Unlimited taxpayers can count foreign taxes paid for foreign income against German income tax, among other things, if the requirements of § 34c EStG are met. However, the crediting is only possible up to the maximum crediting amount of § 34 (1) sentence 2 EStG. However, there is considerable criticism of this ceiling. He is not only criticized under European law, but also under constitutional law. We explain how the credit limit works and why it is so criticised.

1st method overview

1.1. Crediting vs. Exemption method

The sovereignty of states includes the right to freely decide which personal and factual points of reference they use in their territory for the applicability of taxation. This also entails the right to regard a particular situation as non-taxable or to release it – for whatever reason. Restrictions on the right to tax are, in particular, the credit method, but also the exemption method. The methods already have other basic ideas from the ground up.

The background to the exemption method is the principle of capital import neutrality. Accordingly, a taxpayer who invests abroad must not be worse off in terms of tax than the taxpayer who is resident and invests there. Consequently, income is taxed at source under the exemption method and exempted in the State of residence.

The background to the accounting method is, in contrast, capital export neutrality. Therefore, investors resident in a country must apply the same tax rate, regardless of which country they earn income in. Therefore, the tax paid abroad is to be counted on the domestic market. However, with reference to the otherwise arising frictions between the tax revenues of the states, a refund of the higher foreign tax by the state of residence is regularly avoided.

1.2.Legal regulation

In Germany, § 34c EStG provides for the methods for taking foreign tax into account. § 34c (1) EStG regulates the direct accounting of foreign tax. In addition, there is alternatively (§ 34c paragraph 2, 3 EStG) or additionally (§ 34c paragraph 5 EStG) the deduction of the foreign tax from the domestic tax base. Another envisaged option is the lump sum or the remission of the German income tax attributable to foreign income (§ 34c(5) EStG).

However, the credit method regularly applies (§ 34c (1) EStG). However, the exemption method is rarely used. The double taxation agreements often do not contain any specific rules for the design of the crediting method. The details of the application of the credit method are governed by the national law of the respective Contracting State. In fact, this has a detrimental effect on the source state. The residency may negatively affect investments in the source country by not granting the credit in whole or in part.

Unlike the exemption method, the resident state benefits from a low tax rate. After deduction of a lower foreign tax from the German tax on world income, foreign income remains at least partially burdened with domestic tax. Then the total tax burden on foreign income increases to the domestic tax rate level.

2nd credit method

2.1. Credit requirements

In Germany unlimited taxpayers who have been used with their income from a foreign state there for a tax corresponding to the German income tax can offset the foreign tax fixed, paid and not subject to any reduction entitlement to the German tax (§ 34c (1) sentence 1 EStG). This takes into account the foreign taxes that the domestic taxpayer actually paid on his foreign income or that were actually withheld for him.

In summary, it is therefore necessary to apply the credit method