The method article Art. 23A OECD regulates the exemption method under the double taxation treaties (DTA) as a possibility for preventing double taxation. This is also regularly elected in the German DBA. Accordingly, the residency state exempts from tax the income earned abroad (so-called source state). Nevertheless, there is the progression reservation within the meaning of § 32b EStG. This leads to the fact that the actually exempted income is nevertheless taken into account in the context of the progression. This article explains the meaning of this and what consequences the consideration has.

Art. 23A OECD MA provides for the option of exemption to avoid double taxation. States Parties remain free to choose between the credit method and the exemption method. Therefore, the State of residence can exempt the foreign income of the unlimited taxpayer from the tax there. For this purpose, the State of residence excludes this income from the tax base. However, the possibility exists only if two states have the right to tax under the double taxation agreement. Accordingly, the exemption method does not apply to distribution standards with final legal effect. Therefore, the distribution rules apply insofar as they reserve the right of taxation conclusively and exclusively to one of the Contracting States and thereby indirectly order the exemption by the other State.

The exemption method therefore leads to taxation at the tax level of the source state. If Germany is the residence State, then in principle the exemption method is to be assumed, while the other State may take the credit method for all types of income. Often, however, this legal consequence is changed by Treaty Override. In addition, according to § 32b EStG, the progression reservation applies in the event of exemption by Germany.

Due to the progressive rate of income tax, the marginal tax rate increases in the progression zones with higher incomes. In principle, income that is treated as tax-free or income below the basic allowance remains without increasing the burden on the tax rate to which the taxable income is subject. The reservation of progression, on the other hand, now leads to these incomes being taken into account in the context of progression. Therefore, although these incomes are not themselves included in the tax base, they influence the tax rate on the taxable income. The negative progression reservation can therefore have a tax-relief effect by reducing the tax rate. The negative progression reservation includes losses incurred in the area of income generation due to operating expenses and advertising costs. However, losses cannot be justified by special expenses. Therefore, § 32b EStG sets a special tariff for certain income. The provisions apply to both positive and negative progression reservations.

In procedural terms, the reservation of progression is taken into account by way of assessment. According to § 180 V AO, the tax office has to determine the tax bases separately for the determination of offsettable losses. This includes, for example, whether and to what extent the income exempted under a DTA comes from a foreign permanent establishment. For the calculation, the taxable income within the meaning of § 2 V 1 EStG must be adjusted. According to § 32a I EStG, the adjusted income then forms the basis for the assessment of income tax.

The reservation of progression leads to the fact that the income subject to it is added to the taxable income in order to determine the special tax rate. Therefore, for purposes of income tax assessment, a distinction should be made between the determination of income as a tax base and as a tax rate base. Consequently, the taxable income must first be determined in a two-stage procedure. The special tax rate must then be calculated by adding the tax-free income. This rate is then applied to the unchanged tax base. In this way, income not exceeding the basic allowance may nevertheless be covered by the special tariff.

In personal view, § 32b EStG applies to unlimited taxpayers and limited taxpayers to whom § 50 II 2 No. 4 EStG applies. This therefore concerns limited taxable employees who therefore earn income within the meaning of § 49 I No. 4 EStG in conjunction with § 19 EStG. For income that has been subject to the reservation of progression, there is an obligation to make an investment. In individual cases, the assessment can be requested in accordance with § 46 II No. 8 EStG. This makes sense if foreign losses under the DTA have remained out of recognition. These can then be taken into account in the context of the negative progression reservation.

The progression reservation applies according to § 32b I 1 no. 2 EStG for certain foreign income. It is necessary that the tax liability was temporarily unlimited during the assessment period. Then all foreign income generated during the investment period shall be taken into account. In addition, according to § 32b II No. 3 EStG, the income that is tax-free under an agreement to avoid double taxation is subject to the progression reservation. Therefore, it is necessary that the exemption method is relevant in the DBA.

The positive progression reservation is intended to ensure that the tax exemption of individual income does not also prevent the actually increased burden associated with the progressive tariff course with regard to the taxable income. This is intended to meet the actually higher performance by the tax-free income.