Legal situation at the outset
The Retirement Income Act1, which came into effect on 1 January 2005, introduced fundamental changes to the way people who receive statutory pensions are treated. These included a transition to deferred taxation2. In its ruling of 6 March 2002 (2 BvL 17/993), the Federal Constitutional Court had declared the previous rules for taxing pensions to be unconstitutional. Under the old rules, pensions under the statutory pension insurance system and civil servants’ pensions were not treated equally – in the case of the former, only the ‘interest portion’4 was taxed, whereas the latter were taxed in their entirety.
During the transition to the new system of deferred taxation, pensioners under the statutory pension insurance system are given a tax-free pension allowance. This is calculated on an individual basis and fixed in the first full year in which the pension is received, after which it remains in place for the entire term of the pension. The taxable portion of the pension is determined according to a set percentage rate for the year in which the pension payments begin, based on the annual amount of the pension. People who retired prior to 2005 pay tax on 50% of their pensions. Until 2020, this percentage increases by two percentage points each year, reaching 80% for those retiring in 2020. After that, the percentage increases by one percentage point each year until it reaches 100% for those who retire in 2040. The taxable portion is specified by law; the percentages are set out in a table in section 22(1), third sentence, (a)(aa) of the Income Tax Act.
Special situation of pensioners living outside Germany
The legal consequences of these changes also affected pensioners living outside Germany. The amendment to section 49(1)(7) of the Income Tax Act means that statutory pensions5 paid from Germany across national borders are now taxable in Germany and, in some cases, are subject to income tax.
The legal changes affect two groups of pensioners living outside Germany: The first are those who, in addition to their German statutory pension, also have other income that is subject to tax assessment in Germany (typical example: rental income). These pensioners were already obliged to file an income tax return in the past, so the new rules brought no fundamental administrative changes for them. Their usual tax office continues to be responsible for them – it receives notifications of pension payments6 and includes these payments in its annual tax assessments.
The second group is comprised of pensioners living outside Germany who do not have any other taxable income. When the legal changes came into effect, these pensioners posed an administrative challenge for the revenue administration, because it was necessary to inform them of their (potential) tax obligations. Some of these pensioners had been living abroad for decades and had no previous contact with German authorities, let alone the German revenue administration. Some only had a poor grasp of German or spoke no German at all. Hundreds of thousands of notifications of pension payments for these pensioners had to be reviewed within the limitation period and, if appropriate, used as a basis for tax assessments. Moreover, the taxation of non-resident taxpayers (known as taxpayers with “limited tax liability”) is significantly more complex than it is in purely domestic situations. Under double taxation agreements concluded with the pensioners’ countries of residence, Germany has full taxing rights to some pensions, restricted taxing rights to others, and no taxing rights at all to yet others. German taxation rules for taxpayers subject to limited tax liability are also complex and difficult to communicate.
Approaches taken by the Neubrandenburg Tax Office
The first step taken by the revenue authorities of the German Länder was to set up a central tax office for pensioners living outside Germany whose only income from Germany is a statutory pension. This task was given to the Neubrandenburg Tax Office in the Land of Mecklenburg-Western Pomerania, which now has sole responsibility for this group of pensioners.7 Because of the nature of its responsibilities, this tax office was in a position to address the special challenges faced by this group in a targeted way, for example through organisational measures. The process of setting up the tax office was headed by the finance ministry of Mecklenburg-Western Pomerania with the close involvement of the German Federal Ministry of Finance.
Helping pensioners navigate the new situation
Few people are happy about the prospect of having to pay taxes. This was especially true of those who, having received tax-free pensions for many years, suddenly had to pay taxes as a result of changes in German legislation. The pensioners, some of them elderly, were confronted with uncertainties surrounding the new legal situation and, in some cases, with an unfamiliar administrative culture as well as language barriers.
The Neubrandenburg Tax Office addressed these difficulties in a highly user-focused way. With its multilingual website8 and its staff’s specialist knowledge of specific double taxation agreements, it has become a well-known and reliable point of contact for pensioners living outside Germany. Its staff answer frequently asked questions quickly and unbureaucratically, listen to people’s concerns and try to help where they can. Forms that pensioners need to complete in order to fulfil their tax obligations are made available for download from the tax office’s website or are sent by post if required. The aim is to put pensioners in a position to assert their rights and claims in the taxation process without the need for expert advice. Nevertheless, all taxpayers have the right to seek advice from a tax consultant or solicitor if they wish.
In practice, many taxpayers now contact the tax office even before they move abroad (either temporarily or permanently) after retirement to enquire about their future rights and obligations towards the German revenue administration. A growing number of people want to spend at least part of their retirement years outside Germany and are grateful for help in navigating this process. Nevertheless, there are pensioners, including some who moved abroad fairly recently, who find out about their German tax obligations only when they receive a letter from the Neubrandenburg Tax Office.
