Germany-United States International Income Tax Treaty Explained

Germany-United States International Income Tax Treaty Explained

US Germany Tax Treaty

US Germany Tax Treaty: International Agreements “aka US Tax Treaties” between the United States and foreign countries have existed for many years — and the US Germany Tax Treaty is no different. An Income Tax Treaty like the income tax treaty between Germany and the United States is designed to minimize inconsistent and double taxation — although a tax treaty cannot (unfortunately) shield certain tax implications of items such as a foreign pension. Germany and the United States have been engaged in treaty relations for many years. The treaty has been updated and revised  — with the most recent version being 2006. The purpose of the US/Germany Tax Treaty is to help Taxpayers determine what their tax liability is for certain sources of taxable income involving parties to the treaty. While the US Germany Tax treaty is not the final word on how items of income will be taxed — it does help Taxpayers better understand how either the US Government and/or Germany will tax certain sources of income; what the IRS reporting requirements are — and whether or not the saving clause will further impact the outcome. Let’s review the basics of the US Germany Income Tax Treaty – and which income is taxable:

Saving Clause in US Germany Tax Treaty

As we work through the treaty, one important thing to keep in mind is the saving clause. The saving clause (essentially) provides that, despite any information provided in the treaty — both countries reserve the right to tax certain citizens and residents as they would otherwise tax them under the general tax principles of their respective countries.

What does the Saving Clause Say?

      • a) Notwithstanding any provision of the Convention or this Protocol except subparagraph b), the United States may tax its residents (as determined under Article 4 (Residence)) and its citizens as if the Convention had not come into effect. For this purpose, the term “citizen” shall include a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of income tax, but only for a period of 10 years following such loss.

Despite any limitation created by the saving clause, certain portions of the tax treaty are immune from the saving clause — which means the tax treaty will stand despite the Savings Clause:

      • b) The provisions of subparagraph a) shall not affect the benefits conferred by the United States aa) under paragraph 2 of Article 9 (Associated Enterprises), paragraph 6 of Article 13 (Gains), paragraphs 3 and 4 of Article 18 (Pensions, Annuities, Alimony, and Child Support) and paragraphs 1 c) and 2 of Article 19 (Government Service; Social Security), and under Articles 23 (Relief from Double Taxation), 24 (Nondiscrimination), and 25 (Mutual Agreement Procedure); and

      • bb) under paragraph 1 b) of Article 19 (Government Service; Social Security), and under Articles 20 (Visiting Professors and Teachers; Students and Trainees) and 30 (Members of Diplomatic Missions and Consular Posts), upon individuals who are neither citizens of, nor have immigrant status in, the United States.

Resident Defined in the Germany & US Tax Treaty

      • For the purposes of this Convention, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature, provided, however, that a) this term does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein; and b) in the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries.

What does this Mean?

It means that for purposes of the tax treaty, a resident is essentially a person who intends on being a resident of that country by way of domicile, place of management or incorporation — or any other situation when considering the totality of the circumstance, would tend to show that the person intended on being treated as a resident of that country.

Permanent Establishment in the Germany & US Tax Treaty

      • 1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

      • 2. The term “permanent establishment” includes especially; a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; and f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

      • 3. A building site or a construction, assembly or installation project constitutes a permanent establishment only if it lasts more than twelve months.

What does this Mean?

When it comes to Permanent Establishment rules — it can get very complicated since it involves business, and especially with the introduction of the TCJA, the rules are still kinda-sorta in a state of flux. The most important concept of permanent establishment is that unless a company has a permanent establishment “fixed place of business” in this specific country then they are generally not going to be taxed by that country on the income generated in that country.

Real Property Income in the US Germany Income Tax Treaty

      • 1. Income derived by a resident of a Contracting State from immovable (real) property (including income from agriculture or forestry) situated in the other Contracting State may be taxed in that other State.

      • 2. The term “immovable property” shall have the meaning that it has under the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to immovable property; livestock and equipment used in agriculture and forestry; rights to which the provisions of general law respecting landed property apply; usufruct of immovable property; and rights to variable or fixed payment as consideration for the working of, or the right to work, mineral deposits, sources, and other natural resources. Ships and aircraft shall not be regarded as immovable property.

      • 3. The provisions of paragraph 1 shall apply to income derived from the direct use, letting, or use in any other form of immovable property.

      • 4. The provisions of paragraphs 1 and 3 shall also apply to the income from immovable property of an enterprise and to income from immovable property used for the performance of independent personal services.

What does this Mean?

When it comes to real property income, the Germany & US Tax Treaty provides that any income generated from the real property situated in one of the contracting states may still be taxed in that state — in other words, for example, if a US person resides in the United States and has an income generated in Germany, then Germany can still tax the income even though the person is a resident of the other contracting state — and nothing would prevent the state of residence from taxing it as well. (Foreign Tax Credits should minimize the tax outcome).

