Principal tax rates 2002

The Icelandic tax system has undergone a number of changes in recent years. Their aim has, on one hand, been to improve Iceland's competitiveness in international markets and, on the other, to reduce personal income taxes by gradually lowering the standard income tax rate and adopting a capital gains tax. This paper describes the principal tax rates applicable to individuals and companies as they stand in 2002.

1. Personal income taxation

Iceland's personal income tax structure is such that there is a basic tax-free income (67,468 kronur per month in 2002 [The tax free income allowance has been made transferable between spouses in stages. In the income year 2001, 90 per cent of the allowance is transferable, rising to 95 per cent in 2002 and 100 per cent in 2003. The monthly tax-free income is transferable between months inside the calendar year but not between years.]. Once that income has been earned in any given month, a 38.54 per cent PAYE tax rate is applied to all subsequent income. Incomes in excess of 3,865,000 kronur in 2001 for a single individual and 7,730,000 kronur for a couple are subject to 7 per cent surtax [By an amendment to the Tax Code in the autumn of 2001, the tax threshold for the personal income surtax will be raised by 15 per cent on income earned in 2001. The accounting for the surtax takes place through tax returns in 2002.]. For 2002 the amounts are raised to 3,980,000 and 7,960,000, respectively. Seamen get a special tax reduction of 712 kronur per day. The personal income tax comprises both the central government and municipal income tax. Tax rates (assessment year) since 1988 have been as follows [The PAYE tax collection rate is the same for the whole country. Municipalities, however, have different municipal tax rates which explains the slight changes in their average PAYE tax rate from year to year. Actual tax settlements take place in the following year after a tax return has been filed and the actual tax has been assessed.]:

In addition to the above, each individual pays a flat tax of 4,826 kronur per year to the Elderlie's Construction Fund, a central government fund intended to finance the construction and operation of nursing homes and care centres for the elderly. Persons under the age of 16 and older than 70 are exempt from this levy as well as those with an income below 781,579 kronur in 2001.

As of the beginning of 1997, the financing and operation of elementary schools were transferred from the central government to the municipalities. In order to finance the operation of the schools at the municipal level, the central government reduced its tax rate by 2.84 percentage points and the municipalities increased their rate by the same percentage points.

The central government has pursued a policy of reducing its marginal tax rate. It did so with a reduction of 1.1 per cent at the beginning of 1997, by 0.9 per cent at the beginning of 1998 and by 1 per cent at the beginning 1999. As of the beginning of 2001 the central government tax rate was reduced by 0.33 percentage points and the municipalities were authorised to increase their rate by up to 0.66 percentage points in 2001 and by a further 0.33 percentage points in 2002. Both measures were intended to improve municipal finances. At the beginning of 2002, the central government reduced its personal income tax rate by a further 0.33 percentage points.

The personal income tax is levied on gross income other than from capital (for the capital income tax, see below), with a number of minor exceptions. Employee contributions to pension funds are deductible. Such contrac-tual contributions normally comprise 4 per cent of gross pay, to which the employer adds a contribution, normally 6 per cent [In many cases the employer contribution is considerably higher. For central government employees it is 11.2 per cent and for airline pilots and similar professions with a shorter working life it is even higher.] which also is deductible as operating expense on the business side. In addition, the employee can save a further 4 per cent on a voluntary basis to which the employer adds another 0.4 per cent, which in turn is offset against the employer's payment of the social security tax. This voluntary pension savings option was first introduced at the beginning of 1999 in order to encourage personal saving. At that time the contribution percentage was 2 per cent for employees and 0.2 per cent for employers. In May 2000 these percentages were doubled to 4 and 0.4 per cent, respectively, as noted above. In addition, some employers, such as the central government, have increased their employer counter-contribution by agreement with employees. The central government contributed 1 per cent against a voluntary employee contribution of 4 per cent in 2001 and 2 per cent as of the beginning of 2002. All such contributions are tax-free, both with the employer and the employee.

