Circular of the Federal Ministry of Finance on Foreign Activity (former version): no exemption for EDF projects

The Circular on Foreign Activity and section 34c(5) of the Income Tax Act

Under section 34c(5), the supreme tax authorities of the federal states, or the tax authorities commissioned by them, may, with the consent of the Federal Ministry of Finance [Bundesministerium der Finanzen–BMF], waive in whole or in part, or assess at a flat rate, the German income tax attributable to foreign income where this is expedient for macroeconomic reasons or where the crediting of foreign tax is particularly difficult. The provision confers discretion and is a catch-all provision for cases in which the other subsections do not lead to results that are desirable in terms of foreign trade (e.g. Federal Constitutional Court [Bundesverfassungsgericht–BVerfG] order of 19 Apr 1978, file ref. 2 BvL 2/75, Federal Tax Gazette [Bundessteuerblatt–BStBl.] II 1978, p. 548). Only what serves Germany’s foreign trade is expedient for macroeconomic reasons. The Circular on Foreign Activity therefore primarily aims to promote the German export industry (Federal Fiscal Court judgement of 17 Jun 2020, file ref. I R 7/18, Federal Tax Gazette II 2021, p. 211, para. 2).

The Circular on Foreign Activity (Federal Ministry of Finance Circular of 31 Oct 1983, Federal Tax Gazette I 1983, p. 470; replaced from the 2023 assessment period by Federal Ministry of Finance Circular of 10 Jun 2022, Federal Tax Gazette I 2022, p. 997) granted relief, up to and including the 2022 assessment period, under part I no. 4 for, inter alia, activities abroad on behalf of a domestic contractor in connection with “German public development aid” within the framework of “Technical or Financial Cooperation”. The tax office for the employer’s place of business [Betriebsstättenfinanzamt] certifies, upon application by the employer or the employee, that wage tax need not be withheld (part VI no. 1 of the Circular on Foreign Activity). As an administrative regulation guiding the exercise of discretion, the Circular on Foreign Activity binds the administration by virtue of Art. 3(1) of the Basic Law [Grundgesetz–GG]. The tax authority decides on the granting of the exemption in a separate notice, which is a basis notice [Grundlagenbescheid] for the tax assessment (Federal Fiscal Court judgement of 17 Jun 2020, file ref. I R 7/18, Federal Tax Gazette II 2021, p. 211, para. 3).

In the case in dispute, the claimant was employed from 2009 to 2012 as a project manager by a German development aid organisation and worked in Africa. The project was financed wholly or partly from EDF funds, but in any event not by Germany. She retained her residence (section 8 of the Fiscal Code [Abgabenordnung–AO]) in Germany. The tax office for the employer’s place of business issued the employer with an exemption certificate under the Circular on Foreign Activity. No wage tax was withheld for 2011 and 2012. The employment income was not taxed in Africa, either. Following a wage tax audit, the tax office included the employment income in the 2011 and 2012 income tax assessment notices because the project had not been financed from federal funds. The Fiscal Court of Cologne [Finanzgericht Köln–FG Köln] dismissed the action (Fiscal Court of Cologne judgement of 22 Mar 2018, file ref. 7 K 585/15).

The Federal Fiscal Court referred to the Court of Justice the question whether Art. 4(3) of the Treaty on European Union [Vertrag über die Europäische Union–EUV] and Art. 208 in conjunction with Art. 210 of the Treaty on the Functioning of the European Union [Vertrag über die Arbeitsweise der Europäischen Union–AEUV] preclude an administrative practice which refuses the exemption where a project is financed by the EDF but grants it where the project is financed to the extent of at least 75% by the competent federal ministry or a state-owned development aid organisation (Federal Fiscal Court order of 13 Jul 2021, file ref. I R 20/18). The Court of Justice answered that question in the negative (Court of Justice judgement of 7 Sep 2023, file ref. C-15/22, Finanzamt G (Development aid project), ECLI:EU:C:2023:636): the European Development Funds are not bodies of the Union, the practice does not prevent them from financing projects, and Arts. 208 and 210 of the Treaty on the Functioning of the European Union are too general to confer rights on individuals.

Only development aid financed directly by Germany qualifies for relief

The first chamber – after the proceedings had been resumed under a new file reference – dismissed the appeal on points of law as unfounded. The decision contains the following key holdings:

