Deduction procedure for foreign income
The deduction procedure or the deduction method is a procedure to avoid double taxation . In the deduction procedure, foreign income tax such as income- related expenses are deducted when determining the total amount of income . The reduced income is included in the calculation of German income tax ( Section 34c, Paragraphs 2 to 3 EStG ).
requirements
The deduction procedure is applied on request if there is no double taxation agreement (DTA) or if a DTA provides for it for the income concerned. Otherwise, foreign taxes are treated according to the credit method . This option was introduced in 1980 because the credit method can lead to unsatisfactory results in certain cases, especially if the foreign tax is higher than the German income tax. The crediting of a foreign tax is limited to the pro rata German tax that is applicable to the foreign income. With the deduction procedure, on the other hand, the deduction of foreign taxes is unlimited.
Maximum impact
If the deduction method is used, foreign income is relieved at the maximum personal tax rate.
Examples
Foreign income € 1,000; foreign tax paid on it € 300. In the deduction procedure, the tax of € 300 is deducted from this € 1,000 income. According to this, only € 700 is subject to German income tax.
Example 1: German tax higher
Tax rate in Germany: 42%, tax for 1000 € German income so 420 €. As a result of the deduction procedure, the German income tax is 42% of € 700 of = € 294. The total burden on foreign income is (300 € foreign tax + 294 € German tax =) 594 € total tax. In this case, the relief amounts to (420 € - 294 € =) 126 €, this corresponds to the personal tax rate (here 42%) on the foreign tax paid (300 € × 42% =) 126 €. It is always important to check whether the credit method does not produce a better result.
Example 2: German tax lower
Tax rate in Germany: 25%, tax for 1000 € German income so 250 €. As a result of the deduction procedure, the German income tax is 25% of € 700 = € 175. The total burden on foreign income is then (€ 300 foreign tax + € 175 domestic tax =) € 475 total tax. In this case, the relief is (€ 250 - € 175 =) € 75, which corresponds to the personal tax rate (here 25%) on the foreign tax paid (€ 300 × 25% =) € 75. It should always be checked whether the crediting method does not deliver a better result.
Example 3: no German tax
If there is no tax in Germany due to low income, the total charge is only (300 € + 0 € =) 300 €. In this case, the tax relief is (€ 0 - € 0 =) € 0, this corresponds to the personal tax rate (here 0%) on the foreign tax paid (€ 300 × 0% =) € 0. This variant can make sense if tax relief cannot be achieved in the current assessment period, but a loss carryforward can be increased, which can lead to higher tax relief in other years.
The deduction also makes sense if there is no tax on the corresponding income in Germany because there is a loss under German tax law, but a profit and corresponding tax is incurred under foreign law due to differing regulations for determination.
