“Home office in Germany as permanent establishment?” – German tax authorities comment on the topic for the first time

The application decree for the German Fiscal Code (“AEAO”) on Sections 10 and 12, which deal with the national concept of a permanent establishment, were revised with German Ministry of Finance (“BMF”) letter dated 5 February 2024 – IV D 1 – S 0062/23/10003 :001, DOK 2023/1122582. The reason for the amendment to the AEAO was, on the one hand, decisions by the German tax courts in recent years that dealt with the requirements for a permanent establishment. This led to some curious cases, such as that of an online poker player whose children's room was deemed sufficient as a permanent establishment by the German Federal Fiscal Court (”BFH”), ruling of 22 February 2023 – X R 8/21, BStBl. II 2023, 811, no. 66 ff. On the other hand, the new AEAO on Sections 10 and 12 has been shaped by the coronavirus pandemic, which made mobile working necessary across the board. Even after the pandemic subsided, the world of work has changed permanently in that many employees continue to work from home. In the AEAO on Section 12 no. 4, the German tax authorities have now officially commented for the first time on the extent to which an employee working from home can constitute a permanent establishment for their employer.

This article will first explain the issue, clarify the position of the German Ministry of Finance and finally provide an outlook on what companies need to bear in mind. There is a regular need for action, particularly for German companies with employees working from home outside Germany and for all companies whose senior employees work from home in a country other than their country of residence.

Previous issues

Fundamental relevance of permanent establishments in international tax law

Whether working from home establishes a permanent establishment for the employer can have significant tax consequences in cross-border cases.

For foreign companies, a permanent establishment in Germany leads to limited (sometimes even unlimited) tax liability in Germany, which is linked to comprehensive permanent establishment profit determination, notification and documentation obligations. Even in purely domestic cases, the assumption of a home office permanent establishment would have tax consequences, particularly with regard to trade tax.

To approach this issue, it is first necessary to understand that there are several terms of 'permanent establishment'. The relevant term always depends on the context in which the question of permanent establishment arises.

For the upstream question of the tax liability of a foreign company, it is relevant whether a permanent establishment (under national law) exists within the meaning of Section 12 German Fiscal Code (“AO”), which is determined solely under German law.

In the next step, however, a double tax treaty (“DTT”) may be applicable in cases with an international dimension, which initially requires a country of residence and a country of permanent establishment. Each DTT has its own definition of “permanent establishment”, which usually differs from the German definition and is based on Art. 5 OECD model agreement (“OECD-MA”; permanent establishment under treaty law). The question of whether such a permanent establishment exists is therefore always determined by the relevant DTT. As a rule, the country of residence ultimately waives taxation of income from the permanent establishment in favour of the country of the permanent establishment.

What is a permanent establishment?

a) According to Section 12 sentence 1 AO and the case law of the BFH (judgment of 3 February 1993 I R 80-81/91, BStBl. II 1993, 462; judgment of 5 November 2014 – IV R 30/11, BStBl. II 2015, 601, a permanent establishment under national law is defined as:

• business facility or installation
  
• with a fixed connection to the surface of the earth
  
• of a certain duration
  
• which serves the activities of the enterprise and
  
• over which the taxpayer has a power of disposal that is not merely temporary.

Section 12 sentence 2 AO then lists (a few) more examples, which are not exhaustive. Of particular importance in this regard is Section 12 sentence 2 no. 1 in conjunction with Section 10 AO (the so-called management establishment), which, unlike Section 12 sentence 1 AO, does not require a fixed place of business. The latter can even lead to corporations having unlimited tax liability in accordance with Section 1 para. 1 Corporate Income Tax Act (“KStG”). If the registered office and management are located in different places, this often results in the extremely disadvantageous situation of unlimited tax liability in several countries.

b) A distinction must be made between the management establishment and the treaty-based permanent establishment. Under Art. 5 para. 1 OECD-MA and the accompanying model commentary, this is defined as:

• business facility (”place of business”)
  
• at a specific location (“established at a distinct place”)
  
• for a certain period (of time) (“with a certain degree of permanence”)
  
• through which the business activities of the enterprise are carried out (‘persons who [..] are dependent on the enterprise [..] conduct the business of the enterprise’) and
  
• over which the enterprise has power of disposal (‘disposal’).

