Running payroll in Iceland

Nestled in the middle of the North Atlantic Ocean, Iceland is very isolated from the rest of Europe. With manufacturing, tourism and fishing as the most important industries, the economy heavily relies on exports. Despite its remote location, the Nordic country offers great incentives for foreign businesses with regard to R&D and several key industries. 

High levels of education and the English proficiency of its population are further aspects to consider when establishing a business in Iceland. However, setting up and processing payroll in the Land of Fire and Ice is far from being easy. The tax system can be difficult to navigate for foreign organizations, and payroll-related information is often only available in Icelandic.

Unless they decide to outsource their local payroll, international businesses need to set up a local legal entity to process payroll in Iceland. There are several corporate structures to choose from, with the LLC being the most commonly chosen one. The registration processes differ depending on the chosen corporate structure, but registering as an employer with the Directorate of Internal Revenue (RSK) is mandatory in all cases. Payroll-specific set-up and registration processes include making pension fund arrangements, registering with trade unions and opening a local bank account, which is needed for conducting business in Iceland.

With income tax on employment being levied on both national and municipal level, the tax burden on individuals can reach up to 46%. Employers bear full responsibility for calculating and withholding income tax on behalf of their employees, as well as for paying national insurance contributions. The pension system consists of a mandatory public pension scheme and a voluntary private pension scheme. 

Tax considerations

Income is taxed progressively based on three different tax brackets. The basic tax rate is 17% and applies to all income that does not exceed ISK 4,445,783 per year. The next ISK 8,035,492 are taxed at a rate of 23.5%. The top rate is 31.8% and is levied on income exceeding ISK 12,481,275. In addition to this state income tax, individual income is subject to a municipal tax, which is imposed at a rate of 14.45% – the final assessment is made by each municipality individually. The total income tax levied on employment income can therefore be as high as 46.25%, taking into account both state and municipal tax. 

Iceland’s tax system distinguishes between several kinds of income, which are investment income, business income and employment income. Employment income includes salaries and wages as well as bonuses and other benefits provided by the employer. An employee’s taxable income is the salary minus the paid pension insurance premium. However, if the employer’s contributions towards an employee’s pension insurance are higher than 12.5% of the usual calculation base and also higher than ISK 2,000,000 (per year), the excess is considered taxable income. 

There is a personal tax credit of ISK 53,916 per month (ISK 646,993 per year; valid for 2022), which is offset against an individual’s income tax liability – includes both state and municipal income tax. Contributions of up to 8% of the employee’s income towards a pension scheme (including mandatory and private pension fund contributions) are exempt from tax. Further deductions may be available depending on the employee’s personal circumstances. 

Employees are considered tax residents if they spend more than 183 days in Iceland in any given 12-month period. Residents pay taxes on their worldwide income, while nonresidents only have to pay tax on the part of their income that is sourced in Iceland. There is a special tax regime for foreign experts under which qualifying individuals are only taxed on 75% of their income during the first three years of their presence in Iceland. 

Tax withholding and reporting 

Iceland operates a PAYE system (Pay-As-You-Earn) for income tax, which means that income tax is paid on a monthly basis through the employer who calculates, withholds and remits the respective tax amounts on behalf of the employee. The tax collecting authority is the Directorate of Internal Revenue (RSK). 

The final deadline for paying withheld income taxes is the 15th of each month, i.e. 14 days after wages and salaries were paid. There are several forms which need to be submitted along with the tax payment. 

Employees must file an individual tax return. The due date for the tax return varies from year to year, but usually falls into the period between February and March. Joint filing is permitted. The tax year is the calendar year.

Social security contributions

There are two social security levies on employment income, namely a general social security contribution and a separate pension fund contribution. The general social security contribution (known as national insurance contribution) is paid by the employer only and amounts to 6.35% of the employee’s earnings. Furthermore, employers are obligated to make a 0.1% contribution to the Icelandic Rehabilitation Fund (VIRK).

Pension contributions are mandatory for both employee and employer. The mandatory minimum contribution for employers is 11.5%. Employees have to contribute at a rate of at least 4% of their monthly earnings, which leads to a total pension fund contribution of 15.5% per employee (minimum). In addition, employers and employees can contribute to a private pension fund at rates of 2% and 4% respectively – employers are obligated to make the additional 2% contribution if the employee decides to pay into a private pension scheme.

The responsibility of calculating, deducting and paying social security and pension fund contributions is on the employer. National insurance contributions must be paid on a monthly basis. The due date is usually the 14th of the month following the pay period for which the contributions are calculated. 

Employees in Iceland are entitled to various benefits. These include:

• Annual leave and public holidays: minimum 24 days of paid annual leave (increasing with length of service); holiday pay is minimum 10.17% of total wages; many CBAs provide for 25 - 30 days of paid annual leave; 16 public holidays

• Maternity/paternity/parental leave: each parent has an individual right to 3 months of paid maternity/paternity leave; plus another 3 months of leave which can be split between both parents; plus 4 months of unpaid parental leave (to be taken before the child turns 8)

• Sick leave: 2 days of sick leave per month during the first year of employment; thereafter, sick leave increases to 2 months per year (4 months after 5 years of service and 6 months after 10 years of service)

For more information on employee benefits and other employment requirements in Iceland (including severance pay and termination procedures), check out our Global Hiring Guide.

There is no national minimum wage in Iceland. Instead, minimum remuneration is determined for each sector by collective bargaining. Work performed beyond the employee’s regular working hours counts as overtime and must be paid at an hourly rate equal to 1.0385% of an employee’s monthly wages. Employees who are required to work on a public holiday are entitled to a wage supplement equal to 1.375% of their monthly wages on top of their usual earnings. 

After having completed at least 12 months of service with their employer, employees are entitled to two annual bonus payments, an annual holiday bonus and a Christmas bonus. The holiday bonus equals 10.17% of the employee’s annual income and is paid out between 1 May and 15 August of each year. The Christmas bonus is due on 1 December.

Employees in Iceland are typically paid on a monthly basis, with salaries and wages being paid by the 1st of the following month. For instance, wages and salaries earned in March are paid on 1 April. In some sectors, however, it is common practice to pay employees on a weekly or bi-weekly basis. 

Most companies pay their staff via bank transfer, but the law also allows payment by cheque or in cash. Payments to employees must be accompanied by a payslip, which can be issued either in paper or electronically. Payslips should show pay elements and deductions under an itemized format. The following information is mandatory: 

• Name and address of employee and employer

• Pay period

• Itemized gross wages (basic remuneration, overtime etc.)

• Total number of hours worked

• Itemized deductions (taxes, pension contributions etc.)

• Holiday pay

• Additional bonuses and benefits

• Total net pay