Section 2: How is income taxed?

2.1. Income tax progression

2.2. Allowance for pension contributions

2.3. Who has to pay income tax in Denmark?

2.4. How is taxable incom determined?

2.5. How is income tax calculated?

2.6. Tax is paid when the money is there

2.1. Income tax progression

What does progression mean in practice?

The Danish taxation system is progressive. This means that the last Danish Crown you earn is taxed at a higher rate than the first Crown earned. In practice, progression means that low income earners only pay municipal taxes and bottom-bracket tax to the state, those with slightly higher incomes also pay the middle-bracket tax on the upper part of their income and those with the highest incomes pay municipal tax, bottom-bracket tax, middle-bracket tax and top-bracket tax. Taxes are paid when income exceeds the respective tax’s basic allowance, which in the case of the municipal and bottom-bracket tax is also called the personal allowance, for the middle-bracket tax the middle-bracket tax limit and for top-bracket tax the top-bracket tax limit.

Everyone has a personal allowance. If a person does not have an income greater than his or her personal allowance, he or she does not have to pay income tax. (However, labour market contributions must always be paid if the income is earned through paid work, see section 4.3.). The personal allowance is DKK 41,000. Young people under 18 years have a personal allowance of DKK 30,000.

If a person has an income greater than his or her personal allowance, he or she will pay municipal tax and bottom-bracket tax on the excess amount.

Everyone also has a basic allowance in the middle-bracket tax. This middle-bracket tax only has to be paid on income exceeding DKK 279,800. About a fourth of Danish taxpayers pay middle-bracket tax. In 2009 the basic allowance in the middle-bracket tax will be raised to the level for top-tax, se “Lower Taxes on Labour 2008-2009.”

Top-bracket tax is only paid on income over DKK 335,800. One in five taxpayers pays top-bracket tax.

The average taxpayer has a personal income of DKK 223,000.

Below you can see how taxes increase in line with the size of income.

* 15% before any reduction in the tax ceiling (14.94% in an average municipality in 2008).
** The tax rate in an average municipality in 2008. The tax rate varies from 22% in the cheapest to about 27% in Denmark’s most expensive municipality.

2.2. Allowance for pension contributions

Contributions to private pension schemes can be deducted from the total personal income. In principle, this type of contribution is a purely private expense which does not concern the tax authorities. For example, other forms of savings are not tax deductible.

This has been done to give taxpayers an incentive to save for their retirement. This incentive should ensure that society has more total savings. For the individual, the savings ensure that there is a better division of spending over an entire lifetime and that the individual has more consumer options following retirement.

In contrast to this deduction allowance when contributions are paid in, the individual is taxed when the pension savings are paid out.

At the end of 2006, there was a total of more than DKK 2,300 billion set aside in private pension schemes.

2.3. Who has to pay income tax in Denmark?

Tax regulations decide who has to pay tax must in Denmark.

Permanent address in Denmark

If you live in Denmark, all your incomes are also taxed here. This means that, as a rule, income from abroad is also taxable in Denmark according to Danish regulations. In other words you are fully tax liable.

Residence in Denmark is in principle synonymous with being liable to pay tax here. For example, if a person works abroad and has both housing abroad and in Denmark it can be difficult to decide in which of the places the person must be taxed. However, often the actual residence is considered to be the place where the family is.

Sojourn in Denmark

Not only residency, but also a longer period of stay in Denmark can lead to a person being taxed on all of his or her income here. A stay must stretch over at least 6 consecutive months to be considered a longer period of stay.

A person can also be liable to pay tax in Denmark even though he or she is, for example, a sailor on board a ship or someone posted abroad by a Danish authority.

Leaving Denmark

There are tax rules to ensure that people leaving Denmark pay tax on profits earned while they lived in Denmark. For example, if a person owns a portfolio of shares, the person will be taxed when he or she moves as if the shares had been sold at the time of moving. However, a tax extension will be granted.

Other connection to Denmark

Even though a person does not have a permanent address in Denmark, he or she can still be subject to Danish taxation.

For example, if a person lives abroad and owns a rental property or a company in Denmark, the person is taxed on the income from this according to Danish rules. Thus the person has limited tax liability in Denmark. This means that the person does not pay Danish tax on all of his or her income but only on the part of the income that is generated in Denmark.

A special set of rules apply to border commuters i.e. people who live abroad but who work in Denmark. This set of rules is aimed at people who, for example, work in Copenhagen but who daily cross the bridge from Malmø in Sweden where they live. The border commuter rules also apply to pensioners and people who have taken early retirement.

