It happens regularly that pensioners originally worked in Germany, but then moved abroad. But because they have worked in Germany for a while, they have acquired a pension entitlement in Germany. This is why the German Pension Insurance (DRV) pays 1.8 million pensions annually in over 150 countries around the world. In these cases, however, some peculiarities arise. What problems arise in the taxation of the pension in the case of foreign residence, we explain in this article.

1. Taxation of pensions in Germany

If DRV pays pensions abroad, the recipients of the pension are subject to limited taxation in Germany. They earn domestic income within the meaning of § 49 (1) no. 7 EStG. Therefore, the provisions that apply to the limited tax liability apply. Consequently, the pension exemption of § 22(1)(a) double letter (aa) sentence 3 EStG applicable in Germany also applies.

The Neubrandenburg Tax Office is centrally responsible for foreign pension cases. It ensures that the tax liability of the German Treasury from the domestic pension income is determined and enforced under the limited tax liability. However, the procedure of the tax office is problematic for several reasons. Why do we explain below?

In essence, the problem revolves around the actual application of Article 18 paragraph 2 of the Turkey-Germany Double Taxation Convention (DTA), the increase in taxable income by the basic allowance according to § 50 paragraph 1 sentence EStG and the arrangement of the tax deduction according to § 50a paragraph 7 EStG. The problems with the application of the DTA-Turkey occur as a special case exclusively in foreign property conduct, if the pension recipient is resident in Turkey. The other problems are important for all limited taxpayers.

2nd problem: taking into account the lump-sum advertising charge when taxing the pension

Taxation of the pension according to the DBA-Turkey: The problem = allowance of EUR 10,000

If the taxpayer is now resident in Turkey and receives a pension from Germany, he is subject to limited taxation in Germany with the pension income. In Turkey, on the other hand, he has an unlimited tax liability due to his residence. According to the then applicable world income principle, Turkey can tax all income – including German pension income. This leads to a tax collision. Whoever then has the taxation right regulates the double taxation agreement Turkey-Germany (follow: DTA-Turkey).

Article 18 of the DTA-Turkey regulates the taxation of pensions. According to Article 18 paragraph 2 DTA-Turkey, there is an allowance of EUR 10,000. Therefore, payments up to EUR 10,000 in Germany are tax-free. If the payments exceed this amount, then according to the DTA only the exceeding amount is subject to the taxation of the contracting state from which they originate, i.e. Germany. This allowance already includes the wording according to the German pension allowance:

“Notwithstanding paragraph 1, pensions and similar allowances or pensions, including emoluments from statutory social security, may be taxed under the law of that State in the Contracting State from which they originate, except that payments of up to EUR 10,000 per year (including the pension allowance) in that State are exempt from tax.” (Article 18(2), first sentence, DTA Turkey version 19). September 2011

Nationally, in addition to the pension allowance, there is now the so-called advertising cost lump sum of EUR 102 (§ 9a sentence 1 number 3 EStG). The problem now lies in whether this advertising lump sum is to be taken into account in addition to the EUR 10,000 according to the DTA Turkey or whether it is already included in the EUR 10,000.

2.2 Taxation of the pension according to the tax administration

The letter from the Federal Ministry of Finance (BMF) dated 11.12.2014 – IV B 4-S 1301 – TÜR/0:007 states that the flat-rate amount for advertising costs is not to be granted in addition to the allowance (including pension allowance) DBA-Turkey. Accordingly, the following decisions are regularly taken by the German financial administration:

A German pensioner emigrated to Turkey in 2010. He receives the legal old-age pension from the DRV. The German tax office set the income tax from the calendar year 2010 on the basis of the pension payment notifications of the DRV. These income tax notices sent it to the residential address in Turkey. The pensioner's investment was as follows:

The annual amount of the pension was EUR 13,258.

The pension allowance according to § 22 no. 1 aa sentence 3 EStG was 40 % in 2010. Therefore, the pensioner had a pension allowance of EUR 4.312 (40 % of the annual amount of the pension).

At that time, as today, the lump sum for advertising costs amounted to EUR 102 in accordance with § 9a sentence 1 no. 3 EStG.