An opportunity for innovation: making the taxation procedure more user-friendly
As an experiment and on a case-by-case basis, the Neubrandenburg Tax Office has simplified the tax assessment procedure for pensioners living outside Germany considerably. The “standard case” is prepared for taxpayers in such a way that they can maintain their legal position without having to give the tax authorities information that is already available. Pensioners are also proactively made aware of opportunities to apply for more favourable tax treatment and given support in submitting these applications.
In general, pensioners who are subject to limited tax liability are obliged to file a tax return every year. However, this is no longer obligatory for pensioners for whom the Neubrandenburg Tax Office is responsible. The pension notification procedure, which was also introduced under the Retirement Income Act, and the responsibilities of the Neubrandenburg Tax Office mean that the tax office is already automatically informed of all the taxable income of pensioners who fall under its remit. For legal reasons, this group of pensioners is entitled to significantly fewer tax deductions than is the case in equivalent domestic situations. This set of circumstances was used as an opportunity to simplify things for taxpayers.
Some basic information on limited tax liability
Limited tax liability is defined in section 1(4) of the Income Tax Act: Individuals who have neither their domicile nor habitual abode in Germany are subject to limited income tax liability if they have German income as defined in section 49 of the Income Tax Act. For pensioners living outside Germany who fall under the responsibility of the Neubrandenburg Tax Office, the upshot of this is that only pensions received from Germany are subject to German taxation. Income from other countries, for example their country of residence, are not taken into account. However, those who are subject to limited tax liability can claim neither personal deductions nor the tax-free minimum amount of income needed for subsistence (basic personal allowance). Nor is it possible for spouses or civil partners to file joint returns.
However, under section 1(3) of the Income Tax Act, taxpayers with limited tax liability can apply to be treated as taxpayers with unlimited tax liability. This is possible if (a) at least 90% of their income is subject to German income tax liability or (b) the income that is not subject to German income tax does not exceed the basic personal allowance. Applicants must prove that these conditions are met. To do so, they can submit the “EU/EEA, the “Non-EU/EEA Certificate” or, for example, a tax assessment notice from their country of residence. Treatment as a taxpayer with unlimited tax liability under section 1(3) of the Income Tax Act means that they can claim the basic personal allowance and, if applicable, the deduction of special expenses or extraordinary financial burdens.
In the case of taxpayers who have opted for unlimited tax liability, spouses or civil partners can file joint returns only under the additional conditions set out in section 1a of the Income Tax Act: Nationals of a member state of the European Union or of a state covered by the Agreement on the European Economic Area who are subject to unlimited tax liability on the basis of section 1(1) or (3) of the Income Tax Act can be assessed jointly with their spouse or civil partner if they are not permanently separated and if the spouse or civil partner has his or her domicile or habitual abode in the territory of a member state of the European Union or of a country covered by the Agreement on the European Economic Area.
Streamlined procedures without the need to file tax returns
For many pensioners living outside Germany, the pension notification procedure and the rules on limited tax liability mean that taxes can be assessed either without the need for a tax return or just on the basis of the “EU/EEA Certificate” or the “Non-EU/EEA Certificate”.
The Neubrandenburg Tax Office takes the following steps: First, it sends letters to pensioners in various different languages – needless to say, such letters are not sent to pensioners who are not subject to taxation in Germany because of a double taxation agreement. At first contact with the Neubrandenburg Tax Office, pensioners receive a detailed letter9 informing them about taxes in Germany and making them aware of opportunities to apply for more favourable tax treatment, especially the option of applying to be treated as a taxpayer with unlimited tax liability under section 1(3) of the Income Tax Act and, if relevant, the related option of filing joint returns as set out in section 1a of the Income Tax Act. The letter explains where the necessary forms can be found and what deadlines need to be met. Enclosed with the letter is a reply form which makes it easy to apply for more favourable tax treatment. Based on this information, taxpayers can decide whether they want to take advantage of the streamlined procedure offered by the Neubrandenburg Tax Office, or whether it would be more beneficial for them to file a full tax return.
After about four weeks, if no response to the information letter has been received, the pensioner receives the announced tax assessment notice based on section 1(4) of the Income Tax Act (in other words, without personal or family-related tax benefits). Needless to say, pensioners have the full legal right to appeal against this income tax assessment notice. They can lodge an objection, as part of which they can submit any applications or present any evidence not provided before the assessment notice was issued. The reply form enclosed with the tax office’s information letter can be used for this purpose, as well.
If a pensioner already knows that the provisions of section 1(3) of the Income Tax Act (in conjunction with section 1a where applicable) are not an option, he or she does not need to take any further action and can just wait for the tax assessment announced in the information letter to be carried out. In addition, pensioners can now opt to have their tax assessments carried out without the need for tax returns for a period of several years, rather than having to authorise this procedure every year.
