Austrian Federal Financial Court (BFG) ruling on exemption with progression in state of source
A recent decision of the Austrian Federal Financial Court (BFG) considered the question as to whether foreign income must be taken into account in Austria under an “exemption with progression” clause even if Austria is not the state of residence under treaty law. The BFG takes the view that in cases of unlimited tax liability in Austria, foreign income – which is exempt under an “exemption with progression” clause – must be included in the assessment base when calculating income tax. This legal opinion contradicts previous administrative practice in Austria.
An employee was assigned to Austria by a Slovakian employer in order to work for an Austrian group subsidiary. During the assignment, the employee maintained her residence in Slovakia. In addition, the employee also established a residence in Austria, which was only required due to business purposes. For this reason, the employee was subject to unrestricted taxation in Austria for the entire duration of the assignment. In the tax year in question, the employee spent the majority of working days in Austria, but also some (fewer) working days in Slovakia. Based on the assumption that the residence of the employee under treaty law was in Slovakia, the employer split the income proportionately into Austrian and foreign income.
Residence in Slovakia
The double taxation agreement (DTA) between Austria and Slovakia follows the principles of the OECD Model Tax Convention concerning residence. In the case in question, the BFG has ruled that despite the extended period of assignment, the employee’s centre of vital interests and thus her residence was in Slovakia. The reason given was that a limited period of activities abroad does not normally lead to a change in the centre of vital interests if the residence in the other state is maintained.
Thus, in this specific case, Slovakia retained the right to tax the global income of the employee as the state of residence, while Austria as the state of source under the DTA Austria-Slovakia was only able to tax income generated on days actually spent working in Austria.
“Exemption with progression” in the state of source
The question further arises as to whether the right (generally the exclusive right of the state of residence under the DTA) to carry out “exemption with progression” also applies in the state of source. Previously, Austrian administrative practice has consistently denied this right, based on the assumption that the OECD Model Tax Convention (as a placeholder for the applicable national DTA) generally only envisages the “exemption with progression” to apply for the state of residence and not for the state of source.
In the context of the court ruling in question, the BFG unexpectedly stated a different legal opinion for the first time, by recognising the right to “exemption with progression” in the state of source. The BFG substantiated the ruling on the basis that “exemption with progression” already exists under domestic law if unlimited tax liability exists in Austria, and no additional “legitimation” is required under the DTA. Furthermore, the BFG argues that although the “exemption with progression” clause under Article 23 of the DTA Austria-Slovakia only applies to those cases in which Austria is the state of residence, it also does not prevent the state of source from carrying out an “exemption with progression”. According to the court, this is also clarified in the Commentaries on the OECD Model Tax Convention under item 56 on Articles 23A and 23B, which states: “The form of the Article does not prejudice the application by the State of source of the provisions of its domestic laws concerning the progression”.
The transfer of the centre of vital interests during limited periods of activity abroad has once again been assessed negatively by the BFG. This corresponds with previous practice.
However, this ruling is also the first time that the court has given a legal opinion on the “exemption without progression” which diverges from previous administrative practice. The tax authorities have not yet issued a response, meaning that the full practical implications of the case law in question cannot be adequately predicted. The possibility cannot be ruled out that the tax authorities will support the view taken by BFG and assessments will be made in accordance with the new case law. To ensure that you are fully protected against any impacts under tax criminal law, it is advisable to disclose to the tax office any foreign income of taxable persons who are not treaty residents in Austria. On demand, we are available to provide support.