Tax withholding rules targeting foreign contractors deemed to breach EU law

In July, the European Commission decided to initiate an infringement procedure by sending a formal notice to Sweden that the Swedish legislation on preliminary income taxation for foreign enterprises is not compatible with EU law. 

According to the Swedish legislation on tax withholding which entered into force in 2021, principals that pay for work in Sweden performed by contractors from other EU member states or EEA countries must withhold 30% preliminary tax from the total compensation if the contractor is not approved for F-tax by the Swedish Tax Agency. The withholding of such tax on foreign entrepreneurs, that are not established in Sweden and therefore not liable for tax in Sweden, is according to the Commission in conflict with the freedom to provide services.

The Swedish government has responded to the formal notice by stating that it maintains its view that the rules are not in conflict with the freedom to provide services.

The freedom to provide services under EU law is fundamental to the EU and the idea is that goods, services, and labor should be able to move throughout the EU under the same conditions. Furthermore, Member States’ domestic legislation must uphold the EU's common goals and objectives.

According to the European Commission, the legislation on withholding of preliminary tax on renumeration paid to foreign enterprises could be contrary to the free movement of services. The European Commission’s assessment is based on the following circumstances.

Administrative burden

The rules entail more administration for both foreign enterprises and principals when hiring foreign enterprises. Although the rules on tax withholding target both foreign and domestic enterprises it is, according to the European Commission, more likely that a domestic enterprise already has a F-tax registration. Hence, it is more likely that foreign enterprises are affected by the tax withholding and are forced to apply for a registration on an ad-hoc basis. Furthermore, the principal may be required to withhold and report the preliminary tax to the Swedish Tax Agency (“STA”) in case the foreign enterprise cannot present a F-tax registration, which increases the administrative burden for the principal.

Liquidity disadvantage

According to the European Commission, the legislation entails an obvious liquidity disadvantage for foreign enterprises. A foreign enterprise without a F-tax registration needs go through a long administrative process to refund the withheld 30%, which could be considered a considerable amount of the foreign enterprise’s income.

According to court practice, it is considered a limitation of free movement of services if a measure or domestic rule may discourage an enterprise to pursue this freedom. According to the European Commission, it is obvious that the domestic rules regarding preliminary tax may discourage foreign enterprises to offer their services in Sweden as well as discourage Swedish principals to engage foreign enterprises that is not already established on the Swedish market.  

On September 14^th, Sweden formally responded to the formal notice. The government’s position is that the legislation is compatible with EU law and is not in conflict with the freedom to provide services. The government states that the Swedish preliminary tax system is a withholding tax system (tax deducted at source), i.e., the tax should be paid in connection to that the income is earned. Further, according to the government, the system is beneficial for the community as well as the tax payor. For the community it entails a relatively secure source of tax and the tax payor can freely utilize the actual payment received without having to worry about future taxes. 

Furthermore, the government explains that the fact that tax must be withheld when an enterprise receives renumeration for work performed in Sweden, regardless of whether the enterprise is tax resident in Sweden or not, enhances the competitive neutrality between Swedish and foreign enterprises. According to the government, the former rules could lead to principals being less keen on hiring foreign enterprises since they were obligated to assess whether the foreign enterprises had a permanent establishment in Sweden or not. With the current rules, the principals/customers only need to assure that the hired enterprise are registered for F-tax, and if not, withhold tax.

The government states that both Swedish and foreign enterprises must go through the same process to apply for, and receive, a F-tax registration. The government further states that the same conditions apply when applying for an exemption from the withholding tax obligation. Thus, according to the government the regulations do not entail a larger administrative burden for foreign enterprises. 

The European Commission will now review Sweden's position. If the European Commission considers the rules justified after taking part of Swedish government's response, the matter ends there. However, if the European Commission still considers the Swedish rules to restrict the free movement of services, the case may be referred to the European Court of Justice. If the Court is to agree with the European Commission, Sweden would be obliged to amend its domestic rules in a satisfactory manner. 

KPMG Sweden has worked extensively with the rules in question since they entered in to force in 2021.

Initially it can be said that the rules are not always straightforward and easy to apply, for instance when a foreign enterprise in turn has engaged foreign as well as Swedish subcontractors or when the principal is a foreign enterprise itself. Thereto we experience a lot of practical and administrative obstacles.

The rules do not have a minimum threshold but apply from the first Swedish krona invoiced for work carried out/services rendered in Sweden. A foreign enterprise must thus at a very early stage make itself aware of the Swedish rules on tax withholding and take action registering with the STA. This entails an administrative burden, processing time at the STA and may also be costly as local tax advice often needs to be sought to comprehend the rules.

Foreign enterprises engaged in limited one-time jobs or assignments may just accept the tax withheld as a cost not bothering to contact the STA. Thereto, the process for foreign enterprises not registered with the STA to obtain a refund was not clearly communicated from start.

Foreign enterprises entering into larger assignments that do not inform themselves about the rules in time may put themselves into liquidity problems. Refund of tax withheld (i.e. prior to obtaining F-tax) is received in the annual assessment process which may take up to two years and cannot be obtained early.

Thereto it should be mentioned that a foreign enterprise registered for F-tax in Sweden is, under the new rules, obliged to on an annual basis file “specific information”. Specific information is a new filing form in which the foreign enterprise should include information on (i) its activities in Sweden, (ii) the time period over which the activities have been carried out, and (iii) any other information that the STA requires to assess tax liability under the Swedish Income Tax Act. A foreign enterprise that assesses itself to have a Swedish permanent establishment should file an income tax return. The filing of specific information is thus a filing obligation for foreign enterprises not taxable in Sweden. Once again this is an administrative burden for a foreign enterprise not taxable in Sweden.

The Swedish government is expressing a few valid points in their justification of the rules. However, based on our experience, it is often more time consuming for a foreign enterprise than a Swedish company to apply and register for F-tax and try to obtain tax refunds. Although most information is available in English it is naturally more difficult for a foreign enterprise to understand the rules and register for F-tax to be compliant. Accordingly, the rules entail more administrative work for a foreign enterprise and should generally be more costly as it may have to involve a local advisor to assist them. All in all, the Swedish rules on tax withholding do in our view discourage foreign enterprises to engage in work/services in Sweden.

We will keep you posted on the development of the procedure as it continues. 

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European Commission, sw (INFR(2023)4007) 
Swedish government, sw (Fi2023/00940)

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