Taxes in Germany – is it worth it?

The Trend of Moving a Business to Germany

Despite the unfavourable market situation caused by ongoing inflation and rising energy prices, Polish entrepreneurs continue expanding their operations into foreign markets. Germany leads the popularity rankings, where domestic companies offer services either directly from Poland (e.g., by delegating employees to perform a given service) or through opening a branch or establishing a new company abroad.

This often entails a tax liability in the Federal Republic of Germany (FRG). Even without establishing a business in Germany, entrepreneurs providing services from Poland (as well as delegated employees) risk being subject to the foreign tax system. The German tax office – Finanzamt – rigorously examines the grounds for tax liability. Companies wishing to avoid contact with the German tax regime must exercise extreme caution. Tax regulations governing cross-border services are ambiguous and full of exceptions, and many commonly practiced solutions are challenged during audits by German tax authorities. A good example is the famous 183-day rule stemming from the German-Polish double taxation avoidance agreement, which does not always apply (for instance, it does not apply to temporarily delegated employees abroad).

This article aims to outline some of the tax system provisions in Germany that may affect entrepreneurs who are unable to avoid foreign tax obligations.

Offer: Tax law Warsaw, Kraków, Katowice

German Employee Wage Tax

Tax advances are withheld by the employer before paying the salary and transferred directly to the German tax office (Finanzamt). The taxpayer then settles them independently at the end of the tax year. Income tax on employee wages in Germany consists of three components (known as Einkommensteuer):

Income tax (so-called Lohnsteuer)

This tax is progressive. Depending on the gross salary amount and tax class, the tax rate in Germany can range from 14% to 45%. Tax class affiliation affects the amount of the tax-free allowance and the way the tax is calculated.

• Class 1 – single persons, widows/widowers for at least 2 years, divorcees, separated couples, and married persons whose spouse resides outside the European Union.
• Class 2 – single parents raising children alone.
• Class 3 – married persons and widows/widowers within one year of the spouse’s death, as well as married persons where one spouse is unemployed or resides in an EU country.
• Class 4 – other married couples not qualifying for other classes.
• Class 5 – persons with a spouse in Class 3.
• Class 6 – persons employed in more than one job.

The average tax-free allowances in Germany for 2022 were €9,984 for singles and €19,968 for married couples, but exact amounts depend on the tax class. The highest allowances apply to Classes 2 and 3, followed by Classes 1 and 4. Class 5 allowance is usually around €1,200, and Class 6 has no tax-free allowance.

Solidarity surcharge (so-called Solidaritätszuschlag)

The solidarity surcharge rate is 5.5%, with the condition that it is not charged on gross earnings not exceeding €73,800 annually. For married couples and members of tax Class 3, the threshold is €151,990 due to joint taxation.

Church tax (so-called Kirchensteuer)

The church tax ranges from 0.2% to 1.5% of gross salary depending on the federal state (Land). Employees can opt out by officially leaving the church or not being registered as church members.

Trade Tax on Sole Proprietorships (Gewerbesteuer)

This tax applies to entrepreneurs who decide to establish a Gewerbe in Germany, equivalent to a Polish sole proprietorship. The advantage of this tax is the high tax-free allowance of €24,500 compared to Poland. Only income exceeding this threshold is taxed. The tax rate depends on the company’s location (Land) and its income, ranging from 15% to 42%.

Value Added Tax, i.e., German VAT (Mehrwertsteuer)

The standard VAT rate is 19%, with a reduced rate of 7%. Entrepreneurs with turnovers below €22,000 per year are exempt. New taxpayers are obliged to submit monthly VAT declarations for the first two years of business activity in Germany.

Corporate Income Tax (Körperschaftsteuer)

For establishing a legal entity in Germany (e.g., a GmbH – German limited liability company), the income tax rate is 15%. Additionally, a solidarity surcharge of 5.5% must be added. Tax returns must be filed by 31 May following the tax year, but taxpayers are required to pay quarterly advance tax payments throughout the year.

Allowances and Deductions

The complexity of the German tax system also includes numerous allowances, benefits, and deductions, often resulting in substantial tax refunds at the end of the fiscal year. Unfortunately, despite many preferences, navigating the maze of German tax regulations requires a certain level of expertise and often consultation with a foreign tax advisor. Self-preparation of tax returns and declarations can exceed the capabilities of a typical entrepreneur without accounting or tax education.

How to Avoid Paying Tax?

Entrepreneurs often forget that even if their activity is limited solely to cross-border service provision, i.e., providing services to German clients from Poland, there is still a risk of being subject to the foreign tax system. This is particularly true when the Polish employer delegates employees to Germany or provides services on real estate, or operates in certain specific industries. The construction sector, which remains very popular, carries additional risks. It is subject to a special construction tax withheld by the German contractor from the remuneration of the Polish company, as well as additional restrictions. If you are interested in details and ways to obtain exemptions or minimise the risk of falling under a foreign tax system (not only in Germany), please check the law firm’s offer regarding employee delegation and cross-border service provision.