Dividends in the Germany & US Tax Treaty

      • 1. Dividends paid by a company that is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

      • 2. However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State the tax so charged shall not exceed: a) 5 percent of the gross amount of the dividends if the beneficial owner is a company that holds directly at least 10 percent of the voting shares of the company paying the dividends, and b) 15 percent of the gross amount of the dividends in all other cases

What does this Mean?

When it comes to dividends, the general proposition is that even if dividends are paid by a company of one contracting state (Germany) to a resident of the other contracting state (US), it is the other contract state that gets to tax the dividends (US) — although they can still be taxed in this state of the source but only up to a limited amount of tax. When it comes to dividends, there are many exceptions, exclusions, and limitations to be cognizant of — which will vary based on the taxpayer-specific facts and circumstances.

Interest in the US Germany Income Tax Treaty

      • Interest derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State. 2.

      • The term “interest” as used in this Article means income from debt claims of every kind, whether or not secured by mortgage, and, in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures, as well as all other income that is treated as income from money lent by the taxation law of the Contracting State in which the income arises.

      • Penalty charges for late payment shall not be regarded as interest for the purposes of this Convention. However, the term “interest” does not include income dealt with in Article 10 (Dividends).

What does this Mean?

The taxation of interest is a bit more straightforward than dividends, but still has its own set of complexities to be aware of. From a baseline perspective, interest earned in a contracting state (Germany) which arises from the beneficial ownership for a person in the other contracting state (US) is only taxable in that other state — shall vs may. Of course, there are some exceptions and exclusions to the first paragraph which taxpayers should evaluate carefully for their specific situation.

Capital Gain in the Germany & US Tax Treaty

      • Gains derived by a resident of a Contracting State from the alienation of immovable property referred to in Article 6 (Income from Immovable (Real) Property) and situated in the other Contracting State may be taxed in that other State.

      • For the purposes of this Article, the term “immovable” property situated in the other Contracting State shall include a) immovable property referred to in Article 6 ( Income from Immovable (Real) Property); and b) shares or comparable interests in a company that is, or is treated as, a resident of that other Contracting State, the assets of which company consist or consisted wholly or principally of immovable property situated in such other Contracting State, and an interest in a partnership, trust, or estate, to the extent that its assets consist of immovable property situated in that other Contracting State.

      • Gains from the alienation of immovable property forming part of the business property of a permanent establishment that an enterprise of a Contracting State has in the other Contracting State or of immovable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or of such fixed base, may be taxed in that other State.

What does this Mean?

Capital gains are also a common source of passive income. Essentially, if real property is alienated which culminates in a taxable event in a contracting state, then it is taxable in that contracting state. There are specific definitions to be aware of depending on whether the property is located in Germany or the United States –and different rules may apply to each based on their own respective tax regimes. In addition, there are specific definitions involving what is termed as “real property situated in a contracting state.”

Exchange of Information: US Germany Income Tax Treaty

      • The competent authorities of the Contracting States shall exchange such information as is necessary for carrying out the provisions of this Convention and of the domestic law of the Contracting States concerning taxes covered by this Convention insofar as the taxation thereunder is not contrary to this Convention. The exchange of information is not restricted by Article 1 (Personal Scope). Any information received by a Contracting State shall be treated as secret in the same manner as information obtained under the domestic laws of that State and shall be disclosed only to persons or authorities (including courts and administrative bodies) involved in the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to the taxes covered by this Convention. Such persons or authorities shall use the information only for such purposes. They may disclose the information in public court proceedings or in judicial decisions, unless the competent authority of the Contracting State supplying the information raises an objection.

      • In no case shall the provisions of paragraph 1 be construed to impose on a Contracting State the obligation:

        • a) to carry out administrative measures at variance with the laws and administrative practice of that or of the other Contracting State;

        • b) to supply information that is not obtainable under the laws or in the normal course of the administration of that or of the other Contracting State;

        • c) to supply information that would disclose any trade, business, industrial, commercial, or professional secret or trade process, or information, the disclosure of which would be contrary to public policy.

What does this Mean?

The exchange of information portion of the tax treaty is commonplace. It basically provides that each contracting state will exchange information with the other — necessary to carry out the purpose of the treaty. It also explains how the exchange of information may not be restricted under certain other articles of the treaty — but there are also limitations regarding the requirements that a contracting state may or may not have to adhere to.

Pension & Social Security/Government Service in the Germany/US Tax Treaty

One of the most important aspects of tax treaty law is how pension income is taxed. This is especially true so that retirees can plan for their golden years.

