Tax liability in preventive detention?

If there is one thing the German state takes very seriously, it is the observance of and compliance with tax law – a cliché whose truthfulness has been shaken by the numerous cum-ex scandals, but which is once again confirmed in the following case.

The Münster Fiscal Court recently had to deal with the question, which has already been decided by the highest court, of whether the income of a person in preventive detention may be taxed at all. On the other hand, it discussed whether this income should be categorised as non-self-employed or other income within the meaning of the Income Tax Act (EStG).

The question arose in this specific case because the inmate filed an appeal against an income tax assessment in which his wage payments were categorised as other income.

The inmate wanted to ensure that a lump sum for income-related expenses in the amount of EUR 1,000 was recognised and argued that his work in the prison was a non-self-employed activity in accordance with Section 19 (1) EStG.

Furthermore, he argued that his work could generally not be taxed, as the employment of prisoners and inmates is focused on resocialisation and not on generating income and their work is therefore not comparable to a “normal” employment relationship.

In the opinion of the tax office, the income of a person in preventive detention constitutes other income within the meaning of Section 22 No. 3 EStG.

The activities of the person in detention would not stem from an employment relationship and, accordingly, there would be no entitlement to continued payment of wages in the event of illness or to paid holiday. The tax office stated that it was generally recognised that work in the prison system was of a public law nature and that prisoners could therefore not be employees. Furthermore, they were only included in accident and unemployment insurance, but not in health and pension insurance. The tax treatment had to follow these principles.

The Münster Fiscal Court disagrees, at least in part. In its judgement of 20 September 2023 (14 K 1227/21), the court affirmed an existing employment relationship between persons in preventive detention and the prison, citing the different status of prisoners and persons in preventive detention as justification.

In contrast to “regular” prisoners, persons in preventive detention are not obliged to work. This difference resulted from the different protective purpose of the two measures. As the name suggests, a custodial sentence serves to punish the offender and is therefore primarily a repressive measure.

Preventive detention is a custodial measure that can be ordered alongside a custodial sentence. In this case, the offender remains in state custody for preventative reasons, even though he has already served his sentence – he is making a kind of “special sacrifice” for the general public. For this reason, people in preventive detention enjoy certain privileges compared to prisoners.

As people in preventive detention were therefore working voluntarily, they were – in the opinion of the tax court – exercising a “free business will” in the course of their work, which is a decisive criterion for the affirmation of employee status and an employment relationship. As a result, the income of the person in preventive detention was classified as a non-self-employed activity in accordance with Section 19 (1) EStG.

It follows automatically from this reasoning of the tax court that the income of the detainee is taxable.

In 2021, the Federal Court of Justice ruled that prisoners are not exempt from tax liability. The submission of a tax return is regularly possible and reasonable (BGH, judgement of 13.01.2021 – 1 StR 120/20).

In its reasoning, the tax court referred to decisions of the Federal Fiscal Court, which clarified that a special motive on the part of the employer (such as securing resocialisation) does not render the income taxable. The activity is therefore at least also aimed at increasing income through the exchange of services (BFH, judgement of 14 September 1999, IX R 88/95, BFHE 189, 424, BStBl II 1999, 776).

In the case to be decided by the Münster Fiscal Court, the prisoner even used some of the income from his work to pay maintenance to his son – i.e. not just to ensure his resocialisation after his release.