Iceland (famously called the Land of Fire and Ice) is a premier destination for businesses seeking a stable and tax-friendly environment.

Beyond its iconic glaciers, geothermal energy potential, and cinematic landscapes, this country offers a low corporate income tax rate of just 20% (one of the lowest in the world), open-market policies, and a tech-savvy, educated workforce.  

However, if you’re considering expanding your workforce into Iceland or launching a local entity in the country, you need to understand how payroll and income tax work to stay compliant, budget effectively, and attract top talent. 

In this guide, we break down everything you need to know about payroll and income tax in Iceland, including social security, municipal levies, and employer obligations. Let’s get started!

What is the Payroll Tax in Iceland?

Payroll tax in Iceland is a percentage that employers withhold from their employees’ salaries and pay to the Government. This fund is used to support social programs, including unemployment benefits, medical insurance, and the unemployment insurance fund.

Definition and purpose of Payroll Tax in Iceland

Payroll tax in Iceland is referred to as the “Social Security Rate.” Unlike other European countries, this tax is fully borne by the employer, not the employee. Instead, employees (and employers) pay a mandatory Occupational Pension contribution. We’ll share more on this later.  

In addition to payroll tax, employees and employers are mandated to pay income tax in Iceland. For context, income tax is the tax levied on a company’s profits and employees’ salaries to fund public services, such as healthcare, unemployment benefits, and pensions, in the country. 

Iceland operates a progressive income tax system, which means that the higher the income, the higher the tax rate, and vice versa. Also, the income tax is divided into two types:

  • State income tax 
  • Municipal income tax

As an employer, you’re responsible for deducting income tax from your employees’ salaries each month and remitting it directly to the Icelandic Tax Administration.

Employer and Employee Responsibilities

According to Icelandic law, all employers are required to pay a social security contribution (Tryggingagjald) based on their total payroll costs and pay it in cash to the Treasury. This fund is used to finance social programs such as:

  •  Old age pensions 
  • Disability benefits 
  • Unemployment insurance 
  • Parental leave compensation 
  • Occupational rehabilitation services

The social security contribution in Iceland is 6.35% of the employee’s wages or salaries. This fund is paid by the employer and not deducted from employees’ salaries. 

Here’s a breakdown of the social security contributions:

Tax TypeRate
General Social Security Tax4.90%
Employment Social Security Tax1.35%
Wage Guarantee Fund0.05%
Market Contribution0.05%
Total6.35%

Pension Fund

In addition to this social contribution, employers and employees (aged 16-70) are required to pay into a pension fund, which amounts to a total of 15.5%. These payments are mandatory, but not classified as taxes (non-tax compulsory payments).

Employees contribute 4% of their wages, while employers shoulder the remaining 11.5%. Your employees can also choose to contribute an additional 4% of their wages voluntarily, and if they do, you’ll have to match it with an extra 2%.

These contributions are tax-deductible, meaning that they’re subtracted from income tax. Expatriates with foreign A1 certificates are not liable to pay social security contributions for pension funds in Iceland.

This means that if you intend to bring in foreign talent to work in Iceland, the social security contributions and pension funds will be under the jurisdiction of and remitted to their home countries.

Employer Payroll Tax Rates in Iceland

As we mentioned earlier, employers in Iceland are solely responsible for paying payroll tax, also known as social security contribution. This tax is calculated based on the total wages paid to employees. The Directorate of Internal Revenue (RSK) oversees the social security contributions and ensures that employers comply with the payment obligations.

These proceeds are invested in public-related funds such as:

  • Healthcare and disability support services
  • Market development initiatives, etc.
  • Unemployment benefits 
  • Parental leave compensation

As we mentioned above, the total employer payroll tax rate is 6.35%. For example, say your total payroll cost for a month is ISK 2,000,000. This means the payroll tax due would be:

Total Monthly Payroll (ISK)Employer Payroll Tax RatePayroll Tax Due (ISK)
2,000,0006.35%127,000

Overview of Income Tax in Iceland

Anyone earning income in Iceland (whether a resident or a non-resident) is subject to the Icelandic Income Act. This law applies to both employees and businesses. However, the amount payable depends on the residency status of the company and the individual:

Resident Individuals

Resident individuals are taxed based on their worldwide income, including wages/salary, business activities, capital gains, etc. For context, a person is considered to be a “tax resident” in Iceland if they have stayed in the country for 183 days or more within 12 months.

Non-resident Individuals

Non-resident individuals are those who are in Iceland for a temporary stay, i.e., less than 183 days in any 12 months. As a result, they’re taxed only on their income earned from Icelandic sources, such as employment or business conducted within Iceland. Now let’s explore the types of income in Iceland:

Personal Income Tax (PIT)

Personal income tax is the tax levied on an individual’s personal income, including wages, salaries, dividends, and rental fees. In Iceland, this tax is deducted by the employer and remitted to the Icelandic Tax Administration (Ríkisskattstjóri). 

