Not all cash remuneration can be taxed according to the special 26 pct. tax scheme

26 September 2014

Careful consideration should be applied when drawing up employment contracts for foreign highly skilled labour as not all cash remuneration can be taxed according to the special 26 pct. tax scheme.

The special 26 pct. tax scheme allow inbound expatriates to be taxed on salary from employment with a Danish company at a flat rate of 31.92 pct. (8 pct. gross tax and 26 pct. tax on the remaining amount) for a period of up to 5 years.

Taxation according to this scheme is favourable compared to ordinary Danish taxation where the marginal tax rate is approx. 56 pct.

As described in issue no. 4 of tax:watch 2014, the minimum salary requirement for using the special 26 pct. tax scheme for inbound expatriates are expected to be reduced in order to increase the possibility for Danish companies to hire skilled labour.

Hence, it can be expected that more companies - currently unfamiliar with the special 26 pct. tax scheme - will seek to hire employees that can be taxed according to the scheme in the future.

One of the issues to be aware of in this regard is that not all kinds of remuneration can be taxed according to the special 26 pct. tax scheme – not even all cash remuneration. This is important to consider when drawing up employment contracts.

The issue is demonstrated clearly in a new ruling by the High Court (SKM2014.652.VLR).

In the case subject to the ruling, the employment was ending for an individual taxed according to the special 26 pct. tax scheme. In this connection, the employee received a cash bonus according to the contract as compensation for relinquishing the share options awarded to him during the employment. Alternatively, the employee could have chosen to keep the share options instead of converting them to a cash bonus.

Cash salary including bonuses can usually be taxed according to the special 26 pct. tax scheme. However, in this case, the bonus was calculated based on the share options awarded to the employee during the employment - the share options that the employee relinquished in order to receive the bonus.

The High Court reached the conclusion that the bonus was to be deemed remuneration for relinquishing the share options. Such remuneration cannot be taxed according to the special 26 pct. tax scheme. Consequently, the ruling of the High Court led to the result that the bonus was to be taxed according to the ordinary Danish tax rules.

Examples of other kinds of remuneration that cannot be taxed according to the special 26 pct. tax scheme are tax deductible contributions to Danish pension schemes and the taxable value of free housing.

On the other hand, taxable contributions to so called “§ 53 A-pension schemes” where pension payments from the schemes are generally tax free in Denmark can be taxed according to the special 26 pct. tax scheme. Similarly, a housing allowance paid in cash to the employee instead of providing the employee with free housing can be taxed according to the scheme.

Due to the progressive nature and personal allowance of the ordinary Danish tax scheme, it may not always be beneficiary for all kinds of income to be taxed according to the special 26 pct. tax scheme.

If your company considers hiring employees to be taxed according to the special 26 pct. tax scheme, BDO can advise you with regard to taxation of the different elements of the salary package for such employees.