How to Optimize Your Investments for SKAT

The basics of investment taxation in Denmark

Investing can be complicated. Even more so when moving to a new country. Investors need to look for the best brokers in the region, learn about local financial products and be aware of all trading fees. Creating the ideal portfolio can be tricky and will depend a lot on personal preferences such as age, risk profile, wealth, disposable income, etc. However, in some countries, on top of all that complexity there is another element: taxes.

While some European countries, such as Estonia have a straightforward tax model, applying a flat 20% tax for income and capital gains, Denmark is probably on the other end of that spectrum.

Understanding income tax alone in Denmark can be challenging for a beginner. Taxes are progressive (i.e., depend on income level), there are different contributions (e.g., labour market, church), deductions, allowances, and municipal taxes. Hopefully, for those on a permanent job position, the company will provide all details to SKAT (The Danish the Tax Administration) and your task will be mainly to verify and confirm the annual amounts.

For investments the taxation system in Dernmark is even more complicated. In this case investors need to take a more active role, since their investment decisions and selection of financial products (funds, ETFs, stocks, etc.) will directly impact their annual taxes.

Note: When investing with Nordnet, Saxo or another major Danish bank (Danske Bank, Nordea, Nykredit, etc.), your transactions will be automatically reported to SKAT, avoiding the need to keep track of all our operations.

In this article we will look at the main financial products available in Denmark, respective tax regimes, and analyse optimal scenarios enabling you to take strategic decisions to optimize/minimize the taxes on your investments.

Disclaimer: This is not financial advice. All calculations presented are examples and theoretical scenarios based on assumptions made by the author. The results provided might not match exactly real case scenarios. This analysis was made with the intent to be used as a guideline for new investors and expats in Denmark.

Translating Danish investment terms & definitions

First things first. Most of the content about investing and taxation in Denmark is written in Danish, making is even more challenging for investors new to the country that don’t speak the language.

Below we present a summary of the main investment and taxation terms used in Danish and their equivalent in English:

Investment type:

· Aktiebaseret (Stock-based): stock or equity-based investments refer to investments in stocks, equity-based ETFs, funds, or indexes.

· Obligationbaseret (Bond-based): refer to investments in financial products derived from bonds.

Dividend distribution:

· Udbyttebetalende (Dividend-paying): financial products that pay-out dividends directly to the investors account.

· Akkumulerende (Accumulating): financial products that do not pay-out dividends to investors but reinvest the dividends into the same product.

Types of taxes:

· Aktieindkomst (Stock income): refers to taxes on stock gains. The tax amount can vary from 15.3% to 42%, depending on the type of investment and yearly profit. For a regular account, taxes are 27% up to 56,500 DKK gains (2021) and 42% for gains above that.

· Kapitalindkomst (Capital income): refers to taxes on capital gains, and for SKAT are seen as general income and added to the total annual income. Those investments are taxed progressively and depend on income level. Capital income tax can vary from 37% to 42%.

Frequency of taxes:

· Realisationsprincippet (Realization principle): refers to taxes applied to gains when selling the asset, when profit or loss is realized, thus called the realization principle.

· Lagerprincippet (Stock principle): refers to taxes applied to the gains at the end of every calendar year, independent if the investment was sold or not.

Other relevant terms:

· Positivliste (Positiv list): refers to the list of ETFs in the SKAT positive list (https://skat.dk/skat.aspx?oid=2244641). Those ETF issuers have informed SKAT that specific ETFs are stock based.

· Aktiesparkonto or ASK (Stock savings account): introduced in 2019, the ASK is a designated savings account for stock-based investments to attract new investors. Only one account can be created by investor, and it has a deposit ceiling of 102,300 DKK (2021). As a benefit is offers a lower taxation of 17% on annual gains. It follows the stock principle for taxes.

There you go! Just to start thinking about investing in Denmark you need to learn all those definitions, their potential combinations, and implications on your investments.

Let’s see how those terms can be combined.

What are the applicable taxes per type of investment?

The best way to visualise how each tax regimen is applied to each investment type is using the diagram bellow:

Simple, right?

If you don’t care about bonds (low to negative interests) and would like to minimize taxes, then you should avoid bonds-based investments (obligationsbaseret) or investments that are taxed as capital income (kapitalindkomst).

By focusing on equity-based investments that are taxed as stock income, you are left with three main investment options:

1. Stocks: the simplest investments to be taxed. Dividends are paid out on account (not accumulating), and being 100% stock-based those investments will be taxed at 27%/42% on realized gains (on sale).

2. Equity ETF in the positive list with accumulating dividends: the most interesting and popular ETFs accumulate and reinvest dividends, benefiting from the interest compounding effect. Moreover, investors should prioritize ETFs in the positive list to avoid capital income tax. Those investments will be taxed at 27%/42% at unrealized gains, every year.

3. Danish-based index funds with distributing dividends: most equity funds available in Denmark are issued by Danish companies (Sparindex/Sparinvest) and have distributing dividends. Those investments will be taxed at 27%/42% on realized gains (on sale).

Realization principle vs. Stock principle vs. ASK

Now that we know the main terms and definitions and most tax-efficient investment products, let us look at how to prioritize investments based on their taxation regimen. Or simply put: How do I pay fewer taxes?