Interest rebates are granted by the central government in lieu of interest expenses incurred from home purchase loans. Such rebates are subject to debt, income and net wealth ceilings. Maximum rebates in 2002 are: 156,290 kronur for a single individual, 201,000 kronur for a single parent and 258,459 kronur for a couple [The following constraints apply to interest rebates: (1) They can not exceed 7 per cent of the remaining debt balance incurred in buying a home for one's own use. (2) The maximum amount of interest payments that qualify for an interest rebate calculation is 456,112 kronur for an individual, 598,778 kronur for a single parent and 741,442 for a couple. (3) Six per cent of taxable income is subtracted from the interest expense. (4) The rebates begin to be curtailed at a net worth threshold of 3,430,678 kronur for a single individual and 5,686,940 kronur for a couple and are eliminated altogether at a 60 per cent higher amount.]. From 1999, first-time buyers can have the interest rebate remitted to them on a quarterly basis immediately in the year of purchase, whereas for other buyers the rebate only becomes effective at the time of tax settlement in the year following the income year.

Child benefits are granted for each child, subject to income thresholds. In 2002 they are as follows (in kronur per year):

For all children under the age of seven 34,474
Children under the age of sixteen in 2001:
First child 117,031
Each additional child 139,304
Benefits for single parents:
First child 194,921
Each additional child 199,949
Income threshold for benefit curtailment:
For couples 1,354,727
For a single parent 677,364
Curtailment of benefits:
For one child 4 per cent
For two children 8 per cent
For three children or more 10 per cent

The child benefit system was amended with effect from the beginning of 2001. In basic terms, the net wealth threshold previously applicable was eliminated, benefits for children under the age of seven cease to be linked to income and the income threshold rule was eased. The amendments to the child benefit system are spread over three years, 2001-2003.

The income taxation of rent subsidies supplied by municipalities to low-income tenants was abolished as of the beginning of 2002.

A tax deduction is in effect for purchases by individuals of domestic and foreign equity stocks. If an individual buys stocks in any given year, 60 per cent of the purchase price may be deducted from income before tax. The maximum deduction is 60,000 kronur for an individual and double the amount for a couple. This provision used to apply to domestic stocks only but was broadened this year to cover foreign stocks of companies in the EEA area. This right comes with the stipulation that the purchaser must hold the stocks for no less than over five year-ends (before 1998 the limit was three year-ends). Should he sell the stocks he must buy new ones within 30 days or otherwise be liable for a reversal of the tax benefit. This benefit will cease at the end of 2002 under current legislation.

The tax treatment of stock options was introduced into the Tax Code in 2001. The amendment is a result of the fact that a number of companies have begun to reward their employees with options to buy stock at a defined price as a part of the employees' total emolument package. Profits from stock options are now defined as capital gains, subject to a 10 per cent tax, whereas previously they were defined as ordinary income, subject to the common personal income tax rate. The exercise of stock options is subject to certain conditions, the chief being: (1) Stock options must be available to all employees; (2) A minimum of twelve months must pass between the conclusion of a stock option contract until it is exercised. (3) The employee must own the stock for no less than two years after purchase. (4) The annual stock option must not exceed 600,000 kronur at the exercise price.

2. Taxes on capital income and net wealth

A consolidated tax on capital income was introduced at the beginning of 1997. This change represented a complete overhaul of the former system. Before, there were large discrepancies between taxation of different forms of saving with distorting effects on the saver's choice. Interest income was tax-exempt, while other capital income was subject to up to 42-47% personal income tax. Starting in 1997, a general 10% withholding tax is levied on interest income and capital gains, which eliminates the discrepancy between various forms of capital income. Thus, all capital income, such as interest income, dividends, capital gains and rent is currently subject to a uniform tax of 10%. The capital income tax is withheld at source for both businesses and individuals, as applicable. Individuals pay no further tax on capital income, whereas capital income incurred by businesses is taxed as ordinary corporate profits with the withholding capital income tax being offset against the corporate income tax.

The net wealth tax is imposed on net assets beginning at 4,720,000 kronur for an individual. Amounts in excess thereof are taxed at a 1.2 per cent rate. This tax-free amount was increased by 20 per cent for assets at the end of 2001, taxed in 2002. The increase was designed to counter the effects of the recent general review of real property values. The review raised such values by a substantial margin and the tax base thereby. The Government has decided that this should not lead to an increase in net wealth taxation. A net wealth surtax of 0.25% on top of the general net wealth tax is imposed on net assets starting at 6,332,500 kronur for an individual [Individuals older than 67 years are exempt from this higher net wealth tax rate.]. These amounts are double for couples. These rates apply in 2002 in respect of assets at the end of 2001. In 2003 the 1.2 per cent rate will be reduced to 0.6 per cent for assets at the end of 2002 and the net wealth surtax will be abolished.