Art. 5 para. 2 to 7 OECD-MA further elaborate on the treaty-based permanent establishment.

Individual DTTs may deviate from this definition, so that a review of the specific case is always necessary. If we now compare the national and international definitions, the biggest difference is that, under German national law, a permanent establishment only serves the business activity (i.e. even without people on site), whereas under treaty law, a permanent establishment requires the exercise of business activities by people. However, there are also other minor differences. Even though the wording of these definitions is very similar, their interpretation is not necessarily identical. This is because while the interpretation of Section 12 AO is carried out exclusively by German courts, the OECD-MA is influenced by an international perspective. In this context, the OECD model commentary is the essential interpretative aid, which Germany also recognises (BFH, judgment of 11 July 2018 – I R 44/16, BStBl. 2023 II, p. 430).

Legal situation prior to the BMF letter

Both definitions of the management establishment and the treaty-based permanent establishment agree that these require the company to have power of disposal. However, this characteristic is particularly problematic in the case of an employee working from home. Power of disposal in this sense was originally understood by both national courts (see BFH, decision of 8 June 2015 – I B 3/14, BFH/NV 2015, 1553) and the OECD as the actual authority to enter the premises. The assumption that an employer has power of disposal over the private home of one of its employees requires at least some justification, as it cannot be assumed without further ado that the employer can enter the employee's home at any time.

For the treaty-based permanent establishment, the model commentary on Article 5 OECD-MA (margin note 18) from 2017 assumes that the activity of an ordinary employee working from home does not, in principle, lead to a permanent establishment within the meaning of this provision. It should be noted that most DTTs concluded with Germany are based on the previous OECD MA from 2003, which did not yet address the issue of employees working from home. However, it can be assumed that the interpretation of the new model commentary is also decisive for older DTTs that are not based on the current OECD-MA from 2017, as the essential characteristics of a permanent establishment are derived from Art. 5 para. 1 OECD MA and the wording of this provision has not been changed.

However, the model commentary does specify an exception in cases where the company instructs the employee to work regularly (‘continuously’) from home. This can also be done by the company not providing the employee with premises, even though such premises would normally be required by the nature of the employment relationship. According to a non-binding guideline published by the OECD on 3 April 2020, special rules applied to working from home during the coronavirus crisis, as this was mainly due to force majeure (pandemic) and less to a business decision. The OECD model commentary states that the necessary power of disposal is only required if the instruction is based on a business decision. This interpretation reveals a tendency to broaden the definition of the power of disposal and a departure from the previous concept.

At national level, there were previously no published guidelines on the interpretation of the term by the German tax authorities, which meant that there was a degree of legal uncertainty – reinforced by the OECD's new, extensive interpretation.

New regulation of the AEAO

Normal employee

With the aforementioned BMF letter dated 5 February 2024, the German tax authorities are attempting to curb this legal uncertainty. They have succeeded to some extent in doing so, which is welcome.

Firstly, it should be noted that the BMF assumes in AEAO on Section 12 no. 4 that, in the absence of sufficient power of disposal, a permanent establishment under national law does not arise from home office activities carried out by normal employees. This also applies to the cases explicitly mentioned below:

• Assumption of the costs for home office and its equipment by the employer,
  
• tenancy agreement between the employer as tenant and the employee as landlord (exception: the employer has the authority to use these rooms for other purposes in individual cases) and
  
• cases in which the employer does not provide the employee with another workplace.

It is striking that the national and international interpretations differ in the last case in particular. While the OECD assumes a permanent establishment in such a case based on the employer's instruction, the tax authorities are less strict and do not consider this to be sufficient as the employer's power of disposal. Of the three options listed above, this will also be the most relevant in practice. This is positive insofar as such a case generally does not cause tax liability, so that the permanent establishment under treaty law no longer needs to be examined.

However, the other two variants are also noteworthy. In these cases, even if the employer bears the costs or is granted the right of possession under a lease agreement, this is not sufficient for power of disposal.

Employees with management functions

The BMF then emphasises that these principles only apply to ordinary employees.

