Effectiveness of Hypotax Agreements between Employer and Employee

An individual contract which states that a fictitiously calculated wage tax may be withheld by the employer if the employee is sent abroad may violate Section 4 (3) TVG and thus be invalid if the agreement deviates from the collective agreement to the disadvantage of the employee and if the collective agreement does not contain an opening clause permitting the deviation.

The German employer cannot refer to an agreement with the posted employee which allows him to withhold a fictitiously calculated wage tax in Germany because the employee is liable for tax in the host country and the employer bears the employee's lower tax liability there. This violates Sec. 4 (3) TVG and in particular cannot be justified by a comparison of favorability.

If the work performance of a posted employee abroad is to be regarded as temporary, his employment contract shall continue to be governed by German law during the period of posting abroad and the normative validity of a collective bargaining agreement previously applicable shall remain in force for this period. An individual agreement on the deduction of a hypothetically determined tax allowance in Germany from the employee's monthly gross remuneration deviates from the normatively applicable collective agreement provisions on the amount of the gross remuneration to which the employee is entitled - at least if other payments which the employee receives as allowances are not to be included in the favorability comparison pursuant to Section 4 (3) of the TVG, since the required factual group connection is not given.


Decision of the Hamburg Higher Labor Court and relevance to Hypotax practice

The legal dispute to be decided concerned the question of whether the employer was entitled to withhold a portion of the gross salary of the posted employee which the employee would have paid as taxes in Germany if his income had been subject to income tax in Germany during the relevant period of the posting. The ruling thus has implications for the practice of the so-called hypotax (= hypothetically determined tax) if the employee is posted abroad and is liable to pay tax there, in particular if the regulation on the withholding of the hypothetically determined wage tax is based on an individual contractual agreement.

Three key statements can be derived from the ruling of the LAG. Firstly, the court clarified that German law continues to apply in the case of a temporary assignment of the employee and thus also the collective agreements applicable (for the respective parties bound by collective agreements). Furthermore, an agreement between employer and employee in the context of a "tax equalization" violates mandatory law under Section 4 (3) TVG and is thus invalid if the agreement deviates from the collective agreement to the disadvantage of the employee and if the collective agreement does not contain an opening clause allowing the deviation. Finally, payments to the employee which are merely intended to compensate for the employee's higher expenses in the context of the posting but which are not paid in return for work performed are not to be included in the comparison of favorability pursuant to Section 4 (3) TVG.


Application of German law, in particular the TVG

If the TVG would be inapplicable due to the rule of a foreign legal regime, there would be no conflict with Section 4 (3) TVG. Art. 3 Para. 1, Art. 8 Para. 1, 2 Rome I Regulation in principle opens the possibility for the contracting parties to freely choose the legal system applicable to a posting contract. According to Art. 8 Para. 1 Sentence 2 Rome I Regulation, however, the choice of law may not result in the employee being deprived of the protection of the law that would be applicable in the absence of a choice of law. This is the law of the state in which or from which the employee habitually performs his work in fulfillment of the employment contract.

In the case to be decided, the contracting parties had expressly agreed that German law would apply to the posting agreement. Even without the choice of law, however, German law would have been applicable because the employee's usual place of work was in Germany and the merely temporary posting did not lead to a different assessment.

This is particularly the case if - as in the facts to be decided - the parties expect the employee to resume his work in his country of origin after his assignment abroad. This is not precluded - as the Hamburg Higher Labor Court found - even if the employee only receives instructions from the company in the host country where he is deployed during the assignment.

In particular, the focus of the employee's work is still in Germany, if the posting is for a limited period. In the case under review, therefore, the standards of German law and thus also the requirements of the collective agreement had to be applied.


Impermissible deviation from collective bargaining agreements

Section 4 (3) TVG only permits a deviation from the requirements of the collective bargaining agreement on the basis of an individual agreement if the collective bargaining agreement permits it by way of an opening clause or if the agreement contains an amendment of the (collective bargaining agreement) provisions in favor of the employee.

If - as in the case decided - the collectively agreed remuneration stipulates the payment of a gross salary in a certain amount, there is a deviation from the regulations of the collective agreement if fictitious taxes are deducted rather than actually payable taxes. The collective agreement in question exclusively regulates a gross salary, but not a net salary. This constitutes a deviation within the meaning of Section 4 (3) TVG - even if the employee is paid exactly the net amount of the salary owed under the collective agreement that he would have earned if he had continued to work in Germany.

Justification of the deviation through an opening clause in the collective agreement was not possible in the case to be decided by the Hamburg Higher Labor Court.

This leaves the possibility that the deviation is permissible because it changes the provisions of the collective agreement on the monthly gross pay in favor of the employee. The favorability required is to be determined on the basis of an objective approach. A merely objectively neutral provision is not sufficient to qualify a deviation as such "in favor" of the employee.

The provision agreed between the employment parties on the deduction of a hypothetical tax does not stand up to the favorability comparison, especially if the employee - as in the case to be decided - has to pay lower taxes in the host country than in Germany.

According to the Hamburg Higher Labor Court, special payments related to the posting (such as purchasing power compensation payments, lump-sum payments for moving in, moving out and moving in, reimbursement of brokerage costs, home travel costs, etc.) do not make the deviation from the collective wage agreement permissible. These benefits merely compensate for additional financial expenses associated with the posting. However, they are not income paid in return for the work performed. Therefore, these special payments are not to be included in the consideration.

The favorability comparison therefore leads to the conclusion that the individual contractually agreed provision on the deduction of a hypothetical tax does not contain any change to the (collectively agreed) provisions in favor of the employee.

The provision is therefore not compatible with Sec. 4 (3) TVG. There is an impermissible undercutting of the gross salary if the employer withholds the hypothetical wage tax.


Possibility of implementing or further practicing Hypotax

Taking into account the decision of the Hamburg Higher Labor Court, employers should examine whether the deduction of hypotax for employees covered by collective bargaining agreements can or should still be made in similar cases.

Typically, the deduction of hypotax is realized through the tax equalization method. With this method, the employee is charged with the tax level of the home country (in the form of the deduction of hypotax) and the employer in return bears actual taxes in the host country (and - insofar as applicable - in the home country).

The Higher Labor Court left open the question whether a deduction of hypotax would stand up to a favorability comparison if the actual taxes exceed the amount of hypotax (in the case of postings to high-tax countries). If this would be the case, a different treatment of postings to high-tax countries and countries with lower tax levels would be conceivable. However, this would significantly increase the implementation effort, as the expected tax burden in the posting country can often only be determined by an individual calculation. In addition, the general implementation effort increases if different methods of tax equalization are to be applied in the company for different employee groups or country combinations.

A change to a different tax equalization method - e.g. tax protection - would have to be examined. With this method, the employee remains responsible for taxes in the home country and in the country of assignment. If this results in a tax disadvantage (higher burden than in the home country), the additional tax is offset by the employer. In contrast to tax equalization, tax protection is usually associated with higher costs for the employer, as he only has to compensate for tax disadvantages without being able to skim off tax advantages. In addition, this method does not prevent postings to low-tax countries from tending to be more attractive for employees than postings to high-tax countries due to the tax advantage.


Published: November 2022

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