3. The social security tax

Up to the end of 1996, a two-tier system of social security tax was in effect. A lower rate, 3.63%, was levied on agriculture, fisheries, manufacturing, hotels, restaurants, car rentals, the making of motion pictures and computer software services. The higher rate, 6.93%, was levied on all other sectors. The average rate was estimated at 5S%. The two tier system was amended as of the beginning of 1997 with the aim of merging the two rates into one over an adjustment period of four years, 1997-2000. The rates over the adjustment period were as follows:

On January 1, 1997 the first of four steps to harmonise the two-tier system of the social security tax into one became effective. The unified rate of 5.23% for all industries was fully implemented [The rate for employers of seamen is slightly higher due to a 0.65 per cent accident insurance premium collected with the tax.] as of 1 January 2000. As it turned out, the change resulted in a fiscal loss of about 600 million kronur which was spread over the four-year adjustment period.

The 5.23% tax is allocated as follows:

As of the beginning of 1999, employers have had the option of reducing their social security tax by 0.2% in order to finance a counter-contribution to optional supplementary employee pension premiums. That percentage was raised to 0.4% with legislation passed in May 2000. The supplementary scheme is designed to encourage employees to contribute a further 4% in pension savings and thereby oblige employers to contribute a further 0.4%, whereby they qualify for a commensurate reduction in their social security tax. The Treasury estimates that the total loss of revenue resulting from this change could amount to 350-400 million kronur, assuming that a quarter of the labour force avails itself of this savings option.

The social security tax will be raised by 0.5 per cent as of the beginning of 2003 [The social security tax was increased by 0.77 percentage points as of the beginning of 2003 with Act no. 133/2001. Subsequently, the Government agreed with labour unions that if the price assumptions behind the 2002-3 wage agreements would be realised, it would rescind 0.27 percentage points of the above increase. Legislation to that effect was introduced by the Government to the Althingi in the autumn of 2003. ]. The increase must be seen in conjunction with the reduction in the corporate income and net wealth tax that is also being proposed (see below).

4. Corporate taxation

As of the beginning of 2002, Iceland's corporate income tax was lowered from 30 per cent to 18 per cent. Partnerships with unlimited liability that file for taxes as distinct legal entities had their tax rate lowered from 38 per cent to 26 per cent. Since March 1999, so-called international trading companies, having established a venue in Iceland, are subject to a 5 per cent income tax. This refers to companies that exclusively trade in goods and services outside Iceland. So far, several such companies have been established. The table below shows the corporate and partnership taxation rate for the past fourteen years. Furthermore, the corporate net wealth tax will be reduced from 1.2 per cent to 0.6 per cent at the end of 2002. The corporate net wealth surtax will be abolished at the same time.

In recent years, the Althingi has passed a number of changes in the corporate income tax system in order to make it more flexible and in line with that of other European countries. The carry-forward provision for net losses was extended from five to eight years. Depreciation rules were amended so that the rates on machinery were changed from 9-12% to 5-15% (straight line method) and similar changes were implemented for other items. In the long run, these changes will have negligible direct effects on the Treasury. At the beginning of 1998 an amendment to the Tax Code took effect whereby the depreciation of purchases of fishing quotas was curtailed in stages up to and including the income year 2000. The Tax Code was further amended at the end of 1998 to allow for the joint taxation of companies and their subsidiaries, provided that the latter was no less than 90 per cent owned by the parent company.

5. The value added tax

There is a general value added tax of 24.5 per cent on domestic goods and services. Exports of goods and services and several other transactions are zero-rated. As of 1 January 1993, a new lower tax rate, 14%, was introduced and the following transactions, previously zero-rated, were subjected to the 14% rate: Newspapers, periodicals, books in the Icelandic language, subscription to radio and television (from July 1993), geothermal hot water, electricity and fuel oil used for heating and hotel room rentals. The rate on most foodstuffs was reduced as of 1 January 1994 from 24.5% to 14%.

As a general rule, all transactions are taxable except where exemptions are specified. The most common categories of exemption are health services, social services, education, libraries and art, sports, passenger transport, postal services, rental of property and parking spaces, insurance and banking services.

Ministry of Finance, Iceland
October 2002