After deduction of these two items from the annual amount, EUR 8,844 remained.

According to the double taxation agreement Germany-Turkey (Article 18 paragraph 2 DTA-Turkey) EUR 5,586 were tax-free. The tax office came to the amount of 5,586 because it deducted from the allowance according to the DTA Turkey the pension allowance and the advertising cost lump sum: 10,000 – 4,312 – 102 = 5,586.

The income thus amounted to EUR 3.258.

The basic allowance was EUR 9.408 (§ 50 (1) sentence 2 EStG).

As taxable according to the basic tariff declared the tax office EUR 12.666. The income tax to be fixed therefore amounted to EUR 559.

Criticism of the calculation of the tax burden according to the tax office

According to the DTA Turkey, payments up to EUR 10,000 (including the pension allowance) are tax-free in Germany. If the payments exceed this amount, then according to the DTA Turkey only the exceeding amount is subject to the taxation of the contracting state from which they originate, i.e. Germany.

According to the case law of the Bundesfinanzhof (BFH), the DTAs only determine to what extent the tax liability under national law should be waived. DBA and national tax standards coexist.

The national provisions for domestically taxable and taxable pension income result in a flat-rate advertising charge pursuant to § 9a sentence 1 no. 3 EStG in the amount of EUR 102. In the above calculation, however, the taxable income is determined without additional deduction of this advertising lump sum in addition to the DBA allowance.

The tax office first deducts the advertising lump sum in addition to the pension allowance from the annual amount of the pension. Subsequently, however, the tax office deducts the tax-free amount under the DTA with EUR 5,586 EUR instead of EUR 5,688 from the remaining amount EUR 8,844. As a result of this calculation, not EUR 10,000 (including the pension allowance) is tax-free, but only EUR 9,898 (EUR 4.312 pension allowance + EUR 5.586). Only with the addition of the EUR 102 advertising cost lump sum, the tax office comes to the tax-free amount of EUR 10,000. However, the wording of the DBA stipulates that, plus the pension allowance, EUR 10,000 should be tax-free. There is no mention of an advertising lump sum, so that this is also included in the allowance from the DTA Turkey. Therefore, this would have to be added as a deduction amount to the EUR 10,000. Therefore, a deduction of EUR 10.102 would have to result.

2.4. Legal calculation

This procedure of the tax office for the taxation of the pension contradicts the tax scheme prescribed by § 2 (1) to 5 EStG:

The annual amount of the pension is still EUR 13.258. Of this, the tax-free amount under the DBA plus pension allowance – thus EUR 10,000 – must now be deducted. The domestic taxation right for income from the statutory old-age pension thus amounts to EUR 3.258. The flat-rate amount for advertising costs of EUR 102 shall also be deducted from this amount. The surplus revenue from advertising costs is thus EUR 3.156. Thus, the taxable income is also EUR 3.156.

3. Importance of the lump-sum advertising charge for pension income

Now one might think that the pension allowance in the context of the taxation of the pension would also include the advertising lump sum. The lump-sum advertising charge would then not have to be taken into account in addition to the pension allowance. However, this view is contradicted by the Bundesfinanzhof (BFH) in its judgment of 19.05.2021 – X R 33/19. There he emphasised that the lump-sum advertising allowance was not covered by the pension allowance. Rather, the flat-rate advertising charge serves a different purpose. The purpose is to implement the objective net principle. Insofar as the pensioner incurs costs for acquiring, securing or maintaining his pension, his economic capacity, which is fundamentally decisive for the income tax base, is reduced. Under this reasoning, the advertising cost lump sum in addition to the allowance including pension allowance of EUR 10,000 according to the DBA-Turkey must be taken into account when determining the taxable income.

The Finance Court Mecklenburg-Vorpommern also proceeds accordingly in the judgment of 22.01.2019 – 1 K 282/17. Thus, the instruction of the BMF letter of 11.12.2014 – IV B 4-S 1301 – TÜR/0:007, according to which the lump-sum advertising cost amount is not to be granted in addition to the allowance (including pension allowance) DBA-Turkey, is unlawful. Therefore, taxable income is overstated by EUR 102 in all cases. We therefore recommend appealing against the tax ruling in these cases and obtaining a supreme court decision if necessary.

