Foreign companies can choose whether to pay income tax in Iceland, states tax expert and adjunct lecturer at the University of Iceland Ásmundur G. Vilhjálmsson, who was the guest of RÚV’s Kastljós news analysis program Wednesday night.
The term ‘thin capitalization,’ practiced by some foreign firms in Iceland, means, according to RÚV, that a company uses a loan from a parent company to finance its operations, enabling it to deduct interest payments on that loan from local profits, and, thereby, not having to pay income taxes.
The loans can be much higher than the value of total assets in Iceland, making the interest payments sufficiently high to wipe out profits. Instead of financing the operations with equity, the operations are fully-financed with loans.
Ásmundur is one of the country’s experts on tax issues and has written books on the subject. He stated, “I think the main goal is to avoid and escape taxes.” He was asked whether companies can choose not to pay taxes. He responded, “Yes, in a way, that’s so. It’s their choice. If they have unlimited leeway to lend to their subsidiary here in Iceland, and wipe out the profit in the form of interest, then that essentially means they can control their taxes almost entirely by themselves.”
Alcoa, which operates an aluminum smelter in Reyðarfjörður, the East Fjords, has increased its debts from last year. The debts now amount to ISK 50 billion (USD 435 million, EUR 391 million) beyond assets. The company’s more than ISK 200 billion (USD 1.74 billion, EUR 1.56 billion) debt is owed to Alcoa’s sister company in Luxemburg.
The company has never paid income tax in Iceland, having paid ISK 60 billion (USD 522 million, EUR 469 million) in interest on its debt in the past eight years. Those interest payments have been deducted from all profits in Iceland, allowing the company to report losses year after year. Moreover, its accumulated losses amount to ISK 50 billion, which can be deducted from its profits in the coming decade.
Even though the operations of Alcoa in Iceland have been used as a reason to pass laws in Iceland regarding thin capitalization, such laws would not affect the company. The agreement Alcoa signed with Icelandic authorities exempts it from all conditions set by authorities regarding the deduction of loan interest payments from profits, RÚV reports.
The German hardware chain Bauhaus operates one of Iceland’s largest hardware stores on the outskirts of Reykjavík. The company’s operations are twofold: one part is comprised of the running of the store, but the building housing the store belongs to another company. Both companies owe their parent and sister companies in Switzerland and Denmark large amounts of money, even well beyond their assets in Iceland. Those debts and cost paid to those companies have the effect that the operation is run at a great loss.
The store operation part of the company earned ISK 2 billion (USD 17.4 million, EUR 15.6 million) in 2014, according to the latest available annual report. When all costs have been deducted, including ISK 610 million in other operations cost and ISK 180 million in interest payments, the net result is over ISK 600 million in losses. At the end of last year, the company’s assets were almost ISK 2 billion, but debts close to ISK 4 billion. All the company’s operation in Iceland appears to be financed with loans from associate companies.
Alcoa and Bauhaus are not the only companies in Iceland financed, for the most part, this way, and as far as RÚV knows, such financing is not criticized by authorities. This does, however, make competition tough for companies which don’t have this option.
Ásmundur commented, “This is all about ethics and the rules of the game in the market. That people follow some rules that one can call normal and fair and which are generally accepted among civilized nations.”