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PROBLEM AREA 4

Taxation of pensions etc. when working in another Nordic country

The tax processing of pensions and payments pursuant to the social security legislation are among the most frequently mentioned barriers in the reports analysed. For example, the current practice means that citizens who save their pension in another Nordic country risk paying a higher tax rate than colleagues who live and save their pension in the same country. This can lead to increased administration for many employees who work across a national border, as they have to settle any tax on returns on their pension scheme in their country of residence themselves
It is recommended that the barrier be solved with an agreement on mutual recognition of all pension schemes established in a Nordic country, and that current returns and payouts are only taxed in the country where the pension is established. Similarly, payments under social security legislation are only taxable in the country of payment. In short, the recommendation is to return to the system that was in place before 2009.

The barrier to mobility

Each country in the Nordic region has different rules and practices for taxation of pensions and payouts under social security legislation. This means, for example, that Nordic citizens who save for their pension in another Nordic country risk paying more tax than others with similar pension schemes. Barriers can arise in a number of contexts – especially in the context of:
  • Pension payments
  • Pension contributions
  • Tax on returns for pension schemes
  • Payments according to social legislation
The above key challenges are elaborated on below. However, it should be mentioned that minor barriers may also arise in relation to labour market contributions in Denmark. Read more about this issue in the notes
With effect from the 2008 income year, the 8% labour market contribution (AM contribution) changed from an employee contribution to social security to an income tax in line with other income taxes. When paying into a Danish pension scheme, the pension company deducts 8% AM contribution from the payment. As a result, the pension payment is exempt from AM contribution. So far so good as long as you are a resident of Denmark. However, if you live in another Nordic country, you will receive a credit for the tax paid in Denmark at the time of payment. Since the AM contribution is paid upon deposit and not withdrawal, the AM contribution is not included in the credit at the time of withdrawal. This can lead to a higher tax corresponding to the AM contribution over time for employees working across the Nordic region, compared to Danish resident pensioners.
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Pension payments

The focus in previous barrier reports is initially on pension payments – i.e. when a person who has worked in another Nordic country receives a pension that is taxed higher overall than if the pension had been taxed solely in the source country (the country from which the pension is paid), as there is an additional tax on the payment in the person's country of residence.
Often the problem leads to an asymmetry, as the deductibility (exemption right) on the deposit is lower than the tax at the time of payment.
If an employee living in Denmark has a Swedish employer who pays into a Swedish ITP occupational pension insurance scheme, the payment will be exempt from tax at the time of payment. The tax value of the tax exemption corresponds to the SINK tax, i.e. 25%, whereas the tax rate at the time of payment is at least around 44%. Few people would voluntarily choose to save for retirement on those terms. The basic idea is that there should be an incentive to save for a pension compared to receiving it all as salary income.
The above was not an issue prior to the change in the relief method for pensions etc. in Article 18 of the Nordic Tax Treaty. You can find more information about the protocol change and the reasoning behind it below.     

Protocol change on 4 April. 2008 etc. Article 18 of the Nordic Tax Treaty

Pension contributions

According to a protocol amendment on 4 April 2008, the relief principle for pensions etc. in Article 18 of the Nordic Tax Treaty changed from exemption to credit relief. This means that prior to the change, only the country from which the pension was paid could tax the pension payment (exemption relief). According to the amendment, the country of residence can also tax a person on a pension from another Nordic country; however, the country of residence's tax on the pension must be reduced by the other country's tax on the pension payment.
The change was made following a Danish initiative, and the commentary to the bill justifies the change on the grounds that the former provision allowed for "the possibility of unfavourable effects if the other country taxes pensions, but at a low tax rate".
It was probably the Swedish SINK tax of 25% on pension payments from Sweden that the Danish legislator had in mind when pointing to the "possibility of unfavourable effects".
In this context, the unfavourable effects for the individual cross-border worker are disregarded, where the deduction/right of exemption at the time of the pension contribution had a tax value of 25% (Swedish SINK tax), whereas the total tax at the time of payment can be as high as 50%.
This means, for example, that hospital staff who reside in Denmark, commute to work in Sweden and are covered by a pension scheme similar to a collective agreement will be exposed to the above-mentioned asymmetry with a low right of deduction (right of exemption) at the time of contribution in combination with a potentially significantly higher taxation at the time of payment.

Pension contributions

However, it is not only the taxation of pension payments that is problematic in a Nordic context, but also the contributions to a pension scheme.
A pension scheme that is tax exempt/deductible at the time of contribution under the legislation of the country of work may become taxable as salary income at the time of contribution in the employee's country of residence. This means that over time, the pension will de facto be taxed twice – in the country of residence at the time of contribution and again in the former country of employment when the pension is paid out.

Example

An employee lives in Sweden and works 45% of their working hours in Denmark for their Danish employer. The remaining 55% is carried out from their home office in Sweden. The employee has a Danish pension scheme through their employer (in the example, a so-called instalment savings scheme for pension purposes).
The Swedish Tax Agency's position statement of 07-07-2011 states that:
"The employer's payment into the employee's savings account is, according to Swedish law, to be equated with a salary payment".
The consequence of the Swedish Tax Agency's assessment is that 55% of the pension contribution is taxed as earned income in Sweden.
When the pension savings are eventually paid out, the payout is taxed fully in Denmark.
The result of the current provision in Article 18 of the Nordic Tax Treaty is – as the example above shows – that cross-border commuters can incur double taxation over time.
In the example, even if a Swedish pension insurance policy is taken out for the Swedish employee instead, this would result in double taxation over time in the opposite order, as Denmark does not recognise Swedish pension schemes as deductible for tax purposes (right of exemption). In this case, 45% of the pension contribution would be taxed in Denmark at the time of contribution, after which the pension payout will eventually be taxed in Sweden at the time of payout. A similar issue may also arise in situations where a citizen lives in Finland or Norway and has pension savings in another Nordic country, or situations where the citizen has pension savings in Finland or Norway but lives in another Nordic country.