In the graph below we compare the performance of three investments for 20 years, each starting at 100,000 DKK in Year 0:

· Index fund, with net returns after realization tax

· ETF, with net returns after yearly-tax (stock principle)

· Generic fund in ASK (stock savings account), with net returns after realisation tax

Assumptions:

· All investments have a constant yearly return of 8.0%

· ETFs have a total expense ratio (TER) of 0.15%, while index funds have a TER of 0.55% (based on average ÅOP for Nordnet funds)

· Trading fees are assumed as zero

The investment fund in ASK (stock savings account) is the clear winner. Not only because of its lower taxes of 17% per year but also because it does not trigger a top tax of 42%. Unfortunately, ASK has a very low deposit ceiling of only 102,300 DKK.

On the other hand, the index fund investment will trigger the top tax of 42% for the first time on Year 7, once realized profits are above 56,500 DKK.

Due to the stock principle, the ETF investment will not trigger the top tax of 42% in the example above. The yearly taxation of unrealized profits results in smaller amounts of profits being taxed per period. Notice that this is highly reliant on the initial investment amount and expected yearly returns.

Remember to tax harvest your investments

Tax harvesting or, popularly known as tax-loss harvesting is defined by Investopedia as:

“Tax-loss harvesting is the selling of securities at a loss to offset a capital gains tax liability.”

This means selling underperforming funds before the end of the year, resulting in losses that can be used to offset profit from other funds, and consequently, reduce taxes paid on that year.

Another benefit, specifically for Denmark, is “tax harvesting”, or selling investments at a profit to reduce the impact of progressive taxes. This results in avoiding taxes at 42% on profits exceeding 56,500 DKK per year.

To execute that investors, need to sell part of their portfolio or full positions that are generating profits up to 56,500 DKK in that calendar year.

SKAT does not mention specific regulations for tax harvesting in Denmark. But due to SKAT’s average method (gennemsnitsmetoden) or first-in/first-out, buying the same shares at a similar price of the sale will change the average price of the asset owned and will help offset taxes.

However, tax harvesting can only be effectively applied to index funds and stocks, or investments under the realization principle (reaslisationsprincippet), where the investor can control when profits are realized, and consequently, in which year taxes will be applied. Thus, when tax harvesting, investors should focus on index funds and stocks.

For investment products under the stock principle (lagerprincippet), such as ETFs, tax harvesting will only work if a different asset is bought after the sales and realization of profits. At the stock principle, investors cannot control the tax incidence timing.

In the example below we assume a portfolio of investments (stocks and index funds) that generates a profit of 75,000 DKK between January 2021 and December 2022:

When realizing profits by selling at the end of 2021 and buying the same assets again right after, profits below 56,500 DKK will not trigger the top SKAT of 42%, resulting in total tax savings of 2,775 DKK in the example above.

Note: profits above 56,500 DKK per year are mainly applicable to portfolios above 565,000 DKK in a good year (ROI > 10%).

Tax harvesting index funds

Applying tax harvesting to index funds can improve the performance of funds under the realization principle.

Comparing the same three investments from the “Realisation vs. Stock principle vs. ASK” example above, and harvesting profits when gains are above 45,200 DKK (80% of the 56,500 threshold), the performance of the index fund will improve by 13% (from 292,577 DKK to 331,113 DKK).

Note: the relevance of tax harvesting might vary according to the size of your investment. Portfolios above 700,000 DKK (or 56,500/8%), can trigger the top tax bracket every year, reducing the impact of tax harvesting.

Fees

In the examples above we did not include brokerage or trading fees. We only included the fund administration fees (TER, or ÅOP in Danish). The main reason being that trading fees are proportionally much smaller than taxes in Denmark.

While taxes can eat up to 42% of your profits, or 4.2% of the principal (e.g., 10% ROI x 42% Tax) per year, trading fees are less than 1.0% per amount traded (e.g., Nordnet fee of 29 DKK applied to a small transaction of 2,900 DKK).

However, fees can add up for active investors who are constantly buying and selling stocks. In this case, the investor should opt for Saxo Bank, which has the lowest transaction fees among brokers and banks that automatically report to SKAT:

For an index fund investment of 500,000 DKK accumulated during 5 years (or 50 buy orders of 10,000 DKK each) and returns of 8% per year, we have:

When buying funds and consistently using Nordnet’s monthly savings (månedsopsparing) feature, investors will be able to avoid transaction fees, resulting in lower total expenses.

Note: Transactions fees will still be charged when selling investments bought through Nordnet’s monthly savings (månedsopsparing).

When trading stocks, Saxo Bank still offers better transaction fees.

The 5 Must-Dos for tax optimization in Denmark:

1. Maximize your ASK (aktiesparekonto), depositing 102,300 DKK.

2. Focus on Danish Index funds (Sparindex) to benefit from the realization principle and tax harvest your profits when applicable!

3. Invest in ETFs at the SKAT positive list to avoid capital income taxes and benefit from lower TER.

4. Use Nordnet’s monthly savings (månedsopsparing) feature to avoid transaction fees when buying funds.

5. Use Saxo Bank to buy and sell stocks and benefit from lower transaction fees.

I’m Fernando and I’m an expat living in Denmark. I also write about sustainable investing on my blog Your Green Wealth. If you are interested in sustainability, ESG and impact investing go take a look at my work!