Foreign Tax Law in Germany

Foreign Tax Law in Germany

Foreign tax law invariably contains a number of unexpected tax traps which may sometimes result in substantial additional tax payments. However, with careful consideration, there can also be tax advantages. Foreign tax law, therefore, holds significant importance not only for entrepreneurs involved in international business activities but also for self-employed tradespeople and freelancers.

Reducing taxes by establishing a company abroad? Beware of add-back taxation!

Considering the relatively high tax burden in Germany, an increasing number of companies and wealthy taxpayers are striving to lessen their tax burden by internationally shifting profits. The temptation is great: numerous countries and tax havens entice companies and private individuals with low tax rates or even zero taxation.

However, it is not as easy as it seems in reality. This is because German foreign tax law is quite effective in preventing profits from being artificially shifted to low-tax countries where they are hardly taxed or not taxed at all. The Foreign Tax Act (Außensteuergesetz, AStG) makes an important contribution to this in the form of so-called Controlled Foreign Corporation (CFC) Rules. It is the "natural enemy" of taxpayers striving for favorable taxation.

Foreign Tax Law Germany | Law Firm

Tax liability in Germany: Domicile and/or management in Germany

The tax liability of companies and private individuals in Germany depends on whether the company has its registered office in Germany or its management is located in Germany. For natural persons, this depends on their domicile or habitual residence in Germany. In these cases, this is referred to as unlimited tax liability in Germany.

Anyone who is subject to unlimited tax liability in Germany or is resident in Germany under the relevant double taxation treaties must pay tax on their worldwide income in Germany (global income principle or residence principle).

Limited tax liability in Germany: Domestic income

Certain income that taxpayers abroad receive from German sources, e.g.

  • rents from rented German real estate,
  • investment income from Germany,
  • profits from German permanent establishments, etc.,

are also subject to so-called limited German tax liability (territorial principle).


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Avoiding German taxation by setting up abroad?

What could be more obvious than moving abroad and/or setting up a company with its registered office and management abroad and foregoing all domestic/German income? In theory, the profits made abroad in this way would not be taxable in Germany. However, this only applies in theory. For many years, German foreign tax law has stood in the way of this approach. Avoiding its rules requires intensive planning and preparation and usually also a lot of patience.

Exit tax when moving abroad

Exit tax or exit taxation is a major risk, especially for taxpayers with business activities. It applies if a shareholder of a corporation (e.g. a shareholder of at least 1 percent in a GmbH or a foreign corporation) or a sole trader moves abroad and thus gives up their unlimited tax liability in Germany or becomes resident abroad in accordance with the relevant DTA regulations.

Apart from exceptions, the person moving abroad must, in case of doubt, disclose and pay tax on all so-called hidden reserves, e.g. the value of their GmbH shareholding (less acquisition costs). A particularly unpleasant aspect of this is that taxation can be triggered even though the taxpayer does not receive any cash inflow at all (dry income).

Extended limited tax liability after moving to a low-tax country

It is not just moving abroad that can trigger taxes. Foreign tax law has another inconvenience in store with § 2 AStG. According to this, a German who has been subject to unlimited tax liability for at least five years in the last ten years must also pay tax on certain non-foreign income in Germany in the next ten years if he or she is resident in a foreign territory with low taxation and has significant economic interests in Germany. This means that anyone who moves away from Germany may continue to be subject to tax in Germany for a number of years under foreign tax law, even if they would not be subject to limited tax liability in Germany under normal circumstances. In practice, this rule is rarely applied because the conditions are often not met. But caution is still advised.

The provision also poses particular risks for crypto investors because it has not yet been clarified with certainty under which circumstances, for example, income from trading in cryptocurrencies is foreign income or is subject to Section 2 AStG.

Establishing companies in low-tax countries is not a solution either: CFC Rules

Setting up companies (or foundations) abroad in order to make profits subject to low taxation abroad does not usually help either. In fact, the wrong plan often backfires. This is because the provisions of sections 7 to 154 AStG prevent taxpayers from gaining tax advantages by transferring certain activities to a corporation in a low-tax country (so-called intermediate company). § Section 15 AStG extends the provisions of foreign tax law for foundations and trusts abroad. The EU Anti Tax Avoidance Directive (ATAD) obliges the member states of the European Union to introduce a system for Cotrolled Foreign Corporation Tax Rules that meets a certain minimum standard by the end of 2018. German foreign tax law not only largely complies with this standard, but also goes beyond it in some areas.

As a result, passive income of foreign corporations that are controlled by persons with unlimited tax liability in Germany (in exceptional cases, even control is not necessary) and whose income is taxed at a low rate abroad is attributed to the German taxpayer as if he had received it himself. The situation is similar for foreign foundations/trusts. In this case, the German taxpayer must therefore pay tax on income from a foreign company that was not even distributed to him.

Tax profit adjustment of income in accordance with Section 1 AStG

Finally, German foreign tax law also has transfer pricing regulations. According to Section 1 AStG, a taxpayer's income can be adjusted in favor of domestic taxation, e.g. if conditions were agreed with related parties in cross-border business relationships that deviate from the usual conditions with unrelated third parties. Potential reductions in profits in Germany are then corrected by applying the so-called arm's length principle. In other words, a German GmbH cannot, for example, purchase services from a sister company in Dubai and pay inflated prices for them and claim the expenses as operating expenses in Germany.

Foreign tax law prevents such artificial profit shifting by obliging the taxpayer to make and document agreements that would have been agreed between independent third parties.

Your attorney for foreign tax law in Germany

If you are planning to relocate your company abroad, acquire a stake in a company abroad or set up a company or foundation/trust abroad, or if you have already done so, we will provide you with comprehensive support based on our tax law expertise and give you recommendations for the optimal structuring of your project. We are also happy to assist you with all other questions relating to foreign tax law.

So feel free to contact us with your questions!  The easiest way to contact us is by e-mail (, by phone (+49 69 76 75 77 85 31) or via our contact form for international tax law.

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