Taxation of pensions: Criticism of the tax rate progression

4.1. Problem: Adding the basic allowance

For unlimited taxpayers, the law provides for a so-called basic allowance. The basic allowance is not subject to tax in Germany and is therefore tax-free. Methodologically, it is taken into account in the context of the income tax rate, by the input tax rate 14 % and then the progression only after the zero zone – the subsistence minimum or basic allowance. Only the first euro above the basic allowance is therefore subject to tax.

For limited taxpayers, on the other hand, the calculation of the tariff income tax is based on § 50 (1) sentence 2 EStG. Accordingly, the taxable income is to be increased by the basic allowance of § 32a (1) sentence 2 number 1 EStG. The addition is a consequence of the fact that the basic allowance has been incorporated by the legislature into the tariff progression and is not deducted from the taxable income before the tariff is applied. Taxation is subject to the initial tax rate from the first euro.

The tariff is progressive in Germany. Therefore, any increase in taxable income of 1 to 7 EUR within a progression level leads to a higher income tax. This creates a higher average tax burden.

4.2. Taxation of pension and impact on progression

In the context of the taxation of pensions, it may now be that pension adjustments occur in the following years. The adjustments increase the real taxable income. Then there is the addition of the basic allowance. The addition increases the average tax burden on real taxable income disproportionately in relation to the amount of the pension adjustment. This applies even if the real taxable income in each calendar year is within the zero zone. In itself, the real taxable income does not reach the progression zone in any calendar year. The increase in the average tax burden is therefore based solely on the tax rate progression caused by the increase in the real taxable income by the basic allowance. He shifts the real taxable income ever higher into the progression zone.

Thus, the increase in taxable income by the basic allowance for the limited taxpayers assessed for income tax leads to a higher income tax due to the tax rate progression even if their taxable income increases in real terms, for example through pension adjustments, but still remains within the zero zone (basic allowance) and thus outside the progression zone. In these cases, the tax rate progression is based on a pure calculation process (attribution), which is not based on real income, but only on a theoretical amount (basic allowance) for the limited taxpayers.

Legality of the increase in taxable income by the basic allowance

The refusal of the basic allowance for taxable persons subject to income tax by increasing the taxable income by the basic allowance has already been the subject of supreme court decisions on several occasions. In it, the refusal was classified as constitutional and EU-compliant. The objective of the legislature to ensure the subsistence minimum through its tax exemption exclusively for nationals is legitimate. The reason for this is that the basic allowance is already taken into account in the context of taxation abroad.

However, it is not clear whether the progression-related increase in the tax burden is legal even if the real taxable income remains within the zero zone, i.e. outside the progression zone beyond the initial tax rate of 14%. Then taxation is not based on the economic performance of the limited taxpayers.

Unlawful ordering of the tax deduction according to § 50a paragraph 7 EStG

6.1. Condition for ordering the tax deduction

According to § 50a paragraph 7 EStG, the tax office of the remuneration creditor may order that the debtor of the remuneration on behalf of the creditor, i.e. the tax debtor, has to withhold and pay the income tax on limited income, insofar as it is not already subject to the tax deduction, by way of the tax deduction. The prerequisite is that the retention at the source is expedient for securing the control claim.

According to the case law of the BFH, a tax claim is no longer secured if the later enforcement of the tax claim appears endangered or difficult. The order for the tax deduction under Section 50a(7) EStG serves to secure the tax claim against the foreign remuneration creditor, who does not have any significant assets in Germany. The background to this order is that recovery abroad is often associated with particular difficulties.

6.2. Decision of the financial administration in individual cases

In the case in point for the taxation of the pension, from 1.7.2023 the tax office ordered DRV to deduct the tax at source by DRV according to § 50a paragraph 7 EStG. This was due to the fact that the taxpayer has not fully complied with his tax obligations and the tax liability is jeopardised. The tax office considers the tax liability to be endangered because a permanent waiver situation exists and the recovery is permanently hopeless.