Those who retired prior to 2005 in particular can reduce their tax liability to zero through the application of section 1(3) of the Income Tax Act (in conjunction with section 1a where applicable). For this group of pensioners (both in and outside Germany), the taxable portion of their pension is very low – only 50% – so the usual tax deductions are usually sufficient to reduce their liability to zero. In other words, all these pensioners need to do is apply to be treated as taxpayers with unlimited tax liability by submitting the appropriate documents. That way, they do not need to complete a tax return.
These simplifications in the tax assessment procedure have been very well received by pensioners living outside Germany, and many make use of them. Revenue officials in Mecklenburg-Western Pomerania also welcome the proactive approach.
New development: extending the procedure to pensioners living in Germany
Things are not quite as simple for younger pensioners. People who retired in 2017, for example, have to pay tax on 74% of their pensions. Especially for those who spent all or most of their working lives in Germany and whose pensions are therefore higher, this can mean (as is the case for pensioners who still reside in Germany) that income tax is payable despite the application of section 1(3) of the Income Tax Act (in conjunction with section 1a where applicable).
While thinking about how to simplify tax obligations for this group of non-resident pensioners, the finance ministry of Mecklenburg-Western Pomerania has now also launched a pilot project for the simplified assessment of pensioners living in Germany, again with the support of the German Federal Ministry of Finance. The main elements of the approach used for non-resident pensioners were extended to “simple” cases involving resident pensioners, initially only for the Land of Mecklenburg-Western Pomerania. What this means in practice is that there is no need for a conventional tax return if the revenue administration has already received the necessary data electronically. The project has received a high level of public attention, especially in the media. In addition to the information provided on the website of the finance ministry of Mecklenburg-Western Pomerania10, potential participants have been made aware of the project in the press, through direct letters or during open office hours. It goes without saying that participation in the pilot project is voluntary.
In the first year of the pilot, the procedure was open only to pensioners without other taxable income11 who did not wish to claim any tax deductions beyond electronically available health and long-term care insurance contributions and statutory lump-sum allowances, if applicable. Despite this, participation levels were high. There were calls for the procedure to be extended to those who, in addition to a pension under the statutory pension insurance system, receive a civil service pension or other type of pension12. After all, people frequently receive a statutory social security pension plus an occupational pension, for example. Another frequently asked question was whether further tax deductions could be included in the procedure in addition to special expenses for which information is transmitted electronically to the revenue administration.
The procedure was extended to a larger circle of participants for the 2018 assessment period and subsequent years. It is now open to all those whose income from a statutory and/or other pension is notified to the revenue administration electronically and who have no other income that is subject to tax assessment. In addition, charitable donations, extraordinary financial burdens and household-related services can also be deducted under the simplified procedure.
The project has now been extended beyond the Land of Mecklenburg-Western Pomerania. The revenue authorities of other German Länder are carefully looking into whether and how they could introduce similar procedures.
Demographic shifts are changing the makeup of society, and this also affects tax authorities. As a result of the rising number of pensioners, the revenue administration’s caseload is increasing. At the same time, the revenue administration itself is facing the difficult task of replacing officials who will be retiring in the next few years. Not only has the younger generation in particular come to expect streamlined administrative procedures and the use of IT to assist with routine tasks; these things will soon become a sheer necessity.
Unspectacular as they might seem, the administrative changes described in this article point towards further adjustments that authorities will have to make in the future. To the extent possible, other entities should be able to transmit tax-related information electronically to the revenue authorities in order to relieve taxpayers of the obligation to file tax returns. Forms need to be simplified. In some cases, it might be necessary to change the law. A user-focused approach does not mean that the revenue administration should offer personal tax advice to people in all situations. Rather, the idea is that, as part of the provision of services of general economic interest, the state should adapt its requirements to the target group, especially in straightforward “standard” cases, thus saving both sides valuable time.
- Gesetz zur Neuordnung der einkommensteuerrechtlichen Behandlung von Altersvorsorgeaufwendungen und Altersbezügen (or Alterseinkünftegesetz for short) of 5 July 2004 (Federal Law Gazette I, p. 1427).
- Section 22(1), first sentence, (a)(aa) of the Income Tax Act ( Einkommensteuergesetz )
- Federal Tax Gazette II, page 618, and BVerfGE [Judgments of the Federal Constitutional Court] 105, 73 et seqq.
- Section 22 (1), first sentence, (a)(bb) of the Income Tax Act
- This essentially comprises payments as set out in section 22(1), third sentence, (a) of the Income Tax Act made by German statutory pension insurance funds, the agricultural pension scheme, the pension institutions for the free professions, insurance companies and other German paying agents.
- Section 22a of the Income Tax Act
- Section 19(6) of the Fiscal Code in conjunction with the Ordinance on Jurisdiction for Income Tax ( Einkommensteuer-Zuständigkeitsverordnung ).
- In subsequent years, pensioners receive a shortened version of the letter, since by then they are already familiar with the applicable procedures.
- Persons who did not have any assessable income during the assessment period beyond that set out in section 22a of the Income Tax Act.
- Section 19(1) no 2 of the Income Tax Act