Foreign source income and relief for double taxation

29 April 2016

A recent verdict by the High Court may result in an increased total tax burden for some taxpayers earning foreign source income.

The case before the High Court concerned the attribution of expenses to Danish and foreign source income respectively, thus influencing the maximum amount of foreign taxes to be offset against Danish taxes.

Background

When a Danish resident taxpayer earns income from foreign sources, this income may be taxable in the country of source as well as in the country of residence, Denmark.

In order to avoid double taxation, often, the Danish taxes on the foreign source income shall be reduced by an amount equal to the foreign taxes paid. However, the Danish taxes cannot be reduced by more than the Danish taxes attributable to the foreign source income.

Hence, if the calculated Danish taxes on the foreign source income are lower than the foreign paid taxes on said income, the foreign taxes cannot be fully offset against the calculated Danish taxes.

The law stipulates that deductible expenses directly referable to the foreign source income shall be deducted in the foreign source income as opposed to income from Danish sources. This entails a reduction of the Danish taxes attributable to the foreign source income.

Deductible expenses not directly referable to either Danish or foreign source income shall be divided between the Danish and foreign source income based on the ratio between the Danish and foreign source gross income.

Consequently, the Danish taxes attributable to the foreign source income may be the limiting factor for reduction of Danish taxes in order to avoid double taxation.

In other words, the foreign taxes may exceed the Danish taxes attributable to the foreign source income thereby preventing complete offset of foreign taxes.

Naturally, taxpayers would prefer to fully offset the foreign taxes. Hence, it will be preferable to be able to refer deductible expenses to Danish source income to the largest extent possible in order to attribute a larger part of the total Danish taxes to the foreign source income thereby raising the threshold for offsetting foreign taxes.

However, according to a recent case, the High Court ruled in favour of the Danish tax authorities in this respect.

Consequently, certain deductible expenses of a Danish company were divided between the Danish and foreign source income instead of being referred entirely to the Danish source income.

According to the High Court, an individual assessment must be made in reference to each deductible expense in order to determine whether the expense should be attributable entirely to either foreign or Danish source income. In lack hereof, the expense must be divided between the foreign and Danish source income as described above.

Offhand, the verdict seems rather harsh, as the company appeared to have solid arguments that the expenses in question could be referred to the Danish source income instead of being divided proportionately between the Danish and foreign source income.

If the Danish company does not appeal the verdict to the Supreme Court, or if the Supreme Court upholds the verdict of the High Court, taxpayers may experience increased difficulties in referring expenses solely to Danish source income and additional effort may be required to provide solid arguments that expenses can indeed be attributed the way the taxpayer wants.

The above article is taken from tax:watch, our electronic English newsletter on Danish Tax and VAT matters. tax:watch is issued on the last Friday of each month and is free of charge.