BFH: Taxation in the case of severance payments from abroad

BFH ruling of March 20, 2025 – Ref. VI R 24/22

Cross-border employment relationships are commonplace: residence in Germany, work abroad—or vice versa. When the employment relationship ends and a severance payment is made, the question often arises as to which state has the right to tax it. The Federal Fiscal Court (BFH) has outlined key guidelines for severance payments according to the legal situation prior to 2017 in its ruling of March 20, 2025 (Ref. VI R 24/22).

The decisive factor is not solely in which state the work was performed. Rather, it depends on what the severance payment is made for and how the relevant double taxation agreement (DTA) allocates the income. Additionally, it should be noted that as of January 1, 2017, the German legislature introduced a specific regulation for severance payments in cross-border cases (§ 50d Para. 12 EStG), which can significantly change the assessment in newer cases.

Initial situation: Residence in Germany, workplace in Luxembourg

In the case decided by the BFH, the taxpayer was residing in Germany but employed by an employer in Luxembourg. The employment relationship ended in 2015; the employer paid a severance. The taxpayer did report the payment in Germany but assumed it—like ongoing wages—was to be taxed exclusively in Luxembourg under the DTA between Germany and Luxembourg. Therefore, he treated the amount as tax-free in Germany and only considered it in the progression clause.

The tax office, however, allocated the severance (partially) to German taxation. The lawsuit before the tax court was unsuccessful; even the appeal to the BFH did not lead to any change.

Core statement of the BFH: Severance as compensation, not as remuneration for service

The BFH clarified that the right to tax the severance in the disputed year 2015 belongs to Germany as the country of residence. Reasoning: A severance payment is typically made as compensation for the loss of the job. Although it is generally considered income from employment for tax purposes, according to the BFH, it is not a consideration for a specific activity performed abroad.

Therefore, the immediate connection between the payment and a specific work activity abroad, necessary for assignment to the activity state, is lacking. This immediate work relation is often the decisive distinguishing criterion in treaty law.

Allocation according to the Germany-Luxembourg DTA (DTA-Luxembourg 2012)

According to the regulation of the DTA-Luxembourg 2012 (Art. 14 Para. 1 Sentence 1) referred to in the ruling, salaries, wages and similar remuneration are generally taxed in the country of residence—unless the work is performed in the other contracting state. Since the severance is not regarded by the BFH as remuneration “for” the work carried out abroad, it remains taxable in the state of residence (Germany).

Important: This classification concerns the severance itself. Ongoing wages for work actually conducted abroad can still be allocated to the state of activity according to the DTA.

No precedence of bilateral mutual agreements over the wording of the DTA

The taxpayer relied, among other things, on a bilateral mutual agreement between Germany and Luxembourg, according to which severances should be exempted in the state of activity in certain scenarios. The BFH denied a binding effect of such agreements for the courts insofar as they would alter or overlay the clear wording of the DTA.

According to the decision, mutual or consultation agreements can indeed be used as an aid for interpretation. However, they must not establish or restrict independent tax rights if the treaty itself does not provide a basis for this. The DTA remains decisive.

Significant turning point: Legal change from 2017 (§ 50d Para. 12 EStG)

The decision was crucially influenced by the fact that the severance was received in 2015. Since January 1, 2017, § 50d Para. 12 EStG contains a specific assignment rule for severances in the context of cross-border employment relationships: A severance paid due to the termination of employment is considered tax-wise as additional remuneration for a previous activity.

This may result in severances from 2017 onwards (depending on the DTA regulation) having to be partially or fully allocated to the state of activity—i.e., the state where the previous activity was actually performed. At the same time, if the relevant DTA contains a differing provision, that may take precedence. The specific legal consequence in each case therefore strongly depends on the particular DTA and the actual periods of work in and outside of the country.

Practical significance: No “blank check,” but rather a chronological placement

The BFH ruling is not a general benchmark for all current severance cases with a foreign connection. It primarily describes the legal situation for payments before 2017: Severances were not regularly considered a remuneration for a particular activity performed abroad and were hence generally taxable in the state of residence.

For severances from 2017, the situation is much more economically aligned with the assignment to the previous activity because of § 50d Para. 12 EStG. This could lead—especially in cases of extended periods of activity abroad—to a partial taxation in the state of activity.

Note on classification and individual examination

Whether Germany, the state of activity, or both states have a tax right (and how double taxation is to be avoided) depends, among other things, on:

• the relevant double taxation agreement and its wording,
• the timing of the severance payment (before or after January 1, 2017),
• the specific terms of severance (e.g., lump-sum payment, installments, settlement),
• periods of work in the involved states, and
• the treatment by the foreign fiscal authorities.

MTR Legal Attorneys advise in theinternational tax law.

Feel free to contact us.

Transparency Notice: This article is intended as general information and does not replace an individual review of a specific case. Despite careful preparation, liability for the timeliness, completeness, and accuracy cannot be assumed.