Limited Taxation for an Employee relocating Abroad?

When Jerry lost his job, he negotiated a severance pay and then headed home. His German tax office wanted to fully tax him but Jerry only wanted to be partially taxed on this severance pay. When you read this article, you will know who is right because the Federal Tax Court had it it's say on August 27, 2008 (re I R 81/07; published on December 17, 2008).

Severance pay, which is compensation for lost future earnings, for a worker who has moved out of country, does not count as a limited, taxable, domestic income for the purpose of § 49 Abs. 1 Nr. 4 EStG 1997.


Jerry was employed as a managing director of GmbH (Geschäftsführer). It was agreed that his employment was to end prematurely. As a compensation for ending the contract in general as well as the remaining salary, he received 4.6 mil. DM - in installments. Thereupon, Jerry left Germany and relocated to Switzerland. He declared in his tax return as taxable in Germany his salary (as per tax card) plus the part of his severance pay relating to the no-competition clause. He declared the remaining DM 3,226,310 as not taxable in Germany. His tax office was of a different opinion.

The BFH agreed with Jerry. The amount in dispute, DM 3,226,310 was not subject to German taxation. Subject to full German taxation is only such income achieved during the time he had his residence or usual sojourn in Germany (§1 I 1 EStG). Persons are fully subject to German taxation when their residence (§8 AO) or usual sojourn (§9 AO) is in Germany. At the time, he received the remaining part of severance pay, it was evident that he was in Switzerland. He therefore did not have either residence nor a usual sojourn here any more. He was not living for an indefinite time in his German apartment anymore.

The remaining part of his severance pay, i.e. that not to be taxed in full in Germany, is also not subject to partial taxation following §49 EStG. Such income will be partially taxed in Germany, when income from (self-)employment is performed in Germany - and with living here. Precedents of the Federal Tax Court interpreting double taxation law for income from dependent work say severance payments are not paid for a certain activity but for the end of previous employment. Therefore, Jerry's disputed income is not subject to partial taxation in Germany. It remains reserved for taxation in Switzerland.


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