Professional content

New tax levied on financial institutes

25.1.2012 Andri Gunnarsson og Páll Jóhannesson

The rationale for the enactment of Act on Activities Tax levied on financial institutions in Iceland was that the country's financial institutions are exempted from VAT and that they have received great financial aid from the government following the bank crises. It is argued that the financial institutions were in an enviable position, but on the contrary, financial institutions end up bearing a heavier tax burden than VAT obligated industries, which has a significant negative impact

On 17 December 2011, the Parliament passed Act no. 165/2011, on new tax on financial institutions. In short, Financial Activity Tax is a 5.45% tax that now is levied on all financial institutions, which are exempted from VAT under Act no. 50/1988, on VAT. Additionally, a special tax of 6% is levied on income that exceeds ISK 1 billion. The former type of tax is based on payroll and the latter on income.

The notes accompanying the draft that enacted Act on Financial Activity Tax give rise to various observations and the authors do not agree with the act's rationale. On the contrary, the financial position of financial institution to be exempted from VAT is not particularly enviable and does in fact not leave financial institution in a better fiscal position than other companies. If such companies were obligated to pay VAT they would certainly be obliged to charge VAT on their customers, as their competitors, but they would however not have to bear the cost of VAT of purchased goods and services. Companies that are exempted from VAT namely must pay VAT of all purchased goods and services instead of being able to levy that cost directly on their consumers. Taxation on financial institutions is therefore not lower due to exemption from VAT but just much higher. Financial institutions are the largest payers of VAT in Iceland due to the exemption from VAT in light of that they pay VAT of all purchased goods and services without refund. Therefore, the above mentioned act's rationale that exemption from VAT makes this sector more tax-advantageous is outright wrong. 

Accordingly, the rationales for this new taxation seems to be set forth in order to respond to the low taxation of certain companies. But in fact, it implicates increased tax deviation compared to companies in other business sectors. This is done by tax expenditures without regard to whether financial institutions are in with profit or not. Thus, the deviation created by the exemption from VAT results in additional expenses for financial institutions. The Financial Activity Tax includes both financial institutions as well as companies in comparable activities, which are exempted from VAT, from small securities companies and insurance brokers to large commercial banks. Sales and options of these companies to make profit is very different as you can imagine. The justification of the new Financial Activity Tax with reference to previous financial aid of financial institutions by the government can in no way apply to all financial institutions that are exempt from VAT. In addition, this rationale has already been used as argumentation for the enactment of another new tax called Special Tax on Financial Institution under Act no. 155/2010. 

The Financial Activity Tax is now added on top of the massive rise that has been on payroll tax in relation with wage payments. In last three years, payroll tax has increased significantly and thus increased employee costs for companies, which obviously has resulted in reduced initiative for hiring and scope for wage increases. Sadly, recent development of the tax system inevitably reduces competition, as it is hardly inspiring to start business with such predictable additional tax burden.