011. Tax Treaty - Place of Work for Dependent Personal Services

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Germany's tax treaties generally follow the OECD model treaty with respect to dependent personal services by individuals. Under the OECD model, income from such services is taxable only in the country in which the individual is a resident unless the work is performed (exercised) in the other treaty state. Even if the work is performed in the other treaty state, it is still subject to taxation only in the country of residence if the conditions of the 183-day-rule are met.

Obviously, determination of the place of work is of prime importance in applying the article on dependent personal services. In a decision well known to German tax practitioners and tax authorities alike, an en banc panel of Germany's highest tax court ruled in 1971 that the general manager of a German GmbH who managed the company from Switzerland, never setting foot in Germany, nevertheless performed his work for the GmbH in Germany for purposes of the Swiss/German tax treaty. The theory of the decision was that the management function consisted in giving orders and instructions to persons inside Germany at the company's legal seat or principal offices, and that the place where such orders were received was the place where he "exercised" his activities.

This doctrine, which the Federal Tax Court had limited somewhat in its later judgements of 21 May and 16 July 1986, now seems to have been abandoned entirely by the Court's judgement of 5 October 1994 (DB 1995, 301). The case involved the president of a Canadian limited company who was resident in Germany for treaty purposes and sought exemption of his compensation from German taxes. The extent to which work was actually performed in Canada was in dispute. The taxpayer sought to use the 1971 ruling "offensively" by arguing that, as president of the Canadian company, his work was ipso facto performed in Canada. The Court rejected this argument stating that the 1971 ruling related to the old tax treaty with Switzerland, which had been superseded by a new treaty shortly after the 1971 ruling. The Court stated that the 1971 ruling was outdated, in that it had been rendered on a tax treaty which was no longer in force, and implied that the place of exercise of management functions was to be determined with respect only to factual circumstances under all German tax treaties, such as that with Canada, which do not contain special provisions. The Court noted that this was in accordance with Canada's reading of the treaty. Had the Court adhered to the 1971 ruling, this would probably have meant that at least part of the compensation in question would have escaped taxation in both treaty states.

The current tax treaty with Switzerland does, in fact, contain a special provision assigning the right of taxation of compensation paid to the statutory management of corporations to the country where the corporation is resident. Few, if any, other German tax treaties contain such a provision, however.

One should bear in mind that compensation paid to the general managers of a German GmbH or to members of the board of management of an AG is subject to payroll withholding tax. The company is liable for under-withholding. It should secure the certificate provided for by sections 39b par. 6, 39d par. 3 EStG before treating compensation as exempt under a tax treaty.

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