For many employees, mitigating the consequences of increased consumer prices is currently of considerable importance. As a result, the authorities in Germany have reacted with inflation relief measures. On October 25, 2022, they introduced a tax free ‘inflation compensation allowance’ through its new law for the temporary reduction of the value added tax rate for the supply of gas via the natural gas grid.

According to Sec. 3 no. 11c of the German income tax act (GITA), employers may provide their employees an inflation compensation allowance between October 26, 2022 and December 31, 2024 (benefit period) to mitigate increases in consumer prices. This is not subject to either wage tax or social security contributions in the amount of up to EUR 3,000 in the form of cash payments and benefits in kind (the “inflation compensation allowance”). The application of Sec. 3 no. 11c GITA requires that the allowances and benefits in kind are paid/provided – as a voluntary payment on the part of an employer – in addition to salary payments already owed.

Applying the allowance is subject to personnel, timing and factual requirements.

Personnel and timing requirements

The requirements of Sec. 3 no. 11c GITA are only met if the allowance is provided by the employer to its own employees. Given that applying Sec. 3 no. 11c GITA is based on the tax status as an employee, the bonus may also be provided to managing directors who are exempt from social security contributions. Employees who are taxed at a flat rate (short-term or marginal employees) can also benefit from the allowance.

The employer’s business activity is not relevant. However, the regulation does not provide for a group privilege. This means that a compensation allowance provided by the parent company to employees of subsidiaries is not exempt from taxation.

With regard to the form of employment, it does not matter whether the employee is employed full or part-time. The bonus can also be provided to employees who are on short-time work.

In addition, EUR 3,000 can be claimed for each employment relationship (and thus also several times in the case of several employment relationships).

Regarding timing, the inflation compensation allowance must be provided by the employer within the benefit period of October 26, 2022 to December 31, 2024 (the “inflow principle”); a payment of the allowance in instalments within the benefit period is feasible.

Factual requirements

As stipulated in Sec. 3 no. 11c GITA, the inflation compensation allowance is provided to mitigate increases in consumer prices. The law therefore establishes a causal connection between the allowance (in the form of a cash payment or benefit in kind) and higher consumer prices.

However, neither the wording of Sec. 3 no. 11c GITA nor the explanatory memorandum to the law specify in more detail under which conditions the causal connection is given.

Given that increases in consumer prices are macroeconomic events, it can be assumed that every employee is affected. Nevertheless, no concrete proof of the burden on the employee caused by higher consumer prices in each individual case is required pursuant to Sec. 3 no. 11c GITA (i.e. in relation to the respective employee benefiting from an inflation compensation allowance). As a precautionary measure, however, the causal connection should be documented. This can be done, for example, through documenting communication with the employee stating that providing the allowance serves to help compensate the increase in consumer prices.

Meeting the additionality criterion

Providing the allowance must be in addition to the wages already owed. Pursuant to Sec. 8 (4) GITA, this is the case if the allowance is not offset against the entitlement to wages, the entitlement to wages is not reduced in favor of the allowance, the allowance is not provided in lieu of an already agreed future increase in wages, and wages are not increased if the bonus is discontinued.

The conditions for a tax exemption are thus not met if the bonus replaces wage payments already agreed to with the employee or is offset against them. Salary conversions or the waiver of salary therefore do not meet the requirements of the additionality criterion.

From the employer's point of view, the use of variable remuneration components is the most suitable way to finance the allowance. Provided that that the employee has not already acquired a legal claim to the remuneration. This must be examined on a case-by-case basis. Where doubt exists, it is recommended – in view of the employer's wage tax liability – that the exemption for tax purposes is secured by means of a wage tax ruling.

Consequences of the tax exemption of the allowance

If the requirements of Sec. 3 no. 11c GITA are met, the allowance can be paid by the employer free of wage tax up to EUR 3,000; the amount is to be recorded in the wage account. Amounts exceeding EUR 3,000 are subject to taxation.

It does not matter whether the bonus is provided as a cash payment or as a benefit in kind. If the allowance is provided as a benefit in kind, the allowance is not counted towards the exemption limit of EUR 50 for remuneration in kind. Other tax exemptions (such as the allowance for employee discounts) and lump sums remain applicable in addition to Sec. 3 no. 11c GITA.

With cross-border salary split structures, it should be noted that the allowance – in the absence of a corresponding tax exemption under foreign law – may be subject to taxation abroad.

The employer is not obliged to report the allowance in the income tax certificate. Furthermore, the employer is not obliged to declare the allowance in the assessment for income tax purposes; the bonus is also not subject to the progression clause. As a tax-exempt one-off payment, the bonus is not part of the remuneration subject to social security contributions.

Summary

In the case of a higher numbers of cases, the application of Sec. 3 no. 11c GITA can result in inconsiderable compliance risks for the employer. Therefore it is of considerable importance to ensure that the conditions for the tax exemption of salary payments are met.

Where doubt exists, where it is not possible to obtain a wage tax ruling from the tax authorities, it may be advisable to disclose the wage tax-exempt payment in a side letter to the wage tax declaration, therefore mitigating compliance risks.