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The legislator's costly mistake


Withholding taxes levied on interest income are effectively paid by the debtor, not the creditor, who is generating the income. This tax will reduce the options for financing for Icelandic companies in the future.

On the 1st of December 2009, a new tax was introduced in the Icelandic Income Tax Act. A so-called withholding tax, that is levied on interest payments, that persons and entities domiciled in Iceland pay to non-domiciled persons and entities. The reasoning for the new tax was to hinder tax avoidance, by means of non-taxable tax payments, according to the bill, put for the legislator.

During the legislation procedure, numerous parties sent the legislative committee responsible various comments regarding the newly introduced bill. Among those comments where warnings regarding the new tax on interests payments.
The warnings emphasized that due to so called gross-up clauses in most all loan agreements, the recipient of the tax income would not be subject to the tax, but the entity or person domiciled in Iceland, that pays the interests.

Additionally the new tax would only limit the possibilities of business operators of seeking foreign capital, as it limit the possibilities only to states which had concluded favorable double tax treaties with Iceland.

And lastly but not least, the new tax was said to be likely to hinder  operations of various multi-national business, established in Iceland.

In a new bill for state finance, the tax introduced in 2009 is discussed, and the legislative committee stated that the withholding tax on interests has reduced the market options for financing. Secondly it is stated that, due to the gross-up clauses, Icelandic entities have been stuck with paying the tax on the interest income generated by the non-domiciled entities. Therefore, it was concluded that the tax should be abolished.

As evident, the negative experience from the taxation echoed the warnings that had been flagged.
When the legislator is in the process of making drastic changed on the Income Tax Act, it can be sensible to initiate a cooperation with tax specialists. If their had been heeded before introducing the new tax, expensive mistakes could have been avoided.