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Denmark publishes bill to implement EU ATAD

Executive summary

On 3 October 2018, the Danish Minister of Taxation published Bill No L 28 intended to implement the European Union’s (EU’s) Anti-Tax Avoidance Directive (Council directives (EU) 2016/1164 and (EU) 2017/952) (the ATAD) into Danish law. The bill is expected to pass Parliament before the end of 2018.

The main rules addressed by the bill include:

  • Controlled foreign company (CFC) taxation

  • Interest limitation

  • Exit taxation

  • General anti-avoidance rule (GAAR)

  • Hybrid mismatches

This Alert summarizes the key aspects of these rules.

Detailed discussion

CFC taxation

The ATAD provides Member States with two options for CFC taxation:

  • Model A: CFC taxation of non-distributed financial income

  • Model B: CFC taxation of non-distributed income resulting from non-genuine arrangements put in place for the essential purpose of obtaining a tax advantage

Existing Danish CFC taxation is based on model A although the entire income of the CFC is subject to taxation. CFC taxation requires that more than 50% of the income is of a financial nature and that more than 10% of the assets are of a financial nature. The existing rule is applicable irrespective of the level of taxation for the CFC.

The bill retains model A. The following main changes are proposed:

  • The asset test is abolished.

  • The income test is lowered from 50% to 33.3%.

  • The concept of financial income is expanded to cover “other income generated from intellectual property (IP).” According to the proposal, this rule may capture profits from the sale of goods and services that are based on IP. In this context, goodwill is not treated as IP. Moreover, royalties and income from intangibles developed by the CFC itself subsequent to the time where the parent company obtained control over the CFC, is exempt. In order to carry out the income test it will thus be necessary to divide the income of a CFC into the following categories: “ordinary income,” “goodwill income,” “royalties and other income from self-developed intangibles” and “other income generated from IP.” Consequently, this process will be complicated and burdensome for taxpayers. In order to mitigate the effect of this rule, an entry value for an intangible equal to the fair market value thereof at the time where the parent company obtained control over the CFC will be established, provided that the intangible was developed or acquired by the CFC prior to this time, and that the parent company has acquired the CFC from a third party. The entry value may be amortization under Danish tax rules (generally, 1/7 per year) whereby the income from the intangible may wholly or partly be neutralized. Moreover, a grandfathering rule provides that if a number of requirements are satisfied, a parent company will obtain an entry value for intangibles owned by an existing CFC equal to fair market value at the beginning of the income year beginning 1 January 2019 or thereafter.

The proposal does not call for the introduction of the exception outlined in the ATAD under which no CFC taxation should occur where the CFC carries on a substantive economic activity supported by staff, equipment, assets and premises, as evidenced by relevant facts and circumstances.

The new CFC rules will be applicable from income years starting 1 January 2019 and thereafter.

Interest limitation

Existing Danish tax law contains the following rules limiting the deductibility of interest and other financing expenses:

  • Thin capitalization rule applying a debt:equity ratio of 4:1

  • Interest ceiling rule limiting the deductibility of net financing expenses to 2.9% of the tax basis in qualifying assets with a safe harbor of DKK21.3 million.

  • Earnings before interest and taxes (EBIT) rule limiting the deductibility of net financing expenses to 80% of EBIT with a safe harbor of DKK21.3 million.

The proposal will retain the rules on thin capitalization and interest ceiling. However, the EBIT rule will be substituted by an earnings before interest, taxes, depreciation and amortization (EBITDA) rule in accordance with the ATAD. The proposed EBITDA rule will provide:

  • Exceeding borrowing costs may only reduce EBITDA with up to 30%

  • Safe harbor of DKK22.3 million (equal to €3 million)

  • Companies subject to mandatory joint taxation must apply the rule on a consolidated basis

  • Borrowing costs in excess which are disallowed may be carried forward without time limitation

  • Unused interest capacity may be carried forward for a maximum of five years

  • The 30% ratio may be replaced by the actual EBITDA ratio of the consolidated group

  • Financial institutions are outside of the scope of the rule

  • Foundations and associations are within the scope of the rule

The new EBITDA rule will be applicable from income years starting 1 January 2019 and thereafter.

Exit taxation

Existing Danish tax law imposes exit taxation in the following situations:

  • Transfer of assets and liabilities from a Danish company to a permanent establishment in another jurisdiction

  • Transfer of place of effective management to another jurisdiction under a tax treaty

  • Transfer of legal seat of a Danish company to another jurisdiction

Taxpayers can request that payment of exit taxes be deferred for up to seven years, if the company or assets are moved to another EU or European Economic Area country. The proposal will mean that the maximum period of deferral will be five years.

Under existing rules the tax basis for assets that are brought into the Danish tax jurisdiction must often be calculated on the basis of the original purchase price which is deemed to have been subject to maximum depreciation according to Danish tax rules from the time of acquisition and until the time they enter the Danish tax jurisdiction. Under the proposal, Denmark will recognize the arm’s-length price of the assets as tax basis when the assets are brought under Danish tax jurisdiction.

The new rules will be applicable from income years starting 1 January 2020 and thereafter.

GAAR

Existing Danish tax law contains a court-based anti-avoidance rule with a limited scope.

The proposal will introduce a GAAR in accordance with Article 6 of the ATAD that will apply to both resident and nonresident companies. The wording of the rule is:

“1. For the purposes of calculating the corporate tax liability, a Member State shall ignore an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part.

2. For the purposes of paragraph 1, an arrangement or a series thereof shall be regarded as non-genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality.

3. Where arrangements or a series thereof are ignored in accordance with paragraph 1, the tax liability shall be calculated in accordance with national law.”

The GAAR will be applicable from 1 January 2019.

Hybrid mismatches

Existing Danish tax law contains several rules that address hybrid mismatches including the following provisions of the Corporate Tax Act:

  • Section 2 A: A company is recharacterized as a permanent establishment for Danish tax purposes if the company is disregarded by a foreign parent company (hybrid entities).

  • Section 2 B: Controlled debt is recharacterized as equity for Danish tax purposes if it receives equity treatment in the hands of a group company (hybrid financing).

  • Section 2 C: A Danish branch office or partnership is recharacterized as a company for Danish tax purposes, if the entity is treated as corporation in the country of residence of controlling direct owners, or if the controlling owners are tax resident in country outside of the EU with which Denmark has no tax treaty (hybrid entities).

The proposal will abolish Section 2 A and Section 2 B whereas the scope of Section 2 C will be expanded. The rules on hybrid mismatches in the ATAD will be introduced as new Sections 8 C – 8 E of the Corporate Tax Act addressing:

  • Double deductions

  • Deductions without inclusion

  • Deductions without inclusion regarding hybrid entities and permanent establishments

  • Double non-taxation of disregarded permanent establishments and reverse hybrid companies

Taxpayers should carefully analyze whether the change from the existing rules to the new rules on hybrid mismatches will cause any changes in the Danish taxation.

The new rules will be applicable from 1 January 2020.

EYG no. 011392-18Gbl

Download this Tax Alert as a PDF file.

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