Anyone who receives a severance payment as an employee after leaving a company usually has to tax it in Germany. Fortunately, there are ways to have the severance payment paid out tax-free abroad after a departure. However, this is only possible under certain conditions. If the severance payment has the property of being an additional, albeit a subsequent remuneration for the service provided in the past, then the severance payment is taxable in Germany. Also, any double taxation agreements have no influence on this. However, if a severance payment is linked to restrictions on future professional activity and thus corresponds to cartridge damage, then the taxation right falls to the State in which the taxpayer is resident at the time of payment. Incidentally, this also applies to severance payments with a supply character.

Avoid Exit Tax (without double taxation agreement)

1st Introduction: Paying out severance payments tax-free abroad

If an employee leaves an employment relationship and receives a severance payment, this is in principle taxable in Germany. If one considers the restriction on the place of taxation, i.e. Germany, then it is easy to understand that many in such a situation think about first moving abroad and only then making the payment of the severance payment. This is linked to the logically justified hope that the new home state will then tax the severance payment on much better terms than in Germany.

But is this really so? After all, we know that logical conclusions about tax law often spring from an illusion. Therefore, in this post we look at the facts to find out whether you can pay a severance payment tax-free abroad.

2nd severance payout tax-free abroad: legal basis

For this we must of course orient ourselves to tax law, especially with the income tax law for the taxation of income from employed work. In particular, the provisions of § 50d paragraph 12 EStG are relevant here, which regulates the taxation of severance payments in connection with possible double taxation agreements. The corresponding passage on severance payments in the OECD Model Convention for the Prevention of Double Taxation, which in most cases forms the basis of the treaty for agreements with Germany, but also for many other countries, is in Article 15(2) OECD-MA.

Let’s start with Article 15 of the OECD-MA. This stipulates that when a severance payment is paid, the State has jurisdiction over taxation in which the taxpayer is established at the time of payment. On this basis alone, the possibility of having the severance payment paid tax-free abroad seems to be quite realistic.

You usually get severance payments when you leave a company. Normally, such a severance payment can then be understood as additional compensation for services rendered in the course of the employment relationship. On the other hand, however, there are also severance payments in which another function is in the foreground. For example, a temporary ban on working at a competitor company or a ban on competition from the previous employer may be intended to compensate the outgoing employee in monetary terms. This cartridge damage thus represents a severance payment whose character is directed to future situations. In addition, severance payments may have a supply character. In this case, the payment of the severance payment takes place recurring and thus corresponds to a retirement salary.

Because there are several types of severance payments, we now want to examine the conditions under which a severance payment can be paid tax-free abroad.

4th severance payable tax-free abroad: for services provided

For this purpose, we first create the following starting position: An employee – we call him Mr Strada – leaves the company where he worked for many years in Deutschalnd in the first half of the year. He is entitled to a severance payment that takes into account the periods in which he worked for the company. Mr. Strada has long intended to move abroad and is now taking the exit from the company as an opportunity to implement this plan immediately. He also thinks that he could possibly also have the severance payment paid tax-free abroad. His former employer agrees.

The country that is so dear to Mr Strada has concluded a double taxation agreement with Germany. This seems to rule out a double taxation of the severance pay. Fortunately, his new home country knows no taxation on severance payments. Nevertheless, some time later Mr Strada receives news from the German tax office, which calls for the taxation of the severance pay. How can that be?

In order to understand this, in addition to Article 15 OECD-MA, § 50d paragraph 12 EStG must also be considered. This legal norm defines here that such a severance payment is regarded as retroactive compensation from the time of the employment relationship. So at a time when the right to taxation was with Germany. Germany therefore considers that it also has a right to tax the severance payment afterwards, irrespective of the provisions of the double taxation agreement in relation to the residence of the taxable person.

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5th severance payout tax-free abroad: for future waivers

On the other hand, we now consider what happens when Mr. Strada agrees instead, when he leaves, not to work for a competitor or as a competitor within a defined period (usually two years). If he now receives a severance payment for this, then it has a reference to future actions, even if this basically corresponds to an omission. As a result, § 50d(12) EStG does not apply in this case. So the rules laid down in the double taxation agreement apply. And this is taxation in the country where the taxable Mr Strada is tax resident at the time of payment of the severance pay. Thus – provided the corresponding tax regime with regard to the taxation of severance payments in his new home country – Mr. Strada has his severance payment paid tax-free abroad.

Paying out severance payment tax-free abroad: for retirement salaries

In our third case, we assume that Mr. Strada will receive a severance payment in the form of a retirement salary after his departure from the German company and his subsequent departure abroad.

Although here too a reference to his previous activity at the company in Germany applies, one expects, as just learned, a taxation in Germany according to § 50d paragraph 12 EStG. However, retirement salaries, since they are subject to periodic payout, have a pension character. Therefore, this aspect is in the foreground when assessing the application of § 50d(12) EStG. Consequently, Article 18 OECD-MA applies in this case instead of Article 15 OECD-MA. Article 18 of the OECD-MA provides that the right to tax pensions is vested in the State in which the taxpayer is established.

For this reason, many German pensioners in their country of residence chosen for their age, for example in Spain, pay a tax on their pension, which would cause either a significantly lower tax or even no tax at all in Germany. So, from a fiscal point of view, let us hope that Mr Strada receives his regular redundancy payment in a country where such income does not generate taxes.