• Implied decision on the merits: by subjecting the employment income to tax, the tax office implicitly combined its decision under section 34c(5) of the Income Tax Act in conjunction with the Circular on Foreign Activity with the income tax assessment. A separate application by the employee was unnecessary because the employer had applied for the exemption and withholding had already been dispensed with (part VI nos. 1 and 2 of the Circular on Foreign Activity in the version applicable in the years in dispute; para. 13).
• Limited judicial review: administrative instructions are not to be interpreted like statutes. What matters is how the administration understood them and wished them to be understood (e.g. Federal Fiscal Court judgement of 4 Jul 2023, file ref. VIII R 29/20, Federal Tax Gazette II 2023, p. 1005, para. 18). The courts examine only whether that interpretation is possible. Where there are objective doubts, they cannot compel the authority to apply the instruction as long as the authority does not act arbitrarily (para. 15).
• Only direct German financing: the tax office’s understanding that the term “German public development aid” covers only measures financed directly from German budgetary funds is not only possible but obvious. The EDF is funded only in part from German resources. Export promotion is served above all where domestic bodies decide on the use of German funds (para. 16).
• No infringement of higher-ranking law: under EU law, this follows from the judgement of the Court of Justice (para. 18). Art. 3(1) of the Basic Law is not infringed because the promotion of foreign trade justifies the differentiation. The concerns arising from the Court of Justice’s judgement in Petersen (European Court of Justice judgement of 28 Feb 2013, file ref. C-544/11, ECLI:EU:C:2013:124) relate only to the restriction to domestic employers, not to the financing (para. 19).
• No errors of discretion and no protection of legitimate expectations: discretionary considerations could legitimately be set out for the first time in the decision on the objection (para. 21). The tax office was not required to determine the German share of the EDF funds (para. 22). Equity considerations belong in the separate equitable relief proceedings (para. 24). The revocable exemption certificate does not bind the tax office for the place of residence [Wohnsitzfinanzamt] (para. 25).

The result follows consistently from the restrained standard of review, but is not convincing in every respect. The 75% criterion did not derive from the Circular on Foreign Activity, and the tax office made its discretionary considerations only in the briefly reasoned decision on the objection (paras. 21 and 22). Moreover, the tax office for the employer’s place of business had itself issued an exemption certificate. This tends to argue against a uniformly applied practice, which is what matters for the administration’s self-commitment [Selbstbindung der Verwaltung]. The Federal Fiscal Court, however, assesses the certificate only from the perspective of its binding effect.

Nor does the purpose of export promotion compel the narrow interpretation: where a German company wins an EDF tender, foreign funds flow into Germany. This is arguably a classic export of services. The Federal Fiscal Court itself concedes that a broader reading was also possible (para. 16); the new Circular on Foreign Activity now expressly includes indirect financing. In procedural terms, it remains open how the implied combination with the tax assessment fits with the classification as a separate basis notice (Federal Fiscal Court judgement of 17 Jun 2020, file ref. I R 7/18, Federal Tax Gazette II 2021, p. 211, para. 3). The chamber does not address this.

Circular on Foreign Activity from 2023: implications for practice 

For assessment periods up to 2022, the legal position has largely been clarified; objections relating to EDF-financed projects are unlikely to have any prospect of success. Since the 2023 assessment period, the revised Circular on Foreign Activity has applied (Federal Ministry of Finance Circular of 10 Jun 2022, Federal Tax Gazette I 2022, p. 997).

The following points should be noted in practice:

• Employers: since 2023, relief has been available for activities on behalf of employers with their registered office, place of management, permanent establishment or permanent representative in the EU or the EEA (part I para. 1). This takes account of the Court of Justice’s judgement in Petersen (Court of Justice judgement of 28 Feb 2013, file ref. C-544/11, ECLI:EU:C:2013:124), but does not change the requirements relating to financing.
• Financing ratio: German public development aid now qualifies for relief only if the project is funded directly or indirectly to the extent of at least 75% from domestic public funds (part I para. 2 no. 5). Projects funded from the EU budget, into which the EDF has been integrated since 2021, are likely to fall short of this ratio as a rule, even if they are carried out by a German organisation.
• Exclusions: insofar as the employment income is paid directly or indirectly from domestic public funds, the Circular on Foreign Activity does not apply (part V no. 1). In the case of co-financing, the exemption may be limited to the remaining share (para. 14 of the Circular on Foreign Activity). The Circular on Foreign Activity is likewise excluded where a double taxation agreement [Doppelbesteuerungsabkommen–DBA] exists with the state of activity (part V no. 2).
• Minimum taxation: evidence must be provided of tax paid in the state of activity at an average rate of at least 10% (part V no. 3). In the case in dispute, the exemption would already have failed on this ground under the new rules.
• Procedure: the exemption certificate does not protect the employee. Departing from the judgement in I R 7/18 (Federal Fiscal Court judgement of 17 Jun 2020, file ref. I R 7/18, Federal Tax Gazette II 2021, p. 211), the administration permits the application in the assessment procedure only until the assessment has become final (para. 19 of the Circular on Foreign Activity). Financing agreements and financing shares should be documented at the start of the project. In the event of a refusal, it is advisable to insist on a separate decision.

The order is not designated for official publication. It remains open whether equitable relief under sections 163 and 227 of the Fiscal Code can provide a remedy in legacy cases in which employees relied on an exemption certificate.