An increasing number of pensioners who live in Spain or have relocated to Spain receive letters from the Neubrandenburg Tax Office informing them about the possibility of applying for unlimited tax liability in Germany (Behandlung als unbeschränkt steuerpflichtig). As these letters are frequently misunderstood, this article briefly explains the implications of applying for unlimited tax liability and the tax risks associated with such an application.

The letters issued by the German tax authorities often describe the possible negative consequences for taxpayers only by means of the following statement:

"If you have already paid tax on your German pension in your country of residence, you must contact the tax authorities in your country of residence in order to avoid double taxation."

The purpose of applying for unlimited tax liability in Germany is to regain certain tax benefits that are only available to fully taxable residents, such as the basic personal allowance, personal and family-related tax allowances, the deductibility of extraordinary expenses and the possibility of joint taxation for married couples (Ehegattensplitting). These benefits are generally not available to taxpayers who are subject only to limited tax liability.

Spain Remains the Country of Full Taxation under the Double Taxation Agreement

The obligation to declare German pensions in Spain is based on the Spanish Personal Income Tax Act and the Double Taxation Agreement (DTA) concluded between Spain and Germany.

Article 17 of the Double Taxation Agreement – Pensions:

"Benefits paid under the social security legislation of a Contracting State may also be taxed in that State in accordance with its domestic law if the event giving rise to the entitlement to those benefits occurs after 31 December 2014. However, the tax may not exceed 5% of the gross amount of the benefits where the entitlement arises between 1 January 2015 and 31 December 2029. Where the entitlement arises on or after 1 January 2030, the tax may not exceed 10% of the gross amount of the benefits."

Accordingly, Spain currently retains the right to tax up to 95% of the pension income received by individuals who are tax resident in Spain, regardless of whether they apply for unlimited tax liability in Germany. Germany may only tax the remaining 5%, if at all, in accordance with the Double Taxation Agreement.

However, if applying for unlimited tax liability in Germany results in an effective German tax rate exceeding 5%, Spain may only grant a foreign tax credit for that 5%. Any German tax paid above this limit cannot be credited against Spanish tax and therefore results in actual double taxation. This is not a flaw in the Double Taxation Agreement itself, but rather a consequence of voluntarily applying for unlimited tax liability in Germany.

The following example illustrates this situation. For the purpose of the example, it is assumed that at least 90% of the taxpayer's worldwide income originates from Germany and that no other income is received.

Example A) German pension of €36,000 gross per year:

This example shows that German tax can only be credited in Spain up to the 5% limit established by the Double Taxation Agreement. If no application for unlimited tax liability is made, Germany taxes the pension only up to this treaty limit. However, where unlimited tax liability is requested, the actual German tax burden may exceed 5%. The excess cannot be credited against Spanish tax, resulting in genuine double taxation and an additional tax burden of approximately €2,500 per year.

Example B) German pension of €15,200 gross per year:

In this example, the German tax paid can be credited in full against the Spanish tax liability. Consequently, only the difference must be paid in Spain. Since the Spanish tax exceeds the German tax by only €11, applying for unlimited tax liability in Germany merely shifts the tax payment from Germany to Spain without reducing the overall tax burden. Given the additional administrative effort involved, applying for unlimited tax liability would generally not be advisable in this case either.

Example C) German pension of €12,000 gross per year:

Only in this final scenario may an application for unlimited tax liability be advantageous. In this case, the 5% German tax would no longer apply and, at the same time, no Spanish personal income tax would be payable.

 

Notes on the Examples:

The examples above are based on the gross pension amount and are intended solely to illustrate that, above a certain income level, German income tax may exceed the 5% limit provided for in the Double Taxation Agreement (DTA), potentially resulting in double taxation.

For the sake of simplicity, several factors that may influence the actual tax burden have not been taken into account, such as the taxable portion of the pension, deductible expenses or the taxpayer's individual circumstances. Therefore, the actual tax calculation must always be carried out on a case-by-case basis, taking into account, among other factors, the year in which the pension commenced, the existence of additional income and the applicable tax rates.

You can estimate your Spanish tax liability using our online tax calculator. If the Spanish tax payable exceeds 5% of the pension, applying for unlimited tax liability in Germany will generally provide no practical benefit, since the tax will ultimately have to be paid either in Germany or in Spain. However, particular caution is required where the German tax resulting from unlimited tax liability exceeds the 5% threshold provided for in the Double Taxation Agreement.

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General Remarks:

Taxpayers who receive additional German-source income (for example, rental income from property located in Germany) may also apply for unlimited tax liability in Germany under Section 1(3) of the German Income Tax Act (Einkommensteuergesetz – EStG).

In practice, many taxpayers submit this application under the mistaken assumption that it will also change their tax treatment in Spain. This is not the case. Individuals who are tax resident in Spain remain fully liable to Spanish Personal Income Tax, particularly where they spend more than 183 days per calendar year in Spain or where their centre of personal or economic interests is located there. An application for unlimited tax liability in Germany does not alter Spanish tax residence.

Furthermore, this option is only available if at least 90% of the taxpayer's worldwide income is subject to taxation in Germany or if the income earned outside Germany does not exceed the German basic personal allowance. In many cases involving Spanish tax residents, these conditions are not fulfilled, meaning that the application cannot be successfully made in the first place.

Even where these requirements are met, each case should be carefully assessed. Foreign-source income must also be declared in Germany and may affect the applicable German tax rate under the so-called Progressionsvorbehalt (progression clause pursuant to Section 32b EStG), which can significantly increase the German tax burden.

Our law firm will be pleased to analyse your individual circumstances, carry out the necessary administrative procedures on your behalf and assist you with the preparation and filing of the relevant tax returns. Should you require personalised advice or have any questions regarding this topic, please do not hesitate to contact us by email or telephone.

Author:

Christoph Sander
Lawyer and Tax Advisor
CEO, Partner, Director
info@sspartners.es
Tel: (+34) 951 12 13 06
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