Federal Fiscal Court ruling: no “universal” progression clause under section 32b of the Income Tax Act

According to the case law of the Federal Fiscal Court, the progression clause under section 32b is intended to prevent a tax reduction “that results from the fact that, due to the progressive tax rate schedule, a lower tax rate would have to be applied to the taxable income as a result of the tax-exempt status of the income subject to the progression clause than would be the case if this income were taxable…Income subject to the progression clause is therefore included in the calculation of the tax rate applicable to taxable income, but not in the taxable income itself” (Federal Fiscal Court judgement of 22 Sep 2009, file ref. IX R 93/07).

For this purpose, with regard to personal income tax liability, “persons subject to resident tax liability, whether temporarily or throughout the entire assessment period” (section 1(1)) are included within the scope of application. In the case of non-resident tax liability throughout the entire assessment period under section 1(4), however, only a taxpayer to whom section 50(2) sentence 2 no. 4 applies (in the case of income under sections 19, 49(1) no. 4) is to be included. This particularly applies to cases in which an application for income tax assessment is filed (section 46(2) no. 8).

In the special case of personal income tax liability under section 1(3) (i.e., when a taxpayer with non-resident tax liability opts for resident tax liability) section 32b(1) sentence 1 no. 5 clarifies the inclusion of income that “is not taken into account in determining taxable income because it is not subject to German income tax or a tax deduction.” And in the case of the  expanded non-resident income tax liability under section 2 of the Foreign Transactions Tax Act [Außensteuergesetz–AStG], a progression clause is established not by section 32b, but by section 2(5) sentence 1 of the Foreign Transactions Tax Act.

In substance, the scope of the progression clause is defined by the five numbers under the first sentence of section 32b(1). In this context, significant exceptions to the exception must be taken into account in section 32b(1) sentence 2 if income is tax-exempt under double taxation treaties (section 32b(1) sentence 1 no. 3). According to established Federal Fiscal Court case law, the list in section 32b(1) is exhaustive, so “no general progression clause for tax-exempt income can be inferred from section 32b. Section 32b constitutes a (declaratory or constitutive) legal basis for taking these benefits or income into account when calculating the tax rate only under the conditions specified in it and only for the benefits or income specifically described in it” (Federal Fiscal Court judgement of 15 Dec 1999, file ref. I R 80/98). 

For example, sick pay from statutory health insurance, but not daily sickness benefits from private health insurance, is included in the progression clause under section 32b(1) sentence 1 no. 1 (b), without this being constitutionally objectionable (Federal Fiscal Court judgement of 13 Nov 2014, file ref. III R 36/13, Federal Tax Gazette [BundessteuerblattBStBl] II 2015, p. 563). Finally, the progression clause does not apply in the sense of most-favored-nation treatment if the tax exemption of income results from both a DTT and section 3 of the Income Tax Act (Federal Fiscal Court judgement of 22 Jan 1997, file ref. I R 152/94, Federal Tax Gazette II 1997, p. 358).

Exhaustive nature of the list in section 32b(1) of the Income Tax Act

A prominent application of the progression clause in the context of cross-border income is “income that is tax-exempt under a treaty for the avoidance of double taxation” (section 32b(1) sentence 1 no. 3). In particular, foreign income from employment (section 34d no. 5) is generally exempt under double taxation treaties (Federal Finance Ministry Circular of 12 Dec 2023, Federal Tax Gazette I 2023, p. 2179, para. 42 and following), whereby the treaty overrides under section 50d(8) and following must be observed (Federal Finance Ministry Circular of 12 Dec 2023, Federal Tax Gazette I 2023, p. 2179, para. 51). This also generally applies to (active) income from permanent establishments of natural persons from DTT countries.

In cross-border contexts, section 32b(1) first sentence nos. 2 and 5 also cover special cases regarding personal income tax liability. In particular, in cases of “temporary” resident income tax liability, where taxpayers move in or out of the country, section 32b(1) sentence 1 no. 2 provides for a progression clause regarding the (uniform – section 2(7) sentence 3) assessment of income tax for the “year of relocation".

In addition, the first sentence of section 32b(1) lists numerous “income replacement benefits” that in a purely domestic context are subject to the progression clause (“unemployment benefit”, “sickness benefit”, “parental allowance”). Of particular note here for individuals is the list in section 3, which exempts numerous benefits in this area from tax. The “exhaustive nature” of the list in section 32b(1) means that the progression clause applies only in the cases specified in it. Up to EUR 4,500 of the “benefits granted in recognition of special services during the COVID-19 crisis” were tax-exempt (section 3 no. 11b) but did not fall under the progression clause. The “inflation bonus” under section 3 no. 11c did not trigger it either.

The claimant in the appeal X R 29/22, a taxpayer subject to resident tax liability, had received disability compensation as a former serviceman in the United States armed forces for an injury sustained in the line of duty (section 22 no. 1), which the tax office subjected to the progression clause. The Federal Fiscal Court, however, reaffirmed the exhaustive nature of section 32b(1) and confirmed the “most favourable treatment” for income that is tax-exempt under both the DTT and section 3. It also extended the scope of application of section 3 no. 6 to this “third-country case” involving the United States.

Special features of the progression clause

The progression clause has recently been the subject of particular discussion due to the so-called “Goldfinger models”, which utilised the effects of section 32b(1) sentence 1 no. 3 regarding the tax exemption of foreign permanent establishment income under tax treaties in conjunction with the determination of profit “on a cash basis” under section 4(3). In the context of the case law on this matter, the Federal Fiscal Court clarified numerous important issues relating to international tax law. The Federal Fiscal Court particularly affirmed that foreign accounting standards can also constitute such standards within the meaning of section 140 of the Fiscal Code [Abgabenordnung–AO] (“derived accounting obligation”; Federal Fiscal Court judgement of 14 Nov 2018, file ref. I R 81/16, Federal Tax Gazette II 2019, p. 390; most recently confirmed in Federal Fiscal Court judgement of 20 Jan 2026, file ref. VII R 4/25). It also consolidated its established case law regarding the time requirements for a permanent establishment (Federal Fiscal Court judgement of 18 Dec 2024, file ref. I R 39/21). 

In addition, the legislature has responded by introducing section 32b(2) no. 2 sentence 2 (c), which modifies the determination of the income for purposes of the progression clause when applying cash-basis accounting under section 4(3). In the provisions on “tax deferral models” under section 15b, a new paragraph 3a was also introduced specifically for these models.