Denmark

Susanne Nørgaard and Daniel Noe Harboe
PricewaterhouseCoopers
Copenhagen

Recent developments in tax law and tax practice have brought an increased focus on anti-avoidance rules and practice, explain Susanne Nørgaard and Daniel Noe Harboe of PricewaterhouseCoopers

A newly enacted tax reform has led to reduction on taxation of individuals in Denmark. However, the tax reform is financed through increased taxation of business enterprises in the shape of excise duties and amendments to business taxation.

Beneficial owner for dividend and interest payments

The Danish tax authorities have initiated a number of cases concerning non-withholding of tax at source on dividends and interest paid to group enterprises in the EU.

The tax authorities have also begun cases concerning the right to deduct interest expenses paid to group enterprises in the EU when the group's ultimate parent company is a US company applying the so-called check-the-box rules in the USA.

The common feature of these cases is that the Danish tax authorities find that the EU group enterprises receiving dividend and interest payments are not the beneficial owners of these payments. Therefore the tax authorities find that the EU companies have been inserted only to avoid the Danish rules on tax at source or to ensure deduction of the interest expenses in the Danish tax statement.

The problem also applies to companies in countries outside the EU if Denmark has entered into a double taxation treaty with these countries. Apparently, the Danish tax authorities are introducing a requirement for substance in the form of premises, staff and equipment as a precondition for recognising foreign companies for tax purposes.

This policy is a drastic change compared to the taxation of international groups, as so far there have been no cases where the tax authorities have applied such a substance requirement. At the same time, the tax authorities have not described clearly the extent of this new policy.

Therefore it is still unclear how much substance and physical existence the tax authorities will require in future for them to recognise a foreign company as the beneficial owner of, for example, dividends and interest.

A legal clarification of the new policy about substance may therefore be far in the future.

Danish tax reform

In connection with a newly introduced tax reform, changes to the Danish Capital Gains Tax Act and various other acts comprise a number of restrictions within business taxation. In general, the amendments will be effective from the income year 2010.

Harmonisation of taxation of companies' capital gains and dividends

The amendments harmonise the taxation of capital gains and dividends for shareholders that are, for example, companies, associations and foundations. In many respects, the amendments proposed will be to the benefit of the shareholder, however, the Act also imposes restrictions on minor shareholdings. In addition to this, the Act includes a protection rule relating to certain holding company structures, which will affect numerous already existing group structures.

Harmonisation is effected by introducing the following three new definitions in the Danish Capital Gains Tax Act:

Shares of group enterprises (group shares)
Shares of subsidiaries (subsidiary shares)
Portfolio shares

In future, only dividend and capital gains on portfolio shares will be taxed.

Definition of subsidiary shares

Subsidiary shares are shares in companies where the shareholder holds a minimum of 10% of the share capital if the subsidiary is located within the EU/EEA area or in a country with which Denmark has a double taxation treaty.

Definition of group shares

Group shares are defined as shares in companies with which the shareholder is jointly taxed or might be jointly taxed. Furthermore, group shares also comprise shares in companies where a foundation, etc is affiliated with the company in which shares are held.

The consequence of these rules is therefore that a company holding for instance 5% of the shares in another company should consider these group shares if the companies are affiliated through a common ultimate parent company.

Definition of portfolio shares

If the shares do not constitute group shares, subsidiary shares or treasury shares, they constitute portfolio shares. In general, the shares will constitute portfolio shares when the shareholder holds less than 10% of the share capital.

Taxation of gains on shares and dividend

Capital gains from group shares, subsidiary shares and treasury shares will in future be tax-free irrespective of period of ownership. This is a relaxation compared to the the rules now under which shares cannot be sold tax-free until they have been owned for at least three years.

Moreover, dividends from subsidiaries and group shares will in general be tax-free irrespective of period of ownership, which is a relaxation compared to the rules now under which shares should be held for a consecutive period of at least one year.

Also foreign shareholders receiving dividends from a Danish subsidiary need not pay any tax on dividend irrespective of the period of ownership of the shares in the Danish company. This is, however, conditional upon the foreign company being domiciled in the EU/EEA or in a country with which Denmark has entered into a double taxation treaty. Dividends to foreign shareholders of group shares which are not subsidiary shares is tax-free only if the dividend recipient is domiciled in the EU/EEA and the dividend taxation should have been waived under the parent/subsidiary directive or a double taxation treaty if they had been subsidiary shares.

In the case of portfolio shares, the shareholder must in all cases include dividend and capital gains fully in the taxable income.

