In its decisions of 12 December 2024 (VI R 25/22, VI R 26/22 and VI R 27/22) published on 17 April 2025, the Federal Tax Court (Bundesfinanzhof – BFH) dealt with the classification of a foreign permanent establishment as an employer under tax convention law.
The subject of the rulings is the highly relevant practical issue of the allocation of the right to tax wage payments for employees resident abroad under tax convention law. If employees who are allocated to a foreign permanent establishment of a domestic parent company (in accordance with causation principles) work in Germany, the following question arises: Does Germany have the right to tax wages paid on domestic working days – even if employees only work in Germany for a few days, e.g. to attend meetings or training programmes?
Only "legally independent persons" can be employers within the meaning of tax convention law
The plaintiffs were corporations resident in Germany at which the employees working in the branches in other DTC countries (countries with which a double taxation convention exists) were employed. The employees stayed in Germany for only a few days for short business trips. Within the scope of determining permanent establishment profits, all expenses associated with these employees were allocated to the foreign permanent establishments. It was under dispute as to whether Germany has the right to tax under tax convention law with regard to the wage payments attributable to the domestic working days and whether the plaintiffs are obliged to withhold wage tax.
The fact that the wage payments attributable to the employees' working days in Germany were counted as income from employment with limited tax liability in accordance with Sec. 49(1) no. 4 letter a of the German Income Tax Act (Einkommensteuergesetz – EStG) was not under dispute.
The relevant provisions of the respective DTC in the cases of dispute essentially correspond to the OECD-MTC (OECD Model Tax Convention for the Avoidance of Double Taxation). According to Art. 15 para. 1 OECD-MTC, Germany, as the country of employment, has the unrestricted right to tax income from employment. However, Art. 15 para. 2 OECD-MTC restricts the right to tax to the detriment of the host state if the employees do not work in the host state for more than 183 days within a period of 12 months (letter a), the employees do not work for a domestic employer under tax convention law (letter b) and the remuneration is not borne by a permanent establishment of the employer in the host state (letter c). Art. 15 para. 2 letter a and letter c OECD-MTC were indisputably fulfilled in the case in dispute. The employees worked in Germany for less than 183 days and the remuneration was not paid by a domestic permanent establishment.
However, the plaintiffs were of the opinion that the foreign branches (which were indisputably to be classified as permanent establishments under tax convention law) and not the parent company in Germany were to be classified as employers within the meaning of Art. 15 para. 2 letter b OECD-MTC. Germany does not have the right to tax the wage payments attributable to the domestic working days under tax convention law.
The term "employer" is not defined in Art. 15 para. 2 letter b OECD-MTC. The lower court in the proceedings (Tax Court of Lower Saxony of 16 December 2021) had ruled that only a person who can be resident in one of the two contracting states can be considered an employer within the meaning of the tax convention law. A permanent establishment does not fulfil the requirements of a resident within the meaning of the convention and therefore cannot be an employer. The permanent establishment is not a legal entity within the meaning of tax convention law. The BFH agreed with this assessment and thus also confirmed the long-standing administrative opinion (see most recently Federal Ministry of Finance circular of 23 December 2023, para. 221 et seqq.).
Contrary to the plaintiffs' view, the fiction of autonomy and independence of permanent establishments introduced by the Authorised OECD Approach (AOA) does not change this. The fiction of independence is limited to the purposes of determining taxable profits and does not make the permanent establishment a person under tax convention law. Only a "legally" independent person can also assume the status of an economic employer under tax convention law.
Legal consequences in practice
As a result, only the plaintiffs are to be classified as employers under tax convention law. The consequence of this, however, is that Germany has the right to tax the employees' domestic working days under tax convention law. The domestic parent company is obliged to withhold and pay wage tax in accordance with Sec. 38(1) sentence 1 no. 1 EStG (as the employer under civil law).
For the companies concerned, domestic business trips by employees of a permanent establishment result in considerable settlement expenses. Even for a single working day physically spent in Germany, the proportion of wages taxable in Germany must be determined (from 1 January 2025 according to the daily table). For larger companies in the banking and insurance sector in particular, which often structure their foreign business by using permanent establishments, the administrative costs of handling domestic business trips are considerable. As a rule, the parent company will (have to) pay the wage tax due on domestic working days, which triggers an additional benefit subject to wage tax.
Reference to the possibility of flat-rate taxation at the employer's expense
For the practical handling of taxation, please refer to Sec. 40a (7) EStG, which is applicable from 1 January 2020. Under this provision, a domestic parent company (domestic employer) can make use of the option of flat-rate taxation of wage payments at a tax rate of 30% for short-term work assignments of its employees with limited tax liability at foreign permanent establishments.
Section 40a (7) EStG is intended to simplify tax assumption by the employer. There is no limit to the amount of the flat-rate taxation option. However, flat-rate taxation is permitted only for short-term activities in Germany that do not exceed 18 consecutive working days; if the 18-day limit is not met, standard taxation applies. The employer sometimes has to pay dearly for the simplification effect of flat-rate taxation compared to standard taxation (usually with tax bracket I).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