Tax on returns for pension schemes

Sweden and Denmark have a tax on returns for pension schemes, which is typically settled via the pension company. In Norway and Finland, there is generally no current tax on returns for pension schemes.
A problem can arise when you live in Sweden and commute to work in Denmark (as a limited taxpayer in Denmark). Here, you are not liable to pay tax in Denmark on the return on the Danish pension scheme. On the other hand, tax must be paid on the return on the Danish pension scheme in Sweden.
Overall, this does not result in a higher tax. On the other hand, it is administratively more complicated for a cross-border commuter, as this is not managed by the Danish pension company. Instead, the employee must declare the return on their Swedish tax return.
This also leads to a liquidity burden since the tax is not paid out of pension savings, as it is nationally in Denmark and Sweden, but must be financed by cross-border commuters with free funds.

Payments according to social legislation

When a citizen receives payments under social legislation – e.g. sickness benefits – the amount is typically adapted to the tax regulations of the country of payment.
The challenge for this group arises when, for example, the citizen receives a payment from their country of work in connection with illness or similar.
While earned income is generally only taxed in the country of employment, social security payments are also taxed in the country of residence, where they are taxed according to the credit method. This means that a higher tax is paid if the country of residence has a higher tax rate than the country of payment.

Example calculated via the Tax Calculator on Øresunddirekt's website

Gunnar lives in Denmark and normally works in Sweden and is on full-time sick leave. He pays taxes on his work in Sweden and is socially insured there. He pays tax on the Swedish sickness benefit of SEK 26,000 per month in both Sweden and Denmark. The Swedish SINK tax of 20% (since increased to 25%) is deducted from the Danish tax of 44%. As Danish tax is higher than Swedish tax, the net amount he receives per month is SEK 5,300 lower than if the sickness benefit had only been taxed in Sweden.

The scope of the barrier

The above poses a major problem for many citizens who work in another Nordic country, as the challenges can have major consequences for the individual's personal finances. This is especially true for groups that primarily live off public pensions, sickness benefits and the like.
In particular, many have been in a bad situation since 2009, when the relief method for pensions etc. was changed in Article 18 of the Nordic Tax Treaty.

Solution

National pension legislation is extensive and often quite complex. This makes it difficult for Nordic citizens to navigate. In this context, deciding on a simple solution to a complex problem area is recommended, so as to ensure that employees working in the Nordic countries do not end up in a bad situation. Specifically, it is recommended that:
  • Pension contributions to pensions established in another Nordic country are mutually recognised as deductible.
  • Current returns are only taxed according to the legislation in the country where the pension scheme is established.
  • The source country taxes the pension payments at the same time as the country of residence exempts the pension payment from taxation (relieved by the exemption method). This is even if another Nordic country has granted a deduction. Since taxation always takes place in the source country, there is no risk of "double non-taxation".
  • The same principle as above should apply to payments under social legislation. This means that payments should only be taxed in the country that pays the benefit.

Benefits for citizens/businesses

The benefits for Nordic citizens are that they no longer have to risk paying higher taxes than colleagues who live and work in the same country. This would mean that the differing legislation of the countries would no longer risk removing the incentive to contribute to a pension rather than having the funds paid out as salary. It will also make it easier for citizens living and working in different Nordic countries to navigate the legislation and gain security about their financial situation.
If the country in which pension schemes are established is entitled to tax on returns, this will mean higher taxation on returns for citizens who have Danish schemes and reside outside Denmark, as Denmark is not currently authorised to levy tax on returns on persons residing in another Nordic country. On the other hand, taxation will be the same as people living in Denmark.
In addition to the above benefits in relation to pension schemes, the proposed solution will also eliminate the challenge of higher taxation of payments under social security legislation in cases where the taxpayer lives in another Nordic country than the country of payment.
The proposed solution also removes the disadvantage of pension schemes set up in Denmark, where at the time of payment, tax is withheld on AM contributions that are not settled as tax at the time of payment in the employee's country of residence.

Implications for the Nordic countries

The commentary to the bill on the protocol amendment of 4 April 2008, which was created on Danish initiative, states that the amendment that pensions etc. can also be taxed in the country in which the recipient resides would, in the long term, lead to revenue gain. This would depend on the number of people who become residents of Denmark or start receiving pensions from another Nordic country, and the difference between taxation in Denmark and taxation in the other Nordic country. However, it is estimated that the revenue gain will be modest. If, according to the proposed solution, we see a return exclusively to source-country taxation, this would likewise entail a modest loss of revenue.
When it comes to the outlined double taxation over time, i.e. situations where pension savings are taxed both at the time of deposit and at the time of withdrawal, it should not be relevant to discuss tax revenue, as it is hardly the intention to finance welfare systems with the double taxation of the pension savings of cross-border commuters.
Nor can tax revenue be the reason why payments under social security legislation in one Nordic country should be taxed more heavily because you live in another Nordic country.
In short, the change in 2009 has led to inappropriate taxation – to the disadvantage and increased administration for taxpayers and authorities.
A mutual recognition of pensions etc. and a system with only source-country taxation would result in significant administrative relief for the tax authorities, as it would no longer be necessary to qualify the foreign scheme under national law, assess whether the conditions for exemption are met, etc.
Nordic Council of Ministers I www.norden.org/publications I pub@norden.org