The personal income tax in Iceland is progressive, which means the higher your employee’s earnings, the higher the tax rate. Here’s a breakdown of the payment:

EXAMPLE 

If an employee earns ISK 500,000 per month, the income tax will be: 

Income Bracket (ISK)Tax RateTax Amount (ISK)
First 498,12231.49%156,859.62
Remaining 1,87837.99%713.45
Total Income Tax 157,573.07 ISK
This tax rate applies to residents and non-residents. However, non-residents are taxed only on their Icelandic-sourced income.

Therefore, the employee would pay ISK 156,859.62 in personal income tax for the month. The employer would withhold this amount from the employee’s salary and remit it to the Tax Administration.

Municipal Tax

In Iceland, municipal taxes are levied by local municipalities in addition to the national income tax. Employers are required to deduct this tax and income tax from their employees’ salaries. This fund is used to finance public services provided by municipalities, such as schools, roads, and local welfare. 

The municipal tax is 14.94%, but it can vary between 12.44% and 14.94%, depending on the municipality.

Corporate Income Tax

Corporate income tax (CIT) is the tax levied on your company’s net profit, that is, the money left after deducting salaries, business expenses, and all other deductions used to provide, insure, and maintain income.

In Iceland, this tax is collected and disbursed by the state and applies to:

  •  All resident Icelandic companies (taxed on worldwide income) 
  • Non-resident corporations (taxed on Icelandic-source income)

The CIT in Iceland is a flat rate, compared to the PIT, which is progressive. All limited liability companies (LLCs) and limited partnership companies are mandated to pay 20% CIT. All other organizations outside this window, for instance, general partnerships, will pay 337.6%. This rate also applies to non-resident organizations. 

For example, say you have a limited liability company in Iceland that earns ISK 10,000,000 in net profit for the year. After deducting all allowable business expenses, you’ll pay 20% CIT, which is ISK 2,000,000.

Tax Free Allowances and Deductions

Iceland offers several tax deductions to reduce the tax burden on the payers, including businesses. Some of these tax deductions are:

  • Pension funds:  Both the mandatory and voluntary pension fund contributions are deductible from the employee’s taxable income. 
  • Business-related expenses: Car usage, per diem payments for work-related travel, and other work-related expenses are also deductible from an employee’s income.

For instance, employees who use their personal vehicles for work can claim deductions based on mileage. The deductible amount ranges from ISK 83 to ISK 141 per kilometer, but this varies annually.

  • Tax credits: Individuals aged 16 and above are entitled to a personal tax credit of ISK 824,288 per year. Unused personal tax credits can be transferred between partners within the same calendar year. 
  • Dependent support deductions: Employees with dependents aged 16 – 21 who are students or have low income can also apply for a tax reduction. However, this is only permissible if the dependent isn’t enrolled in a study program eligible for student loans.

Tax Treaties and Withholding Taxes in Iceland

Tax treaties and withholding taxes help to prevent double taxation and facilitate cross-border trade. Let’s cover how both systems operate in Iceland:

Withholding Tax on Foreign Income

Withholding tax is tax deducted at the source, and paid to the Government before it’s paid to the recipient. When you pay income from Iceland to a non-resident, specific withholding tax rates apply. 

However, this can be reduced if a tax treaty exists between the recipient’s resident country and the country of the recipient’s residence. 

Here’s a breakdown of the withholding taxes in Iceland:

Payment TypeResident CompanyNon-resident Company
Dividends20% WHT20% WHT
Interest20% WHT12% WHT
Royalties20% WHT20% WHT

Keep in mind that the higher rate applies to royalties for the use of trademarks, patents, designs, formulas, or processes.

Double Taxation Agreement

The Icelandic government has established double taxation agreements (DTAs) with several countries, including:

  • Austria 
  • Australia 
  • Cypris 
  • Estonia 
  • Denmark 
  • United states 
  • United kingdom 
  • Vietnam 
  • Slovakia

This partnership aims to avoid double taxation in Iceland and the taxpayer’s country of residence.

Iceland Payroll Tax Calculator

You can use the RemotePeople Global Payroll Calculator to estimate your payroll expenses for resident and nonresident employees in Iceland.

How the Calculator Works

To use the RemotePeople Global Payroll Calculator, follow these steps:

Step 1: Choose the country and employment type, i.e., either local or expat:

Remote People Payroll Calculator, Step 1

Step 2: Input the employee’s gross salary in the local currency (€) and the calculation period. The calculation period can be monthly or annually:

Remote People Payroll Calculator, Step 2

Step 3:  Click calculate, and the tool automatically gives you a detailed breakdown of your net salary, tax deductions, and employee costs in real time!

Remote People Payroll Calculator, Step 3

Simplify Payroll and Tax Compliance in Iceland

Although Iceland has a progressive tax structure with various deductions, allowances, and municipal levies, its tax system remains relatively straightforward and transparent. This helps both employers and employees stay compliant and avoid costly penalties.

To streamline payroll operations and ensure full compliance as your team grows, consider using Icelandic Payroll Outsourcing Services or an Employer of Record (EOR) provider.

These partners can help manage tax calculations, salary disbursements, pension contributions, and filings to ensure all your tax filings are in line with Icelandic tax regulations.