This restricts the rules for taxation of capital gains on shares as under the rules now capital gains are tax-free after three years of ownership. Moreover, it is a restriction compared to dividend taxation as, so far, Danish shareholders have only included 66% of the dividend amount in the taxable income.

In general, companies' gains from portfolio shares should in future be taxed under the inventory principle, according to which the shareholder should include price increases and decreases in its taxable income irrespective of whether the shares have been sold.

In respect of unquoted shares, the shareholder may choose to apply the realisation principle, which entails that the shareholder does not include any gain/loss until the shares are sold. The realisation principle however entails that any losses on portfolio shares cannot be set off against income other than gains on shares.

The company cannot decide to apply the realisation principle if previously it applied the inventory principle.

Transitional rules

Basically, the new rules shall apply as from the income year 2010. For dividends, the rules shall however apply as from the calendar year 2010 and later.

As gains from portfolio shares will be taxable in future, an entry value of portfolio shares must be fixed upon transition to the new rules. In general, the market value at the beginning of the income year 2010 is applied as the entry value. Due to the negative development of the share market in recent years, the market value of the companies' portfolio shares will often be lower than cost for tax purposes, which entails a loss for the company.

Consequently, a rule is introduced for a statement of a net loss balance. Basically, the net loss balance must be calculated in aggregate for all portfolio shares of the company. If the company's total cost of portfolio shares is more than the total market value at the beginning of the income year 2010, the difference will be the company's net loss balance. However, several modifications to this rules exist.

The net loss balance calculated may be carried forward for set off against net gains on portfolio shares in later income years.

Protection rule applying to "reversed Christmas trees"

Today many groups are structured with holding companies at different levels so that the holding company at each level holds at least 10% of the share capital of the company at the lower level and can therefore receive tax-free dividends. These models are designated "reversed Christmas trees".

If, for example, two shareholders, Company A and Company B, each holds 9% of the share capital of Company 1, A and B could establish a joint holding company, Company 2, which would then hold 18% of the share capital of Company 1. If additional conditions were met, the structure would allow Company 1 to distribute tax-free dividends to Company 2, which again might distribute tax-free dividends to A and B.

The Danish Parliament has now passed a protection rule against the "reversed Christmas trees". According to the protection rule the subsidiary shares (the shares in Company 1 in the above example) are considered to be held directly by the shareholders (A and B) of the parent company (Company 2) if:

the main function of the parent company is the ownership of subsidiary shares and group shares;
the parent company does not exercise any actual economic activity relating to the shareholding;
more than 50% of the share capital of the parent company is held directly or indirectly by companies that cannot receive dividends free of tax through direct ownership, and
the shares in the parent company are not quoted.

If the requirements are all met, A and B are considered each to hold 9% of the share capital in Company 1, and the shares must therefore be treated as portfolio shares. A and B are therefore taxed in case of distribution of dividends from Company 1 to Company 2 or sale of shares in Company 1 irrespective of the dividend/gain is re-distributed to A and B.

The protection rule applies only to Danish shareholders and therefore not to shareholders domiciled abroad. The argument for this is that foreign shareholders are instead met with beneficial ownership and substance requirements.

Taxation of capital fund partners

The Danish Parliament has adopted special legislation for persons having a privileged position in a capital or venture fund.

According to the Act, return to capital fund partners, for example, exceeding the return of the other investors in the fund is defined as "extra return". In future, the extra return shall be taxed as personal income with the capital fund partners; and not as a gain on shares as today, which under the previous rules was the main rule.

The new rules on the taxation of capital fund partners apply both in case of the capital fund partners investing personally and via a company. If the investment is made via a company, the capital fund partners must include the company's positive income from shares as CFC income. The income from shares is calculated with deduction of standard return so that only the extra return is included in the capital fund partner's CFC income. Moreover, the partners may obtain credit for the tax paid by the company.

Right to deduct interest upon acquisition of foreign companies

As part of the intervention against capital funds an interest deduction ceiling was introduced in 2007, which limits companies' possibility of deducting interest expenses, for example, up to an amount corresponding to the tax base of certain assets of the company multiplied by a standard rate of interest (6.5% now).

Shares held by a company should usually not be included in the basis of assets and thus in the calculation of how many interest expenses the company may deduct.

In this respect an exception was however passed, as the company was able to include 20% a year of the total cost of shares held directly by the company in foreign group enterprises.

This possibility of including shares in foreign companies is now abolished.

The abolition will however be made gradually over eight years as the inclusion percentage is reduced by 2.5 percentage points per year. As from 2017, the rule will therefore be abolished.

Susanne Nørgaard (sun@pwc.dk) and Daniel Noe Harboe (dnh@pwc.dk) are partners of PricewaterhouseCoopers in Denmark