The most important Articel for calculating the tax burden is Articel 23. What are the main finding in this articel and why?
The OECD MTC uses two types of barrier provisions:
Barrier provisions with final legal consequence (“may only”) and
barrier provisions with open legal consequence (“may” or “may also”).
Barrier provisions with open legal consequence do not exclude either of the two Contracting States from taxation.
In this case, the country of residence shall retain the taxation right, but double taxation must be eliminated by applying the Methods article.
OECD Articel 23 A Exemption Method
OECD Articel 23 B Tax credit Method
What is the Progression Provisio (Name a example) ?
If a taxable person earns income from a State with which Germany has signed a DTT, then the DTT will stipulate either
the tax credit method; or
the exemption method for eliminating double taxation.
In the case of the exemption method,
however, it should be ensured that, despite the exemption of the foreign income, the tax rate be applied to the tax‐liable income that would have resulted had the foreign income not been tax‐exempt (taxation according to ability to pay). This is ensured by the so‐called progression proviso
Notwithstanding domestic tax indemnity, the foreign income is included when determining the (progressive) income tax rate to be applied.(
Ungeachtet der inländischen Steuerbefreiung werden die ausländischen Einkünfte bei der Ermittlung des
(progressiven) Einkommensteuersatzes berücksichtigt.)
The progression proviso can have a “positive” or “negative” effect and, as such, can result in an increase or reduction of the tax rate to be applied to the remaining income.
Application of the progression proviso must result in the remaining income that is subject to German taxation being subject to the tax rate that would have arisen had the DTT not been in place.
Solve the Example of Thomas Mustermann!
Thomas Mustermann receives domestic income in the amount of €80,000, as well as foreign income (non‐dividend income) in the amount of €40,000 from a state with which Germany has entered into a DTT. The regulation stipulates that the taxation right belongs to the foreign state, with Germany able to apply the progression proviso. Thomas Mustermann has special expenses in the amount of €8,000.
Solution: 1. Determining global income (§ 2 EStG)
Domestic income 80,000
Foreign income 40,000
Total income 120,000
Special expenses ‐ 8,000
Income used to calculate tax rate 112,000
2. Determining German income tax
(§ 32, para. 1 EStG) 0.42 × 112,000 − 8.394 = €38,646
3. Determining average tax rate Average tax rate = 38,646/112,000x100 = 34.5 %
Applying the average tax rate to the domestic income (progression proviso § 32b, para. 1 EStG) 72,000 × 0.345 = €24,840
Not applying the progression proviso, i.e. fully exempting the foreignincome, would result in a domestic tax burden in the amount of 72,000 × 0.42 − 8,394 = €21,846
If the exemption is made without a progression proviso, the taxable person can reduce their tax burden due to the progressive income tax tariff by distributing their income to several states (splitting effect).
Explain the Exemption (Befreiung) Method of Articel 23 A OECD
Article 23 A, para. 1 regulates the exemption method as the first alternative for eliminating double taxation by the country of residence.
According to the exemption method, income that can be taxed in the source country is exempted (befreit) from the domestic tax base in the country of residence. The exemption method results in a burden of the foreign income in the amount of the foreign tax level. In this manner, the taxable person is treated, in tax terms, in the same way as other competitors in the source country (capital import neutrality).
Exempting foreign income also results in negative foreign income being exempted from the domestic tax base.
When it comes to interest and dividend income for which the OECD MTC provides for distribution of the tax revenue between the country of residence and the source country (articles 10 and 11), then, according to article 23 A, para. 2,the tax credit method should be applied.
Article 23 A, para. 2 provides for a maximum credit amount.
Article 23 A, para. 3 grants the country of residence the option of considering applying the exempted income in order to calculate the tax rate applicable to the remaining income (so‐called progression proviso: § 32, para. 1 EStG).
The progression proviso should eliminate a double tax burden by reducing the tax base and by making use of the progression tariff. Theprogression proviso has no bearing on corporation tax, since corporation tax is a linear tariff.
The purpose of article 23 A, para. 4 OECD MTC is to prevent double non‐taxation. If the other Contracting State (source country) applies the Convention such that it exempts the income or capital from taxation, there shall be no exemption on the part of the country of residence.However, in numerous articles of the OECD MTC, although the source country possesses the right of taxation (“may” or “”may also”), it does not have to exercise this right.
For such case, article 23 A, para. 4 stipulates that the country of residence shall regain the full right of taxation in order to prevent any “blank income” from arising as income not subject to taxation.
Explain the tax credit method of articel 23 B OECD
Article 23 B, para. 1 regulates the tax credit method as a further alternative to eliminate double taxation by the country of residence.
The credit method, as the name suggests, eliminates double taxation by deducting the foreign tax from the domestic tax debt. The credit method therefore focusses on the tax debt and not, unlike the exemption method, on the calculation basis.
An essential feature of the credit method is the maximum credit amount according to article 23 B, para. 1, sentence 2 and, as a result, only the amount corresponding to the domestic taxes levied (Erhoben) on the foreign income can be deducted. The maximum credit amount allows the State to profit from a lower foreign tax level while at the same time allowing it to protect itself from the reimbursement of foreign taxes in the event that the foreign tax level is higher.
Solve the example with the credit method
Thomas Mustermann is resident in Germany and earns domestic income in the amount of €90,000 and foreign income in the amount of €30,000 from letting and leasing activity in Spain. He has special expenses in the amount of €10,000 and paid tax in the amount of €7,500 on his foreign income. Germany applies the tax credit method to this foreign income.
Solution 1. Determining global income (§ 2 EStG)
Domestic income 90,000
Foreign income 30,000
Special expenses ‐ 10,000
Taxable income 110,000
2. Determining German income tax (§ 32a, para. 1 EStG)
0.42 × 110,000 − 8,394 = €37,806
3. Determining the maximum credit amount (MCA)
MCA = 37,806 × 30,000/120,000 = €9,451 (>7,500)
4. Deducting the foreign tax: 37,806 − 7,500 = €30,306
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