Attorney for International Tax Law in Münster

Key concepts, double taxation and DTTs explained in plain terms

This page gives you the overview — from tax liability through the double taxation treaties to the decisive distinction between EU and third-country cases.

1. What is International Tax Law?

The term brings together four areas of German tax law that deal with foreign elements. The full picture only emerges from their interplay:

1. The double taxation treaties (DTTs) — treaties under international law with currently around 100 states, which allocate the right of taxation between Germany and the respective contracting state.
2. National provisions with a foreign element — for example the crediting of foreign tax under sections 34c, 34d of the Income Tax Act (EStG), the progression proviso under section 32b EStG, or the loss-deduction restriction of section 2a EStG.
3. The Foreign Tax Act (Außensteuergesetz, AStG) — the anti-avoidance provisions against exploiting the international tax differential: exit taxation, controlled-foreign-company (CFC) taxation, transfer pricing.
4. EU law on direct taxation — the fundamental freedoms of the TFEU, the case law of the ECJ and the relevant directives.

2. Worldwide income, territoriality and tax liability: the basic principles

Almost all states link taxation to two connecting factors:

• The worldwide income principle applies to individuals and companies resident in Germany (domestic taxpayers). They are subject to unlimited tax liability and are liable to German tax on their entire domestic and foreign income (section 2(1) EStG). For individuals, unlimited tax liability is triggered by domicile or habitual abode (section 1 EStG in conjunction with sections 8, 9 AO).
• The territoriality principle covers persons without a domestic domicile (foreign taxpayers). They are subject to limited tax liability only on their domestic income (section 49 EStG).

A pitfall of real practical relevance: tax domicile under section 8 AO is to be assessed solely on the basis of the actual circumstances. Registration-law or civil-law criteria are irrelevant. Anyone who keeps a furnished home in Germany that is available for use at any time often remains subject to unlimited tax liability even during a posting abroad lasting several years — even where the centre of their life has long been abroad. The fiscal courts and the Federal Fiscal Court (BFH) have developed extensive case law on this, for instance on the so-called stand-by cases.

Some states — the USA above all — add a third variant with the citizenship principle: US citizens and green-card holders remain subject to US filing and tax obligations regardless of their domicile. Dual residence is thus pre-programmed.

3. How double taxation arises

Double taxation typically threatens in three constellations:

• A person resident in Germany is partly active abroad (a fitter on a construction site, a posted specialist).
• A resident person receives foreign income — dividends, interest, royalties, rents — or holds assets there.
• A person is subject to unlimited tax liability in several states at once (dual domicile).

Added to this are qualification conflicts: both states assess the same facts differently — for example the existence of a permanent establishment or the type of income. In a positive qualification conflict both states levy tax; in a negative one neither does. The latter leads to the notorious “white income” that is taxed in none of the states involved — a result that the OECD’s BEPS project expressly aims to curb and that the German legislator combats with subject-to-tax clauses (Section 6).

4. Double Taxation Treaties (DTTs): structure and mode of operation

DTTs are treaties under international law that are transposed into domestic law by an act of ratification. The German treaties largely follow the OECD Model Tax Convention (OECD-MC). You should be familiar with three building blocks:

The allocation articles

The distributive rules (Arts. 6 to 21 OECD-MC) govern where what may be taxed and to what extent. Some basic lines:

• Immovable property — state where it is situated.
• Business profits — state of residence, exceptionally the permanent-establishment state.
• Dividends, interest, royalties — in principle the state of residence, frequently with a limited right to levy withholding tax (often 15% on dividends).
• Employment income — state of activity, subject to the well-known 183-day exception in favour of the state of residence.

The method article

While the allocation article distributes the right of taxation, the method article (Art. 23 A/B OECD-MC) determines how the state of residence eliminates double taxation: by exemption or by crediting the foreign tax (Section 5).

Residence and the tie-breaker rule

Anyone who has a domicile in both states is initially resident twice over. Art. 4(2) OECD-MC resolves this by a stepped test: permanent home → centre of vital interests → habitual abode → nationality → mutual agreement of the authorities. The “centre of vital interests” is by far the most litigation-prone criterion; here the tax authorities work with extensive questionnaires (size of home, utility-consumption figures, club memberships, vehicle registration). We devote a separate in-depth article to residence.

5. Exemption or crediting: the two methods compared

The choice of method often decides thousands of euros — and the right legal form for a foreign venture.

Exemption method (with progression proviso). The foreign income is excluded from tax in Germany, but through the progression proviso (section 32b EStG) it increases the tax rate on the remaining income. Business and professional profits, employment income and “box-privileged” (participation) dividends are regularly exempted. The appeal: where the foreign tax level is lower, that advantage is preserved.

Crediting method (section 34c EStG). The foreign tax is credited against the German tax — but only up to the amount of the proportionate German tax on that income (maximum-amount calculation, “per-country limitation”). In effect the tax is “brought up” to the higher German level. Where no DTT exists, the credit under section 34c EStG is the unilateral fallback mechanism.

