Withholding tax

What is withholding tax?

The term “withholding tax” does not refer to a specific type of tax. Withholding tax is withheld directly when income is earned and at the source of payment for the earned income. The taxpayer therefore does not have to pay it themselves, which simplifies the process of filing a tax return. Since withholding tax is paid directly to the tax office, the government also benefits by ensuring its liquidity.

Legal entities and individuals are subject to withholding tax if they earn income or receive proceeds in a country that withholds tax at source. Withholding tax refers to the deduction of taxes directly at the source of income, before the taxpayer receives the income.

What types of withholding tax are there?

Withholding tax is a form of taxation that covers various types of taxes. The source may be employers, financial institutions, or other entities that pay out income.

Common domestic withholding taxes levied in Germany include:

Income Tax: Employers deduct income tax from the salaries of taxable employees each month and remit it directly to the tax office. Employees thus receive a net income and do not have to calculate and deduct taxes from their gross income themselves when filing their tax returns. The amount of income tax depends on the tax bracket, the level of income, and the number of children. It can range from 14% to 45%.

Supervisory Board Tax: The supervisory board tax is a specific type of withholding tax in Germany that is levied on payments made to members of certain domestic supervisory boards, such as those of stock corporations or limited partnerships with share capital. When remuneration is paid to the members, the paying entity must withhold 30% of the amount as tax and remit it to the tax office.

Construction Withholding Tax: Construction withholding taxes are levied on services provided by companies or self-employed individuals. The 15% tax is withheld by clients or building owners at the time of payment and remitted to the tax office.

Capital Gains Tax: Banks withhold tax at source on capital gains, such as profits from the sale of stocks, dividends, and interest. This is referred to as capital gains tax (formerly known as interest withholding tax), which is a form of final withholding tax—that is, a flat-rate taxation of capital gains. Capital gains tax is settled at the end of a tax year in the form of a statement showing the total amount of final-accounting tax paid.

In common parlance, the term “withholding tax” usually refers to capital gains tax and not to income tax or other taxes. The following discussion therefore refers to withholding tax in the form of capital gains tax.

Is withholding tax levied on investment income from abroad?

For foreign investment income, tax is withheld in the country where the income is earned. Since Germany has a flat-rate withholding tax in addition to the withholding tax on foreign investment income, this may result in double taxation.

What is the withholding tax rate on investment income?

The amount of withholding tax on investment income depends on the tax laws and the withholding tax exemption amount of the country in which the income is earned. To calculate the withholding tax, the tax rate of the respective country must first be determined. The same applies to the withholding tax exemption amount.  

All investment income, such as dividends or interest, is included in the calculation of withholding tax. The determined exemption amount is taken into account in this calculation. Taxable investment income is calculated by subtracting the exemption amount from the total investment income. The applicable tax rate is then applied.

Withholding Tax Rates in Germany

For single individuals, a tax-free allowance of €1,000 (previously €801) per year per person applies to withholding tax on time deposits or overnight deposits. For married couples and registered domestic partnerships, €2,000 (previously €1,602) per year is tax-free. Taxpayers must have filed an exemption request in advance to qualify. A flat-rate withholding tax of 25% is levied on investment income that exceeds these exemption amounts. In addition, the solidarity surcharge and, if applicable, church tax are added.

Amount of Foreign Withholding Tax

Depending on the tax laws of the respective country, withholding tax abroad can amount to up to 35% of investment income. This is the case in Switzerland. Finland and Sweden also have higher rates—30%—than Germany. Nevertheless, the German tax rate is considered high compared to other EU countries. EU countries that levy withholding tax include, for example, Bulgaria (10% of investment income), Croatia (12%), Austria (25%), Portugal (28%), Italy (26%), and Spain (20%).

In some countries, foreign investors are not subject to withholding tax. These include Ireland and the United Kingdom.

Is it possible to credit a foreign withholding tax?

To avoid multiple taxation, Germany has concluded double taxation treaties with more than 80 countries. The treaty specifies the proportion of the foreign withholding tax that is credited against the German final withholding tax and whether the source country is entitled to any taxes. The double taxation treaties stipulate that no more than 15% of the withholding tax paid abroad is creditable in Germany.

The banks handle the tax credit calculation automatically. They calculate the difference between the flat tax rate (25%) and the creditable portion of the withholding tax. Only the remaining balance after the credit has been applied must be paid to the German tax office.

An exception to this rule applies if an exemption order has been set up in advance and has not yet been exhausted. As long as it has not been exhausted, the bank will not withhold withholding tax from the investment income.

Accordingly, withholding tax paid abroad cannot be credited directly. In this case, creditable portions of the withholding tax are first credited to the withholding tax offset pool and are only offset once the exemption order has been fully utilized. Any amounts remaining in the offset pool can be offset at the end of the year on the tax return, provided that additional final-accounting taxes have been incurred at other banks.

How does the refund of foreign withholding tax work?

If the foreign withholding tax is higher than 15%, German investors can file a refund claim with the relevant foreign tax authority. For designated countries, this makes it possible to recover the portion of the withholding tax that exceeds the creditable withholding tax.

The amount of the withholding tax that can be reclaimed depends on the specific provisions of the double taxation treaty with Germany. EU countries where a refund of withholding tax is possible include, for example, Austria (15.5% of investment income), Spain (4%), and Italy (11%).

The process for applying for a withholding tax refund also depends on the legal requirements of the country in question. The foreign tax authority provides an application form that must be completed and submitted along with the required documents. These documents may include certificates from the German tax office or the bank.

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