Perhaps someone here can help explain at what point does cleverness turn into illegal tax evasion.

Suppose John, a freelancer, makes $100K a year.

John lives in Germany, where he must pay an income tax of 45% for that level of income.

John registers a company in Gibraltar where the corporate tax rate is a mere 10%. His clients pay the company, which in turn pays John a more modest salary of $50K a year, bringing his tax rate down to 30%. He uses the company credit card to spend the other $50K.

Before, John was making $55K a year after taxes. Now, that figure is $75K.

Is this situation illegal? If yes, why?

  • sidenote: the maximum tax rate in Germany is 42%, and you only pay it on the portion of your income above 55k EUR. You have to earn almost 120k EUR to reach an average tax rate of 35% – Michael Borgwardt May 21 '14 at 11:09
  • What's the dividend tax rate for company owners? Your grocery purchases will likely be treated as dividend distribution. – littleadv May 21 '14 at 15:52

It's illegal at the point where he uses the company credit card to buy things for himself and does not report this as taxable non-wage compensation.

However, there might still be a (smaller) gain to be had in your specific scenario: in Germany since 2007, the employer can pay the taxes for non-wage compensation at a flat rate of 30%.

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  • I'm reading that, if John were to use the company's card to buy groceries, that should be reported so it's taxed as non-wage compensation. Correct? – Júlio Santos May 21 '14 at 14:39
  • @JúlioSantos: correct. – Michael Borgwardt May 21 '14 at 15:09
  • a version of this is to have the company pay for (and deduct when calculating its own taxes) things that are useful primarily to John - a car, internet access, office supplies, trips to tropical destinations for meetings, etc. This works in small doses and attracts audits in large doses. – Kate Gregory May 21 '14 at 18:46
  • @KateGregory: note that specifically in Germany, there are very clear and strict rules for taxing the private use of a company car. – Michael Borgwardt May 22 '14 at 7:16
  • @MichaelBorgwardt in Canada, too. There are plenty of rules, and audits do happen to ensure the rules are followed. My company car has a logbook for recording personal/business use. – Kate Gregory May 22 '14 at 13:18

Usually countries tax income sourced to them. So if John's company's clients are in Germany - John's company still has to pay German income tax on the money received from the clients, even if it is registered in Gibraltar (tax treaties may affect that). In addition, John will pay tax on the dividends received from the company.

I'm not familiar with the German tax law, but I doubt that using company credit card for grocery purchases can provide legal tax benefit. Usually, rules for owner employees are not the same as the rules for arm-length employees.

You should talk to a licensed tax adviser if you're planning doing something like this.

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