Pension

      • Subject to the provisions of Article 19 (Government Service; Social Security). pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment shall be taxable only in that State.

      • 2. Subject to the provisions of Article 19 (Government Service; Social Security), annuities derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State. The term “annuities” as used in this paragraph means a stated sum paid periodically at stated times during a specified number of years, under an obligation to make the payment in return for adequate and full consideration (other than services rendered).

      • 3. Alimony paid by a resident of a Contracting State and deductible there to a resident of the other Contracting State shall be taxable only in that other State. The term “alimony” as used in this Article means periodic payment (made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support) that are taxable to the recipient under the laws of the State of which he is a resident.

      • 4. Nondeductible alimony, and periodic payment for the support of a minor child (made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support), paid by a resident of a Contracting State to a resident of the other Contracting State shall be taxable only in the first-mentioned State.

What does this Mean for Pension Income?

When the payments refer to pension, it refers to pension distributions that arise in one state as a result of past employment paid to the resident of the other state — it is only taxable in the first state (in other words, the state that made the payments). But, it is limited by the Saving Clause (so the source country can still tax the income).

Social Security and Government Service

      • Wages, salaries, and similar compensation and pensions paid by the United States or by its states or political subdivisions to a natural person, other than a German national, shall be exempt from tax by the Federal Republic of Germany.

          • Wages, salaries, and similar compensation and pensions paid by the Federal Republic of Germany or by its Laender or by municipalities, or pensions paid by a public pension fund thereof to a natural person, other than a citizen of the United States and other than an individual who has been admitted to the United States for permanent residence therein, shall be exempt from tax by the United States. c

          • Pensions, annuities, and other amounts paid by one of the Contracting States or by a juridical person organized under the public laws of that State as compensation for an injury or damage sustained as a result of hostilities or political persecution shall be exempt from tax by the other State. d

          • For the purposes of this paragraph the term “pensions” includes annuities paid to a retired civilian government employee.

      • Social security benefits paid under the social security legislation of a Contracting State and other public pensions (not dealt with in paragraph 1) paid by a Contracting State to a resident of the other Contracting State shall be taxable only in that other Contracting State. In applying the preceding sentence, that other Contracting State shall treat such benefit or pension as though it were a social security benefit paid under the social security legislation of that other Contracting State.

What does this Mean for Social Security Income and Government Income?

When the payments refer to payments that are Social Security — and payments are being made to a resident of the other state or to a citizen of the United States – it is only taxable in the first state (in other words, the state that made the payments) — this will generally hold true for payments made by the Government for wages paid by the Government. It further clarifies that in this situation in which a US citizen resides in Germany, and receives Social Security or similar payments from the Germany — Germany is the only country that gets to tax the income (despite US worldwide income rules).

Reporting Forms for Germany Pension

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:

      • Single or Filing Separate (in the U.S.): $50,000/$75,000

      • Married with a Joint Returns (In the U.S): $100,000/$150,000

      • Single or Filing Separate (Outside the U.S.): $200,000/$300,000

      • Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance, or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

    • Gift from a Foreign Person: More than $100,000.

    • Gift from a Foreign Business: More than $16,815

    • Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have an ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

      • Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.

      • Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.

      • Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.

      • Category 4: Control of a foreign corporation for at least 30 days during the accounting period.

      • Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company). The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to the filing requirements.

Received a Gift or Inheritance From Germany?

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business, or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in Germany Report U.S. Account Holders?

There are thousands of Foreign Financial Institutions within Germany that report US account holder information to the IRS. The list can be found here: FFI List:.

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

      • Bank Accounts

      • Investment Accounts

      • Retirement Accounts

      • Direct Stock Ownership

      • ETF and Mutual Fund Accounts

      • Pension Accounts

      • Life Insurance or Life Assurance Policies

Totalization Agreement & the United States/Germany

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the IRS:

      • An agreement, effective July 1, 1988, between the United States and Germany improves Social Security protection for people who work or have worked in both countries. It helps many people who, without the agreement, would not be eligible for monthly retirement, disability or survivors benefits under the Social Security system of one or both countries. It also helps people who would otherwise have to pay Social Security taxes to both countries on the same earnings.

      • The agreement covers Social Security taxes (including the U.S. Medicare portion) and retirement, disability and survivors insurance benefits. It does not cover benefits under the U.S. Medicare program or the Supplemental Security Income (SSI) program.

      • This document covers highlights of the agreement and explains how it may help you while you work and when you apply for benefits.

The United States has entered into 26 Totalization Agreements, including Germany (as of 1979).

US Germany Income Tax Treaty is Complex

In conclusion, The US and Germany tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income, and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure on matters involving the United States-Germany Tax Treaty.

Contact our firm for assistance.