The payroll office records the employee names and foreign addresses. Since they are all single and, according to their statements, pay social security contributions in their home countries, their wages are calculated and paid using tax class 1, without social security deductions. The employees cannot provide tax ID numbers at this time – these will be submitted later. After nine months, the project is completed, the employees are deregistered, and they return to their home countries.

The following year, a routine social security audit and an off-site payroll tax audit take place. The audits result in significant back payments for payroll tax and social security. What happened?

Social security

If foreign employees are directly employed by a German employer and perform their work in Germany, they are subject to social security contributions under German law. German social security obligations may be waived only in the case of a temporary posting where the foreign employment relationship continues, or when EU or treaty law applies (submission of an A1 certificate is required).

Income tax

Wages paid to a foreign employee who performs their work in Germany are subject to German income tax, provided the employer is based in Germany. The tax liability applies regardless of whether the employee is subject to unlimited or limited income tax liability in Germany; the decisive factors are that the work is performed in Germany and the wages are paid by a German employer.

Regarding the tax bracket: if no German tax identification number is available, the employer may apply for a wage tax withholding certificate from the competent tax office for the place of business. In this case, tax bracket I is assigned. If no certificate is presented, tax bracket VI must be applied.

Consequences

The wages paid to employees are considered net wages. These net wages are extrapolated to gross wages. For tax bracket 6, the tax rate ranges between 50% and 60%. Added to this are social security contributions, comprising both the employer’s and employee’s shares, totalling approximately 45%. This quickly doubles the cost per employee, as the following example illustrates. A supposed “bargain” can quickly turn into a cost trap. Therefore, it is important for employers to seek advice in a timely manner.

Sample calculation before tax

Each of the 10 employees receives EUR 4,500 gross per month. The total cost for all employees working over 9 months would be EUR 405,000. After deducting EUR 960.08 per person in payroll tax, there is a net payment of EUR 3,539.92 per employee per month. Extrapolated over 9 months, EUR 86,407.20 in total income tax is paid to the tax office and EUR 318,533.40 is paid to the 10 employees.

Example calculation after adjustments

The amount paid to the employee is considered net pay. This results in the following calculation:

Payment amount EUR 3,539.92

Plus

Wage tax (tax bracket 6) 2,067.00
Solidarity surcharge 44.16
Employee health insurance contribution 510.92
Employee long-term care insurance contribution 139.50
Employee pension insurance contribution 655.52
Employee unemployment insurance contribution 91.63 3,508.73

Gross wages EUR 7,048.65

Plus

Employer’s share of health insurance 510.92
Long-term care insurance 104.63
Pension insurance 655.52
Unemployment insurance 91.63
Insolvency fund contribution 10.57
Contribution 1 for continued pay during illness 169.17
Contribution 2 for continued pay during maternity leave 30.31
Contribution to the employers’ liability insurance association (accident insurance) approx. 70.00 1,642.75

Costs per employee EUR 8,691.40

Costs for 10 employees for 9 months EUR 782,226

The costs have thus nearly doubled.

Martin Thieslauk has been working as a tax adviser for over 30 years. He specialises in international tax law and has extensive experience in VAT law and payroll matters, including those relating to expatriates.

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