6.3 Criticism of the classification by the Financial Administration

6.3.1. No endangerment of tax liability

Pensioners regularly only have the pension as their only source of income. Therefore, recovery in Turkey is not particularly difficult in these cases. Under current law, pensions are treated as income from work. Therefore, it can be attached to the DRV as a domestic third party debtor. Therefore, the tax office has the legal means to enforce the domestic tax claim with DRV. Therefore, any enforcement which may become necessary is neither jeopardised nor made more difficult as such.

Restriction is, however, to the extent that by law only that part of the pension may be seized which is above the unseizable income (attachment allowance). This is regulated indirectly in § 319 AO. There it is pointed out that the restrictions and prohibitions that exist according to §§ 850 to 852 ZPO for the attachment of claims and claims are also applicable for enforcement in tax law. There is no distinction between unlimited and limited taxpayers. According to §§ 850, 850c (1) ZPO, the earned income is unattachable if it does not exceed EUR 1.402 monthly. This unseizable amount applies from 1.7.2023 and must be observed ex officio by the tax offices.

In the initial case, the net pension of EUR 1,075,93 is well below the attachment allowance of EUR 1.402,28. This makes it unattachable. If the prohibition on attachment is to be applied, there is no tax entitlement to be secured because it is endangered by special circumstances. Because the tax claim is not enforceable by law because of the unseizability of the pension. In this case, however, the means used for arranging the tax deduction for securing it cannot be expedient either. There is nothing to be assured, because nothing is possible to seize. As a result, the arrangement runs empty. Rather, it is misused and thus used unlawfully. It breaks through the legal attachment protection.

6.3.2. View of the BFH

The BFH also chooses a corresponding argument for refusing to waive tax liability on equity grounds. The waiver of the right on personal equity grounds should not be considered if the economic circumstances of the taxpayer are such that enforcement of the tax liability is excluded on account of the protection against attachment. Personal inequity in matters of decree must lie in the collection of the tax itself. Therefore, the BFH expressly points out in its rejection of the application for remission that because of the attachment protection according to § 850c ZPO an enforcement of tax claims is excluded and therefore personal equity reasons do not exist.

6.3.3. Excess of discretion

Even if it can be assumed that the actual requirements of § 50a(7) EStG would exist, i.e. the tax deduction must be allowed because the tax liability is jeopardized, the order of the tax deduction in the case of taxation of the pension would be unlawful. The arrangement of the control deduction is erroneous.

The administrative order of the tax deduction according to § 50a paragraph 7 EStG, in contrast to the legal order of the tax deduction according to § 50a paragraph 1 no. 1 EStG, is at the discretion of the authority. As a result of ordering the tax deduction, there is an obligation to deduct the tax, which would not exist without order. Consequently, the arrangement is constitutive in this sense. The authority has discretion in this regard as to whether or not the tax deduction is ordered (so-called measure of resolution) and as to the amount of the tax deduction (so-called measure of selection).

The tax administration assumes that the tax deduction order is an interim measure to secure tax liability. The provisions of §§ 281 ff. BGB were to be applied to these. Therefore, the attachment provisions of Section 319 AO in conjunction with Sections 850 to 852 AO do not apply.

From an economic point of view, however, the order of the tax deduction seems like a garnishment. The financial administration is also forcibly contributing money here by using a legal means. Thus, the tax deduction order constitutes a measure similar to enforcement. The tax office is constitutionally obliged under Article 20 paragraph 3 GG (principle of the rule of law) to comply with the standards on attachment protection. Therefore, it may not exclude the enforcement suspension according to § 319 AO in the exercise of discretion to order the tax deduction. Otherwise, I would have the legally enshrined enforcement protection undermined by an opposing exercise of discretion.

7th Summary on the taxation of pensions in the case of foreign residence

In summary, only the amount exceeding the allowance of EUR 10,000 (including the pension allowance) (Article 18 paragraph 2 DTA Turkey) is subject to domestic taxation under the limited tax liability. This bilateral regime is in line with the national tax norm. In Germany, therefore, the lump-sum amount for advertising costs is to be deducted at the stage of determining the surplus of the revenue on advertising costs. It is therefore added to the allowance. Ordering the tax deduction at source for only low pension income is regularly illegal.