Taxation of Severance Payments Under German Double Tax Treaties

Pickup of wage income in a cross-border context    

German income tax covers income from employment under Sect. 19 of the Income Tax Act for taxpayers subject to resident tax liability (Sect. 1(1) of the Income Tax Act) regardless of where it is earned. In the case of employment abroad, this results in “foreign income” within the meaning of Sect. 34d no. 5 of the Income Tax Act; however, this income is also part of “worldwide income” and is therefore taxable (Circular of the Federal Finance Ministry dated December 12, 2023, Federal Tax Gazette I 2023, p. 2179, margin no. 43). For such income, Sect. 34c of the Income Tax Act generally imposes an obligation to credit foreign income taxes.

In the “inbound case”, i.e. in the case of nonresident income tax liability (Sect. 1(4) of the Income Tax Act), domestic income arises pursuant to Sect. 49(1) no. 4 of the Income Tax Act. The performance or realization of the work on German soil is the essential connecting factor (Sect.49(1) no. 4 lit. a of the Income Tax Act; Circular of the Federal Finance Ministry dated December 12, 2023, Federal Tax Gazette I 2023, p. 2179, margin no. 44). However, the list of domestic income under Sect. 49(1) no. 4 of the Income Tax Act has been significantly expanded over the decades: In the year 2000, the performance or realization of work within Germany was still the sole criterion. By the year 2006, there were already four criteria, while under current law there are six. 

These criteria also include Sect. 49(1) no. 4 lit. d of the Income Tax Act: Income under Sect. 19 of the Income Tax Act is also considered domestic income if it is paid as compensation within the meaning of Sect. 24 no. 1 of the Income Tax Act for the termination of an employment relationship, provided that the income received for the previously performed work was subject to domestic taxation. A domestic tax claim for severance payments is thus established – however, in many cases, the priority (Sect. 2(1) of the General Tax Code (“Abgabenordnung”)) of a double taxation treaty with the other country must be observed (Circular of the Federal Finance Ministry dated December 12, 2023, Federal Tax Gazette I 2023, p. 2179, margin no. 254 et seqq.). 

Pursuant to Art. 15 of the 2025 OECD Model Tax Convention (OECD-MC), double taxation agreements typically permit the taxation of severance pay only in the state of residence (e.g. Federal Tax Court, Judgement dated September 2, 2009, file number I R 111/08). In an inbound case, this would mean that Germany, as the source state, would lose the right to tax the severance payment. The German legislature – encouraged by the constitutional confirmation of the Federal Constitutional Court (Federal Constitutional Court, Judgement dated December 15, 2015, file number 2 BvL 1/12, regarding Sect. 50d(8) of the Income Tax Act) – has, however, created a corresponding “treaty override” in the form of Sect. 50d(12) of the Income Tax Act (for the historical development, see Lower Tax Court of Münster, Judgement dated August 23, 2022, file number 15 K 791/19 L, legally binding since no valid appeal to the Federal Tax Court was filed). 

Treaty override for severance payments under Sect. 50d(12) of the Income Tax Act 

Pursuant to Sect. 50d(12) of the Income Tax Act, severance payments made upon the termination of an employment relationship are treated, for the purposes of applying a double taxation treaty, as additional remuneration for prior work, unless the double tax treaty provides for a different rule in a separate provision expressly concerning such severance payments. The plaintiff in the appeal proceedings (file number VI R 3/24) had terminated her employment relationship in Germany by mutual agreement in February 2016, effective at the end of September 2016, and was entitled to a severance payment for the loss of her job. However, she had deliberately deferred the receipt of the payment (Sect. 11(1) of the Income Tax Act) until January 2017. In September 2016, she moved from Germany to Malta and relinquished her resident tax liability in Germany.

In assessing her income tax for the 2017 assessment period – as requested by the plaintiff pursuant to Sect. 50(2) sent. 2 no. 4 lit. b of the Income Tax Act – the tax office applied Sect. 50d(12) of the Income Tax Act. Accordingly, the severance payment was taxed in Germany, while the remaining income was subject to the progression clause (Sect. 32b(1) sent. 1 no. 5 of the Income Tax Act). 

The sixth chamber of the Federal Tax Court has now confirmed this treatment on appeal: Sect. 50d(12) of the Income Tax Act was applicable from January 1, 2017 (Sect. 52(1) of the Income Tax Act). The double tax treaty between Germany and Malta could therefore not offer the plaintiff protection from German taxation. The Federal Tax Court answers the constitutional questions raised by “retroactive laws” (most recently and in great detail covered in Federal Tax Court, Judgement dated November 20, 2025, file number II R 7/23, margin no. 21 et seqq.) by holding that “only” a quasi-retroactive effect exists: Insofar as the adverse legal consequences of a provision arise only after its promulgation but are factually triggered by circumstances that have already occurred (“factual retroactivity”), there is a case of quasi-retroactivity (Federal Constitutional Court, Judgement dated March 25, 2021, file number 2 BvL 1/11, margin no. 53). One of the central arguments against invalidity of the legal provision concerns the fact that the plaintiff herself had brought about her change of residence and the transfer of her domicile (margin no. 26, 28).