Taxation of UK Government Service Pensions Abroad

Recently one of our visitors enquired about what appeared to be the double taxation of his UK service pension in Germany. As this is a concern which might be shared by a number of expats in a similar situation we thought it might be useful to reproduce the question (anonymously) and the reply from a UK tax advisor here.

Question:

I am an ex-serviceman living in Germany. My Service pension is being subjected to what amounts to double taxation, which under Article 9 of the Double Taxation Agreement is forbidden. Article 9 states clearly that only the Government issuing a service pension may levy income tax.The device being used by both the German and French taxation authorities is contained in Article 18. By adding the balance of a service pension, that remains after UK tax, to any locally earned income they arrive at a combined income which they then tax at local rates.

This amounts to a doubling of the actual tax deducted from my pension!

Whatever the disguise; this is double taxation, surely?

Reply from Nicki Reynolds, UK expat taxation specialist

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My understanding of the system used by Germany and France (Exemption with Progression) is not quite as you describe it. Rather, the income is included for the purpose of determining the marginal rate of tax but then not actually subjected to this tax. In effect, it is being regarded as using up the personal allowances and lower rates of tax in Germany, although not actually being subjected to these rates. The rationale for this is that the income will have received the benefit of personal allowances and lower rate bands in the country of taxation (which would certainly be the case with the UK so in your situation). Therefore, Germany is not taxing the income twice, it is simply operating a system to ensure it gets tax once, on a global basis.

The other option of dealing with potentially doubly taxed income, which is used by most other countries, is via giving relief for the actual foreign taxes suffered on the income. So, in an opposite situation, the UK would seek to tax worldwide income then give a credit for the tax charged in Germany. Since tax rates are generally higher in Germany, this would result in excess tax credits (which can’t be utilised) and therefore a higher liability than would be the case without the German involvement. In the event that the foreign taxes were lower, there would be excess UK tax to pay of the difference according to UK tax rates.

Whereas, with foreign tax credits, the taxpayer can never be better off than had he been subject to tax in just one country, with Exemption with Progression, it is possible that the taxpayer can actually save tax overall. This will be the case if the tax rates effectively used up in Germany by the pension income are higher than those used up, actually, in the UK and this is often the case with these two countries. Many individuals will therefore use the Exemption with Progression system to their advantage by getting as much of their income subjected to tax in the UK and, as a result, being effectively disregarded in Germany. For a single taxpayer, the 47% tax rate in Germany starts at income in excess of EUR52,293, i.e., around GBP34,862. The 40% rate in the UK starts at a slightly higher level once personal allowances are taken into account. Therefore, any income above these amounts that was subjected to tax in the UK and ‘exempted’ in Germany would save tax at 7%. The same applies for lower amounts of income also as the 19.9% tax rate in Germany starts, for a single taxpayer, at income of over EUR12,755, i.e., a much lower level than the 22% rate in the UK.

If you were to manage to pressurise Germany into adopting the same system as most of the rest of the world, i.e., foreign tax credits instead of Exemption with Progression, you would quite likely find yourself paying more tax than you do currently since your UK liability would remain as is, any excess UK credits would not be repayable and, if the German (lower end) liability was higher on the same income then you would have to pay the excess in Germany.


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