Alignment with tax rules in other countries

In many ways, the Danish tax rules are aligned with tax rules in other countries. However, in other countries there may well be other rules for when an income should be taxed and where.

In some cases, this may mean that both Denmark and another country believe they have the right to tax the same income. To prevent double taxation in these cases, Denmark has entered into double taxation agreements with other countries. These agreements state when the income must be taxed according to Danish tax rules and when the other country has the right to tax the income.

Entering into these double tax agreements takes account of the fact that both citizens and companies are becoming increasingly international.

2.4. How is taxable income determined?

Since the beginning of the 20th century, the main principle for calculating taxable income has been the net income principle.

To work out taxable income, the total income is calculated and then all expenses are deducted. This gives a net income to be taxed.

For example, a regular wage earner may pay into a trade union or an unemployment insurance fund, make payments into a pension scheme and perhaps pay interest on debt in a house or on a car loan. These are all deducted to work out the income.

Net income and gross income

The net income principle does not always apply. For example, state taxes and labour market contributions are levied on gross income, i.e. income without allowance.

Since the tax reform of 1987 and until 2001, the changes in tax rules have moved largely towards taxing gross income, where tax is progressive. Or in other words, the changes to the tax rules have gradually removed the possibility of deducting expenses from income which is progressively taxed.

The effect of this is that allowances have gradually been given the same tax value for all taxpayers and are no longer dependent on income size. The value of the allowances no longer takes progression in income tax into account.

Different income bases

However, there is no simple way in a progressive tax system to ensure everyone the same tax value of an allowance. The deviation from the net income principle has therefore partly taken place at the expense of the desire for a simple tax system.

It has introduced different income bases, taxed individually and at different tax percentages.

Today, income is divided into personal income, capital income and share income. This is shown below. Additionally, there is a special income base for the labour market contribution.

* Contributions to pension savings made directly by the employer before tax and wage payment calculations.

1987 tax reform

The 1987 tax reform aimed to increase the incentive to save instead of getting into debt. It focused very directly on reducing the value of tax relief on interest for those with the highest incomes. This was through the introduction of capital income as a special income base, where income was taxed at a lower tax rate.

Following the 1987 tax reform, capital income had to be calculated as a total amount of income and deductions. For example, if interest payments were larger than interest income, the net capital income was negative. If the interest payments were less than the positive amount, the net capital income was positive. In this way, a net income principle was introduced which was only valid for capital income.

At the same time the option to deduct negative net capital income from progressively taxed income was removed. From 1987, interest payments could only be deducted from the taxable income.

Very large interest payments could not longer be used to reduce top-bracket income tax.

1993 tax changes

The 1993 tax changes further reduced the value of the tax relief on interest in the period 1994-1998.

The principle of the 1987 reform was retained that capital income should be calculated on its own according to a net principle and that negative net capital income could not be deducted from the top tax bracket. The fall in the taxable value of the tax relief on interest was therefore only due to the reduction in income taxes at the same time as the introduction of the labour market contribution.

For well paid people, this meant a fall in the value of tax relief on interest to approx. 46%. However, at the same time this group experienced a fall in tax paid on the last earned krone of 10 percentage points. Or of approx. 6 percentage points when labour market contributions were taken into account.

1998 tax adjustments (the Whitsun tax package)

The tax adjustments in 1998 meant a continued reduction in the taxable value of the tax relief on interest. From 2001, when fully implemented, the adjustments no longer allowed negative net capital income to be deducted when calculating bottom-bracket tax. Following this, interest payments can only be deducted when calculating municipal taxes.

This means that tax relief on interest now amounts to 33% for all taxpayers.

Development in the taxable value of tax relief on interest

Lower work tax and the Spring package 2004 (Forårspakken)

From 2004, an employment allowance of 2.5% on income from work up to the middle-bracket tax limit was introduced. The allowance can be maximum DKK 7,300. It is awarded as an assessment oriented deduction to everyone engaged in active employment. The value of the allowance is therefore approximately 33%. The aim of the allowance is to give the unemployed and those outside the labour market an incentive to work and to retain those who are in active employment. The allowance also gives those in active employment under the middle-bracket tax limit an incentive to work harder.

Redistribution via income tax

As shown on the diagram below, Denmark has a tax system where people with high incomes are taxed more punitively than those with low incomes.

The diagram shows that approximately 20% of taxpayers had the lowest incomes and only earned approximately 3% of the total incomes, which accounted for just under 3% of the total income tax. Conversely the diagram shows that approximately 11% of taxpayers earned the highest incomes, approximately 25% of the total incomes and paid approximately 50% of all income taxes.

