What is the difference between limited and unlimited tax liability? Why is this important when determining the amount of tax?
The question of how much tax someone has to pay depends on the size of their income and on any expenditure that can be taken into account to reduce the amount of tax. Whether an individual can offset expenses against their taxes depends on what kind of tax liability they have (limited or unlimited tax liability).
Individuals who are not resident in Germany generally have limited tax liability. “Limited” in this context means that the taxes are only calculated on income originating in Germany. In contrast, “unlimited tax liability” means that the whole worldwide income would be included when calculating the amount of tax -- in other words, both German and foreign sources of income.
However, having limited tax liability also means that no personal or family-related expenses can be taken into account when calculating the tax. In this case, the tax is calculated entirely on the basis of the income from Germany. As a result, in the absence of tax-free allowances and exemption thresholds, taxes become due even on very small amounts of income.
Someone who has their residence or place of habitual abode in Germany is subject to unlimited tax liability. Individuals subject to unlimited tax liability have the right to a tax-free minimum amount of income that is needed for subsistence (Existenzminimum). They can also take advantage of other tax benefits related to their personal and family situation.
However, if certain conditions are fulfilled, there is the option of applying to be treated as a person with unlimited tax liability even if your residence is outside Germany. In this case, individuals who would normally have limited tax liability can take advantage of almost all the tax benefits that are available to a German resident.