The Netherlands has concluded tax treaties with many countries around the world. This is also the case with our neighbouring countries, Germany and Belgium. The tax treaties that the Netherlands has concluded with Germany and Belgium include a special scheme for cross-border workers. This is known as the ‘compensation scheme’.
Why a compensation scheme?
If an employee is resident in the Netherlands and works in Germany or Belgium (and also receives income from there), he (or she) will almost always pay tax and social security contributions in Germany or Belgium. This may mean that they miss out on certain tax deductions (such as mortgage interest) in the Netherlands. In that case, the employee pays more tax and contributions than they would if they were working in the Netherlands. To compensate for this financial disadvantage, the tax treaties that the Netherlands has concluded with Belgium and Germany include a so-called compensation scheme.
How the compensation scheme works
In short, the compensation scheme works as follows. An employee resident in the Netherlands receives compensation in the Netherlands amounting to A minus B, where,
A = Total tax and social security contributions paid in the Netherlands and in Germany/Belgium, added together.
B = The amount that would have been paid in the Netherlands in tax and social security contributions if the income from abroad were taxable in the Netherlands.
In this way, the situation is effectively the same as if the employee’s entire income were subject to tax and social security contributions in the Netherlands. In short, the employee must not now be worse off than they would have been had they earned their entire income in the Netherlands. Employees resident in the Netherlands can claim this reduction by requesting a reduction under the compensation scheme in their Dutch income tax return.
Change to the compensation scheme between the Netherlands and Germany
On 26 May 2016, the Netherlands and Germany signed a agreement agreed on the application of the compensation scheme in the tax treaty between the Netherlands and Germany. The question was whether social security contributions paid in Germany could be taken into account in the Netherlands in the aforementioned calculation of the reduction in the Netherlands. The agreement of 26 May 2016 states that German social security contributions are not comparable to Dutch national insurance contributions. German social security contributions do not count towards the reduction that cross-border workers residing in the Netherlands can claim in the Netherlands.
For the purposes of the tax treaty with Belgium, it had already become clear in the past that social security contributions paid in Belgium do not count towards a reduction claimable in the Netherlands under the compensation scheme.