-tax Avoidance Directive (ATAD).
Net wealth tax – Luxembourg financial companies are subject to net wealth tax based on wealth located in Luxembourg at sliding scale between 0.5 and 0.05%.
VAT – Financial institutions established in Luxembourg are treated as VAT taxable persons and are subject to the 17% maximum VAT rate. In principle, management funds, insurance and main banking activities are VAT exempt. Financial companies may benefit from the VAT group rules introduced in 2018, which allows intermediate supplies between the members of a VAT group to be treated as internal supplies and is thus ignored for VAT purposes.
Individual tax exemptions
Individuals in Luxembourg are subject to a progressive rate up to 42%, depending on their income and personal situation. The double taxation treaty signed with the UK solves potential issues concerning dual residency.
Some income may be totally or partly exempted, such as dividends and capital gains on non-substantial participation held for more than six months.
Individuals established in Luxembourg are not subject to Luxembourg net wealth tax. Luxembourg is also known for its favourable inheritance tax regime, which includes exemption in direct line and a registration gift rate of between 1.8 and 2.4% in direct line.
Some interesting compensation structures may be put in place by employers for individuals working for a Luxembourg company as, for instance, stock option plan and carried interest scheme.
Individuals moving to Luxembourg also benefit from the Luxembourg “step up” mechanism which allows the revaluation of the acquisition price of substantial shareholdings to their market value at the date of arrival in Luxembourg.
Attracting highly skilled and qualified workers
Luxembourg has set up tax incentives covering the employer-sponsored costs and expenses of relocating highly skilled and qualified workers to Luxembourg. Some costs and expenses are treated as deductible operating income for the employer and are not seen as taxable income for employees. These include moving costs (including travel and packing costs), accommodation costs, children’s school fees and travel expenses for special occasions.
User-friendly employment law regime
As of May 2018, 33 companies had already migrated from the UK to Luxembourg in preparation for Brexit, creating over 200 jobs. Most of these moves were in the financial sector, specifically in banking and funds. As outlined above, the Luxembourg tax regime has specific measures that makes employing workers from the UK financially interesting, both for the employees and the employer. Key aspects of Luxembourg’s employment law regime could also play a role for companies considering making the move.
Employees in Luxembourg benefit from safeguarding measures covering pay, dismissal procedures, staff representation and social security.
Pay – Salaries are linked to the cost of living – if the consumer price index rises by 2.5%, salaries in Luxembourg must be adjusted by this percentage. The minimum monthly wage for a full-time employee is EUR 2,048.54 (EUR 2,458.25 for qualified workers)
Unfair dismissal – Luxembourg workers are protected against dismissal in case of sickness, maternity or parental leave. They can only be dismissed for gross misconduct or for real and serious reasons linked to their performance or the financial situation of the company. Summary dismissals based on health are unfounded are therefore prohibited. The only exception is during the trial period (up to 12 months depending on the qualification of the employee), when employers are free to terminate the employment contract without having to justify their decision.
Employee representation – Staff representatives are required in any company that employs at least 15 employees. Depending on the situation, they either have an information and consultation role or a co-determination right. Unions exist in Luxembourg but are not as aggressive as in neighbouring countries and strikes almost never happen. Unions play an important role in specific circumstances, however, such as in collective redundancies. In these cases, the employer must agree a social plan with the unions and this often involves negotiating extra-legal indemnities for the employees affected.
Social security – Employees are well covered as Luxembourg’s social security scheme includes health insurance, long-term care insurance, pension insurance, accident insurance and unemployment insurance for a cost that is quite low compared to other EU countries. Contributions are shared between the employee and the employer, each paying around 14% of the employee's gross salary.
Luxembourg’s courts are neither pro-employee nor pro-employer; they tend to be as objective as possible. Damages for unfair dismissal are limited and rarely reach more than 12 months’ pay. Luxembourg has a strong practice of settling labour disputes out-of-court.
Flexible working arrangements are possible in Luxembourg. These include the global employment contract, which enables several companies of the same group to share employees under one sole employment agreement.