For a range of reasons, it might be worthwhile setting up a business in Germany. Located in the very centre of Europe, with good access to emerging Eastern European markets, Germany offers a huge variety of investment possibilities. Germany is one of the most popular destinations for GEANetwork clients, with client industries ranging from traditional manufacturing to knowledge based services and high-tech startups.
Issues for smaller businesses
Many successful operations in Germany have developed from a very small starting point - perhaps only one German employee working from home initially. In these micro-startup situations, clients often ask if it is possible to administer a German payroll without having to create a German entity. There is a solution for such companies, but recent developments suggest this may not be quite right for every expanding business.
Historically, these small companies entering Germany might have been able to apply to the German tax authority to register as a foreign employer and not have to register for VAT or corporation tax. The payroll would be calculated each month and the employer would arrange for taxes and social security to be paid to the authorities on behalf of the employee(s) as one might expect. Whilst historically this has been accepted by the authorities, we have witnessed of late a tightening of their approach and a general resistance to such arrangements.
What has changed?
Under strict interpretation of German law, where there is no permanent establishment and no local representative appointed, there is no German employer. Where there is no German employer, legally, there is no right to withhold taxes from the individual’s pay. A payroll would still need to be operated in Germany but only in respect of social security contributions, which would remain due as usual.
The employee, however, would need to deal with their own tax affairs direct with the German authorities, which may include quarterly payments of the taxes due.
For many companies, this is not the expansion structure they wish to adopt. Whilst the tax liabilities are legally those of the individual and therefore would not cause the company any complications should there be a default, the cause for concern is clear.
Whilst nothing has changed in law, what we have seen is a general drive by the authorities toward applying the rules far more strictly and not permitting the previously relaxed approach that allowed the foreign employer to withhold and pay taxes each month.
What about expanding into Germany?
If you do not foresee any significant growth in the German operation beyond the initial recruitment and you are satisfied with the local hire handling their own tax affairs, then entering Germany without creating an entity remains possible. Some GEANetwork clients using the structure above have asked for monthly tax calculations to be performed, albeit with no deduction of tax from the individual, so that the individual is aware of the accruing liability throughout the year. Whilst this ‘dummy’ payroll approach can afford clients some comfort it does remain the individual’s responsibility to pay and file on time.
In some cases, it may be preferable to appoint a local representative in Germany, which could also be the local hire. Acting as a local representative comes with additional legal and operational responsibilities, as the individual effectively takes on legal responsibility for the company. Whether the local hire is willing or able to act in such a capacity will depend on each individual circumstance. Where a local representative is appointed, that representative will need to ensure that payroll filings and payments are made on time.
All of the above assumes that no permanent establishment has been created by the company. Where a permanent establishment is created (deliberately or otherwise) then an entity will be advisable in just about every case.
In our experience, if a foreign employer operates for a few years then in the majority of cases the business will, intentionally or as a matter of fact, create a permanent establishment. From this time a full tax registration and regular payroll will become necessary, most likely in the name of a GmbH or branch. The German authorities are increasingly focused on companies that have payroll registrations in place but no corporate tax or VAT records.
A number of these businesses have already been approached with a view to determining:
- whether correct payroll procedures have been applied with particular reference to the withheld tax issues above; and
- whether the German operation has progressed to a point where a permanent establishment has been created.
For existing companies operating in Germany, now is the time to review the structure and compliance processes in advance of any queries from the authorities.
For new entrants, our recent experience suggests that improved confidence from investors in the success of a new German office means that many clients have opted for incorporating a GmbH from the very beginning. Whilst this will be more expensive initially, it does have operational upsides for the company including a greater degree of credibility in Germany and the ability to offer staff certain benefits, such as a pension scheme, that cannot be offered by a non-resident employer.
GEANetwork member, LM Audit & Tax GmbH, offer a full range of services related to employment in Germany: bilingual employment contracts, bilingual payroll processing, bilingual travel expense and related accounting services, the assessment of a permanent establishment status, the set up of a legal entity and any further related tax consulting, accounting and legal services.
Contact us for more information on setting up a business in Germany.