2.5. How is income tax calculated?

Calculating what you should pay in income tax can be slightly complicated. There are rules on municipal tax, bottom-bracket tax, middle-bracket tax and top-bracket tax and rules on calculating income in the different income taxation bases.

Many people are not interested in the techniques that go into tax calculation; neither do they need to know about them in detail. They are most interested in the tax authorities using the correct figures when they calculate tax. But both the preliminary income assessment form and the annual statement from the tax authorities are so detailed that you can see how the tax has been calculated.

Tax calculation - an example

Below is an example of how income is first assessed and then how the different forms of income tax are calculated.

The example is based on a wage earner with interest payments on a mortgage, and with allowances for payments to a trade union and an unemployment insurance fund. The example wage earner earns DKK 350,000 annually.

Note: The limits for amounts and tax rates are valid for 2008. The municipal tax percentage rate corresponds to the total tax percentage rate for the municipality and church in an average municipality.
*) The tax ceiling is 59% and the reduction constitutes the part of the amount of the tax percentage to the municipality and state that in total exceeds 59%. Church tax is not covered by a tax ceiling. In an average municipality in 2008 the reduction amounted to 028% (24.8% + 8,0% + 5.48% + 6.0% + 15.0% - 59.0% = 0.28%.).

In the example, the calculation of income tax starts with a wage income where 8% is deducted in labour market contributions.

This leaves an income base called personal income.

To be able to assess the total taxable income, the interest payments are then deducted - the negative capital income. If, contrary to the example shown, the wage earner had had significant interest income instead of large interest payments and thereby a positive net capital income, this should be added on.

At the same time the wage earner’s payments to a trade union and an unemployment insurance fund are deducted. And finally the employment allowance is deducted. The employment allowance is calculated as 4 % of the base of the labour market contribution. It can not exceed DKK 12,300. The earned income allowance and employment allowance are the ones stated as assessment oriented deductions.

When the personal income has been calculated and the negative capital income and assessment oriented deductions have been taken off, you can see the size of the taxable income.

Tax payers pay state income tax, a national health contribution, tax to municipalities and tax to the church. Church tax is paid only members of the Lutheran Church (Folkekirken). That makes up about 85 % of all Danes.

Bottom-bracket tax to the state is composed of personal income supplemented by positive capital income.

Before compiling municipal tax, church tax, national health contribution and bottom bracket tax, one's personal allowance is deducted from income tax.

Middle-bracket and top-bracket tax to state are paid on personal income supplemented with positive capital income. There is no person allowance, rather a basic allowance of DKK 279,800 and DKK 335,800 respectively.

Interest allowances and assessment allowances have then no influence on how much one has to be in bottom-bracket tax, middle-bracket tax or top-bracket tax. They have as stated only value in compiling the national health contribution and municipal taxes.

Even though top-bracket tax is 15%, you will not end up paying the full 15% in all the municipalities. This is because a tax ceiling of 59% applies. The tax ceiling means that no one can pay more than DKK 0.59 of the last earned Crown, not including church tax and labour market contributions. As municipal tax in many municipalities is so high that the top taxpayers end up paying more than 59%, a reduction is given in top-bracket tax. In 2008, the total tax percentage is above the tax ceiling in 77 of the country’s 98 municipalities.

The tax calculation in the example shows that the wage earner must pay 36% of his income of DKK 375,000 in tax to the municipality, county, church and state as well as pay labour market contributions. The greatest part of the amount paid goes to the municipality.

2.6. Tax is paid when the money is there

Another general principle in income taxation is that tax is paid when the wage or pension is paid to the taxpayer.

Only a minority of taxpayers have to remember to set aside money for tax. Tax is deducted when the wage is paid out. This also reduces the risk faced by the public sector that tax is never paid.

Pay-as-you-earn taxation is also connected with the desire to make tax is as easy as possible for the individual to administer. Citizens should not have to waste time calculating their tax, going to the post office to pay their tax or having a long and drawn out correspondence with the tax authority.

For this reason, much has been done in recent years to make life easier for taxpayers. New technology has helped greatly in this task.

Today the tax authorities have most of the information they need to calculate tax for the vast majority of taxpayers. The employer provides information about payment of wages. The bank informs about interest income and payments. Pension funds send information about pension contributions to and payments from pension savings schemes. Unemployment insurance funds and trade unions also directly inform the tax authorities of payments to unemployment insurance funds, payments to early retirement pension schemes and trade union subscriptions.

The individual does not have to supply much information. Most people can just check that the information is correct. If this is not the case, many corrections and changes to the preliminary income registration and income tax return can be carried out over the telephone or on the internet.