A Comprehensive Guide to the US-Denmark Tax Treaty
Understanding the US-Denmark Tax Treaty is crucial for Americans living in Denmark and to Danish residents who are non-US citizens but have U.S. sourced income. This guide breaks down the treaty's provisions, offering clarity on how it affects personal taxation and helps avoid double taxation.
Introduction to the US-Denmark Tax Treaty
The US-Denmark tax treaty, signed in 1999, serves as an agreement between the two countries for determining the taxation of income where both nations may have the legal right to tax according to their respective laws. The treaty covers, among many topics, avoidance of double taxation, residency tie-breakers and taxation of various forms of income, including business profits, dividends, interest, pensions, and capital gains. This article will focus on some of the key aspects of the treaty that hold particular significance.
Relief of Double Taxation
The Denmark-US tax treaty provides mechanisms for relief from double taxation, ensuring that income earned in one country by residents or citizens of the other is not taxed twice. Specifically, the treaty allows U.S. citizens and residents to claim a foreign tax credit for the income tax they pay on Danish sourced income to Denmark against their U.S. tax liability. Conversely, Denmark offers a credit for U.S. taxes paid on U.S. sourced income against it's own tax liabilities.
Lars Jensen, a U.S. citizen living in Copenhagen, Denmark, earns an annual salary of $80,000. In Denmark, he pays $25,000 in taxes for the year. Lars's U.S. tax liability for this income amounts to $22,000. Thanks to the relief of double taxation provision of the tax treaty, he is entitled to claim a foreign tax credit on his US taxes. Lars applies the $25,000 he paid in Danish taxes against his U.S. tax obligation, effectively reducing his U.S. tax liability to zero and even generating a $3,000 credit surplus, which may be carried over to subsequent tax years.
The Savings Clause
The Danish-US tax treaty contains a "savings clause" which preserves the right of the U.S. to impose taxes on its citizens according to its own laws, even if this contradicts the provisions of the treaty. As a result of this clause, the majority of the benefits and reductions offered by the treaty do not apply to U.S. citizens living in Denmark.
Sofie Christensen, a U.S. citizen, resides in Aarhus, Denmark and works for an American bio-tech company. She performs all her work duties in Denmark and has no physical presence in the U.S. Although the Denmark-U.S. tax treaty exempts such income from U.S. taxation on the basis that there is no permanent establishment in the U.S., the savings clause overrides this, requiring Sofie to declare and possibly pay U.S. taxes on her income. Nevertheless, Sofie can take advantage of foreign earned income exclusion or foreign tax credits for the taxes paid in Denmark to avoid being taxed twice on the same income.
Expert Tip: It's crucial for U.S. citizens to familiarize themselves with the savings clause exclusions in the tax treaty to accurately determine which tax benefits they can utilize.
Tax Residency and the Tie-Breaker Rules
The United States and Denmark each have their own criteria for determining who is a resident for tax purposes. It's possible for someone to meet the residency requirements of both countries simultaneously. To prevent the problems that dual tax residency could cause, the U.S.-Denmark tax treaty provides a series of tie-breaker rules. These rules help to decide which country has the primary right to tax the individual's income.
Permanent Home Test: The first consideration is whether the individual has a permanent home available to them in one of the countries. If a permanent home is available in only one country, that country is generally considered the individual's country of residence for tax purposes.
Centre of vital interests Test: If the individual has a permanent home in both countries or in neither country, the treaty looks at where the individuals center of vital interests lies, in other words, where they have a closer personal and economic interests.
Habitual Abode Test: If the individual has a center of vital interests in both countries or in neither country, the treaty looks at where the individual has a habitual abode; in other words, where they live regularly. This could be where they spend more time or where they have a regular presence.
Nationality Test: If the individual has a habitual abode in both countries or in neither, the next factor considered is nationality. If the person is a citizen of only one of the countries, that country is typically considered their country of residence for tax purposes.
Mutual Agreement Procedure: In the rare case that the individual is a citizen of both countries or of neither, and the above tests do not resolve the issue of residency, the competent authorities of the United States and Denmark will determine the individual's residency through a mutual agreement, taking into account the person's facts and circumstances.
Taxation of US-Sourced Passive Income
Passive income from U.S. sources, which is not tied to a U.S. trade or business, is generally taxed at a flat rate of 30% if earned by a non-resident alien. However, the US-Denmark tax treaty lowers this rate and in some cases totally exempts it from US taxation for certain types of income. We've summarized some of the tax treaty rates in the table below. It's important to note that that these rates generally do not apply to U.S. citizens due to the savings clause mentioned earlier.
Treat Article Citation
Dividends - Paid by U.S. Corporations
10(2) / PII
Dividends - Qualifying for Direct Dividend Rate
Pensions and Alimony
*The rate applies to both periodic and lump-sum payments.
**Tax rate applies to 85% of the social security payments.
Income Earned While Temporarily Present in the US
Generally, income earned from work performed in the US would be considered US source income and would be subject to US taxation. However, the US Denmark tax treaty lists certain exemptions where such income is not subject to US taxes. It's important to note that these exceptions generally do not apply to U.S. citizens because of the savings clause mentioned earlier. We've summarized some of these exceptions in the table below:
Maximum Presence in U.S
Required Employer or Payer
Maximum Amount of Compensation
Treaty Article Citation
Any foreign resident*
Any U.S. or foreign resident
Full-time students - remittances or allowances
Any foreign resident
*The exemption does not apply if the employee's compensation is borne by a permanent establishment that the employer has in the United States.
**Does not apply to fees paid to a director of a U.S. corporation.
***Exemption does not apply to the extent income is attributable to the recipient's fixed U.S. base.
The United States and Denmark have a totalization agreement in place, aimed at preventing the double taxation of income in relation to social security taxes. This agreement sets forth guidelines regarding which country's social security system a taxpayer is subject to. Consequently, employees or self-employed individuals are subject to social security taxation in only one country at a time.
State Taxes and Tax Treaties
Numerous states within the United States impose income taxes on their residents. The adherence to the Denmark-U.S. tax treaty provisions varies by state, some may recognize them, while others may not.
Expert Insight: Always check with a tax professional about how state tax laws interact with the treaty, as this can vary significantly from state to state.
Need Help Navigating the US Denmark Tax Treaty?
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