Since unlimited tax liability takes precedence over limited tax liability, it must first be determined for this group of persons whether a management permanent establishment exists in accordance with Section 12 sentence 2 no. 1 in conjunction with Section 10 AO. The main factor here is where the centre of management is located, i.e. where the essential day-to-day operational decisions (‘day-to-day business’) are made. In this respect, a work corner in the living room is sufficient (see BFH ruling of 15 July 1986 – VIII R 134/83, BStBl. II 1986, 744), i.e. fixed business premises are not required here (see also AEAO on Section 10 no. 4). If a company carries out the relevant business or measures in Germany, this alone results in more extensive unlimited tax liability, so that Section 12 sentence 1 AO does not apply.

However, if there is no management establishment, reference must be made to Section 12 sentence 1 AO, i.e. whether the executive employee grants the company power of disposal over the premises. In the case of a managing director who holds 100% of the shares in a corporation, this is probably to be affirmed. However, the BMF did not explicitly comment on employees with management functions.

How should the BMF letter be assessed?

It is welcome and long overdue that the German tax authorities have addressed the issue of mobile working. The new application decree therefore provides clarity in the aforementioned cases. The (particular) value of the BMF letter lies in its listing of three negative variants. This reveals a pragmatic approach on the part of the BMF, which is closely aligned with the previous understanding of the term. It sets high requirements for the assumption of a permanent establishment in Germany by an ordinary employee working from home. Unfortunately, the interpretation of the national and international concepts of permanent establishment is drifting further and further apart, which further increases the complexity of the matter. For German companies whose employees work from home abroad, this could mean that they may have to pay tax on part of their profits in the foreign country if it, like the OECD, applies a different definition of ‘permanent establishment’. In such a case, the scope of application of a double taxation agreement would initially be opened up by the permanent establishment under the national law of the other country. The DTT would also assume a permanent establishment, so that the German company would become subject to limited tax liability abroad. Subsequently, Germany would exempt the income attributable to the permanent establishment from taxation under the DTT (see Art. 7 in conjunction with 23a OECD-MA). Unfortunately, German companies cannot rely on their own national definition. This lack of consistency is extremely unfortunate, especially in the context of the European single market.

It is also regrettable that the BMF has not addressed the criteria for senior executives working from home in Germany. This can lead to unlimited tax liability for the companies concerned, simply because of a management permanent establishment within the meaning of Section 12 para. 1 no. 1 in conjunction with Section 10 AO. Low requirements are imposed on the premises, but higher requirements are imposed on the activity itself. Even if management is considered to be exercised outside Germany, such companies still run the risk of being subject to limited tax liability due to a normal permanent establishment under Section 12 sentence 1 AO. This is because the criteria for decision-making power in the case of senior executives are currently completely unclear. It remains to be seen how the case law will develop in this regard.

Outlook

Companies operating in several countries should be aware of the topic “working from home” due to the far-reaching implications of having a permanent establishment. First, a distinction must be made between whether a foreign company employs persons who work from home in Germany (an inbound case) or whether employees of a domestic company work from home abroad (an outbound case).

Then, a distinction must be made between normal and senior employees. This results in the following abstract constellations:

• Home office activities of normal employees of foreign companies in Germany (inbound) are supported by the BMF letter and only in exceptional cases constitute a permanent establishment under national law and thus a tax liability in this country. However, problems can arise, particularly in the case of rental agreements between employers and employees – for example, if the employee is the tenant (not regulated by the BMF) or if the rental agreement is atypical and the employee is the landlord.
  
• For senior executives in the inbound case, there is initially a risk that the tax authorities will assume a management permanent establishment. To avoid this, it is essential to document the place where the senior executives carry out their work. This can be used to prove that day-to-day business is not conducted in Germany. The tax authorities could then assume the existence of a regular permanent establishment by affirming the employer's power of disposal. This should be countered with forward-looking planning and contract drafting so that the employer's right of access is excluded.
  
• For employees of German companies working from home abroad (outbound), the national law of the relevant country initially governs. The next step is a detailed examination of the relevant DTT (if there is one). This applies to both executive and non-executive employees. In the case of executive employees, the above-mentioned documentation should also be provided.

In the case of inbound employees, clarity can be provided by obtaining binding information subject to a fee, in accordance with Section 89 AO in conjunction with the German Tax Information Regulation (StAuskVO).

If an employee works abroad in their home office, there are also a variety of income tax and social security consequences that employers must take into account. Finally, for income tax issues, income tax information can be gained within the meaning of Section 42e of the German Income Tax Act (EStG).

With the kind assistance of Robin Abel (research assistant).