The reduced flat rate for payroll tax is to be limited

Company events and payroll tax

A landmark judgment by the Federal Fiscal Court (BFH) from 27 March 2024 has had an impact on flat rates for payroll tax for company events such as Christmas parties and company anniversaries. It concerned the question whether a company event must be open to all employees within the entire organisational unit in order for the reduced flat tax rate of 25 percent to apply (under Section 40(2) sentence 1 no.2 of the Income Tax Act [Einkommensteuergesetz – EStG]). 

The tax authorities were requiring that it must be open in this way if a flat rate of 25 percent under Section 40(2) sentence 1 no.2 of the Income Tax Act (EStG) were to be applied to any benefits. If this characteristic was not present, only applying the flat rate as laid down by Section 37b(2) EStG (flat rate of 30 percent) would come into consideration. This is the view that the fiscal court of first instance took. However, the Federal Fiscal Court (BFH) did not consider this characteristic to be necessary. 

Flat rate tax for company events

Besides the obvious difference in tax rates, applying the flat rate of Section 40(2) EStG offers a further benefit – non-monetary benefits that are reported and taxed on time under Section 40(2) are not subject to social insurance payments. That would be different in the case of Section 37b(2) EStG. 

According to the head note of the judgment, a company event under Section 19(1) no.1a sentence 1 EStG is still deemed such even if it is not open to all the members of a business or part of a business. The term “company event” in the flat rate rule under Section 40(2) sentence 1 no.2 EStG matches this legal definition. 

In the operative part of the judgment, the Federal Fiscal Court found for the appellant. It had applied tax at a flat rate of 25 percent under Section 40(2) EStG for a Christmas party which only managers were allowed to attend. The Federal Fiscal Court found it inconsequential to the application of Section 40(2) EStG whether the company event was open to all the employees of an organisational unit or not.

Benefits of the Federal Fiscal Court decision on flat rate taxation for companies 

This Federal Fiscal Court judgment opens new possibilities and benefits for companies. Alongside the lower tax rate, applying the flat rate of Section 40(2) EStG also results in exemption from social insurance. There is also potential to save on administrative expenses. Employers should also take note of the current Federal Social Court (BSG) case law – in its judgment on 23 April 2024 the Federal Social Court decided that flat rate taxation must be applied with the payroll for the period in question to retain exemption from social insurance. But the employer has until the payroll tax return is submitted on 28 February of the following year to submit the change to the payroll tax deduction. Social insurance contributions will be charged on company events that are reported late. Late-payment penalties may also need to be paid.

It should also be noted that the application of the allowance of 110 euros under Section 19(1a) sentence 3 EStG is still determined by the event being open to all. Tax auditors are increasingly becoming aware of this allowance because the number of participants who actually attend the event must be recorded (BFH file ref. VI R 31/18, appeal to Federal Constitutional Court file ref. 2 BvR 1443/21). Referring to planning figures is no longer accepted. 

Legislation planned on non-application 

The Bundesrat, the upper chamber of parliament, has now recommended, in publication 369/1/24 published on 17 September 2024, making an addition to Section 40(2) sentence 1 no.2 EStG, according to which applying a flat rate should be linked to “attending the company event being open to all members of the business or part of the business.” This new rule would apply to cases after 31 December 2024. The proposal was discussed in the context of the Annual Tax Act 2024 in the session held on 27 September.

Surprisingly, the Bundesrat has not taken up a major argument from the grounds to the Federal Fiscal Court’s judgment – the legal definition of “company event” in Section 19(1) sentence 1 no.1a EStG. Systematically speaking, adapting this would have been more germane to the matter. 

Flat rates on payroll tax – the legislative process should be viewed critically 

The Bundesrat’s legislative initiative does not take account of the well-known practical problems of definition. In an age of agile teams and interdisciplinary work, making a limit out of the business as a whole or a “part of the business” (however that is to be defined) is no longer up-to-date. Simplifications to administration that could have been derived from the judgment have not been taken into account in the explanatory memorandum.

It remains to be seen how the legislative process will develop. The signal the legislative is sending, however, is clear – employers should carefully follow the legislative process and adapt their internal processes as necessary. 

Employers may, however, continue to appeal to the favourable Federal Fiscal Court decision for payroll tax audits for periods from 1 January 2015 to 31 December 2024.