6. White income, subject-to-tax clauses and treaty override

The clean allocation of taxing rights only works as long as tax is actually levied somewhere. To prevent “white income”, the legislator has built in several safeguards:

• Subject-to-tax clauses grant the exemption only if the income was demonstrably taxed in the other state.
• Switch-over clauses permit a unilateral switch from exemption to crediting.
• Section 50d(8) EStG makes the exemption of employment income conditional on proof of foreign taxation (or of a waiver of taxation).
• Section 50d(9) EStG causes the exemption to lapse where a qualification conflict leads to non-taxation. Since 2017, non-taxation of individual parts of the income is already sufficient for this (“atomisation”).

These provisions are so-called treaty overrides — national rules that deliberately override a DTT. That this is constitutionally permissible was expressly confirmed by the Federal Constitutional Court for section 50d(8) EStG: domestically a DTT has only the rank of an ordinary statute that the legislator may later amend again (BVerfG, order of 15 Dec. 2015 – 2 BvL 1/12).

In addition, section 50d(3) EStG (anti-treaty-shopping) ensures that functionless foreign companies are not used as a mere “shell” to obtain withholding-tax relief.

7. EU or third country? The decisive distinction

Whether the foreign state belongs to the European Union (or the EEA) or is a third country fundamentally changes the legal position. This distinction runs through virtually every cross-border case — and it is the common thread for the in-depth country articles that we are adding here step by step.

Taxation within the EU/EEA

Within the internal market, two powerful additional layers operate that do not exist in the same way vis-à-vis third countries:

The fundamental freedoms of the TFEU and the ECJ case law. Freedom of establishment (Art. 49), free movement of workers (Art. 45), freedom to provide services (Art. 56) and free movement of capital (Art. 63) are directly applicable individual rights — including in tax law. In this respect the ECJ sees itself as the “engine of the internal market” and has corrected numerous national provisions. One practical consequence: the loss-deduction restriction of section 2a EStG is no longer applicable in relation to EU states.

EU secondary law (directives). This is where the greatest practical significance lies:

• Merger Directive — tax-neutral cross-border reorganisations (Reorganisation Tax Act, UmwStG).
• ATAD (Anti-Tax-Avoidance Directive) — implemented by the ATAD Implementation Act; it reformed CFC taxation, exit and unwinding taxation, and the combating of hybrid arrangements.
• Directive on global minimum taxation (Pillar Two) — implemented by the Minimum Taxation Directive Implementation Act; it secures effective minimum taxation for large corporate groups.
• EU Mutual Assistance Directive (DAC) — automatic exchange of information and reporting obligations; the DAC7 stage is implemented in sections 138d et seq. AO.
• EU Dispute Resolution Directive — supplements the DTT mutual-agreement procedures with a de facto obligation to reach agreement within clear deadlines.

Taxation with third countries

Outside the EU, essentially only two tools are available:

• The respective DTT — provided one exists. Otherwise, only the unilateral avoidance of double taxation via the credit under section 34c EStG remains.
• German national law, including the subject-to-tax clauses described above.

The fundamental freedoms generally do not apply here — with one important exception: the free movement of capital (Art. 63 TFEU) is the only fundamental freedom that also applies vis-à-vis third countries, albeit restricted by the standstill clause of Art. 64 TFEU.

One particularity deserves attention: the Tax Haven Defence Act (Steueroasen-Abwehrgesetz, StAbwG), in force since 25 June 2021, in some cases even imposes a complete treaty override for non-cooperative tax jurisdictions on the EU list — the DTT is declared inapplicable to that extent. The Russian Federation, for example, is affected.

8. The Foreign Tax Act: exit, CFC taxation, transfer pricing

As soon as arrangements exploit the international tax differential, the AStG comes into play. Four topics are to the fore:

• Exit taxation (section 6 AStG). Anyone who, as a substantial shareholder within the meaning of section 17 EStG, transfers their domicile abroad must tax the hidden reserves in the shares — even without an actual sale. The rule was fundamentally recast by the ATAD Implementation Act as of 2022.
• CFC taxation (sections 7 et seq. AStG). Passive, low-taxed income of a controlled foreign intermediary company is attributed directly to the domestic shareholders. The low-tax threshold currently stands at 15%.
• Extended limited tax liability (section 2 AStG). Where German nationals move to a low-tax jurisdiction, German taxation may — if substantial economic interests in Germany continue — have after-effects for up to ten further years.
• Transfer pricing (section 1 AStG). Supply and service relationships between affiliated enterprises must withstand the arm’s-length test; otherwise an off-balance-sheet adjustment is made.

In addition there is the de facto look-through to foreign family foundations (section 15 AStG). We address each of these topics in dedicated focus articles.

9. How to examine a cross-border matter

For sound handling, a fixed sequence has proven effective:

5. Clarify tax liability — Is there (still) unlimited tax liability? Does the worldwide income principle apply?
6. Examine the DTT — Does a treaty exist? Is it applicable in substance, in territory and in respect of the person? Does the StAbwG intervene?
7. Allocation article — Which type of income is present, and to what extent may the source state tax?
8. Determination of income — The nature and amount of the foreign income are always to be determined under German law (including currency conversion).
9. Method article — Exemption (with progression proviso) or crediting?
10. National particularities — section 2a EStG, progression proviso, subject-to-tax clauses of section 50d EStG.
11. AStG — Should exit, CFC taxation or transfer pricing additionally be considered?

This structure prevents the most common errors — for example premature German taxation even though the allocation article already supports an exemption.

10. Frequently Asked Questions (FAQ)