Mandatory Danish tax consolidation
A mandatory tax consolidation regime obligates all Danish resident companies and Danish branches that are members of the same Danish or international group to file a joint group tax return. The definition of a group generally corresponds with the definition of a group for accounting purposes. The tax consolidated income is equal to the sum of the taxable income of each individual Danish company and Danish branches of foreign companies that are a member of the consolidated group.
The top parent company participating in the Danish tax consolidation group will be appointed the role of a so-called ‘management company’; this company is responsible for settling tax on account and final corporate tax payments of all group members.
Companies included in a mandatory tax consolidation are jointly and severally liable for payment of corporate taxes. Withholding taxes (WHTs) on dividends, interest, and royalty payments are also covered by the joint and several liability. For companies with external minority shareholders, the company has a reduced liability and is merely liable if none of the other jointly taxed companies are able to pay the taxes.
Elective cross-border tax consolidation
A non-Danish subsidiary may be included as a member to a Danish tax grouping, provided that the group includes all group companies and branches in the Danish tax grouping. In effect, this all-or-nothing provision rules out the possibility for major international groups to have their Danish subgroup file a Danish group tax return that includes only certain hand-picked (typically loss-making) foreign group members. Losses deducted in an elective cross-border tax consolidation will be recaptured either fully or to a limited extent.
If a general cross-border tax consolidation is established, it will be binding for ten years; however, there are certain possibilities of ‘breaking’ the ten-year period (e.g. in connection with takeovers). ‘Breaking’ the ten-year period will result in a full recapture of previously deducted tax losses.
The comments under Mandatory Danish tax consolidation with respect to the calculation of the tax consolidation income, ‘management company’, etc. generally also apply to international tax consolidation.
Danish transfer pricing rules apply to transactions between related parties (e.g. inter-group transactions), whether the transactions are made between residents or non-residents. The rules apply when a company or person directly or indirectly controls more than 50% ownership of the share capital or more than 50% of the voting power of an entity. Transactions with PEs are also considered subject to the rules, whether domestic or foreign.
Companies with inter-company transaction above DKK 5 million are obligated to disclose in the annual tax return certain information regarding type and volume of inter-company transactions. The submission should be submitted via form 05.022, which is part of the electronic tax return (in TastSelv). If the company does not disclose the required information, penalties may apply for providing misleading information in the tax return.
Groups with a consolidated turnover of DKK 5.6 billion (approximately 750 million euros [EUR]) or more, based on previous year's turnover, must additionally prepare a country-by-country (CbC) report. The CbC report must contain a range of information for each country in which the group operates, including revenue, profit, tax, capital structure, assets, and employees. Furthermore, the group has to identify each entity within the group and specify the entities’ tax residencies and the activities of each entity.
The deadline for submission of the CbC report is 12 months after the end of the income year (i.e. for the financial year 2018, the deadline is the end of 2019). The rules apply for income years starting on 1 January 2016 or later. A Danish subsidiary, which is part of a multinational group, but is not the ultimate parent entity, will have to file the CbC report if certain requirements are met. However, this is only applicable for income years starting 1 January 2017 or later.
Additionally, Danish taxpayers must notify the Danish tax authorities about which group entity is obligated to file the CbC report. To notify the Danish tax authorities, the taxpayer must fill out form 05.034 and submit it electronically to the Danish tax authorities either through the Danish digital system (TastSelv) or the Danish tax authorities’ website. Form 05.034 should be submitted before the year-end of the year covering the CbC report (e.g. if the CbC report will include information for the financial year ending 31 December 2019, form 05.034 must be submitted no later than 31 December 2019).
A group must prepare detailed and extensive transfer pricing documentation to substantiate that intra-group transactions are conducted in accordance with the arm’s-length principle if it employs 250 or more employees (calculated as the average number of full time employees during the income year).
If the group employs less than 250 employees, it will qualify for the small business exemption if it meets either of the following criteria: (i) has revenue under DKK 250 million, or (ii) has a balance sheet sum under DKK 125 million.
However, an enterprise that is generally exempted for preparing transfer pricing documentation based on the above criteria must prepare transfer pricing documentation for transactions with group companies resident in countries outside the EU/European Economic Area (EEA) with which Denmark does not have a DTT.
The Danish tax authorities have in the past interpreted section 3 B of the Danish Tax Control Act to require contemporaneous preparation of documentation, i.e. the final documentation must be in place by the statutory filing date of the tax return. On 1 January 2019, the current provisions in section 3 B of the Danish Tax Control Act will be abolished and replaced by new provisions, which clearly outlines this contemporaneous requirement and is supported by recent case law.
The Danish tax authorities may request a group’s transfer pricing documentation to be submitted within 60 days. The Danish tax authorities could request five years of documentation.
If the transfer pricing documentation is missing or declared inadequate, meaning that the transfer pricing documentation is not submitted within the 60 days deadline, not prepared and finalised by the statutory filing date of the tax return, or if it does not meet the requirement as outlined in the Executive Order no. 1297 of 31 October 2018 ('the Executive Order on Documentation'), the Danish tax authorities can make an arbitrary assessment of the group’s income.
The Danish tax authorities may also impose a penalty of DKK 250,000 per year, per company where transfer pricing documentation is missing or is declared inadequate by the Danish tax authorities. If adequate documentation is subsequently submitted, the penalty may be reduced by 50%.
Furthermore, if an upward income adjustment is issued (i.e. on the basis that inter-company prices were not at arm’s length), the penalty may be increased with an amount equal to 10% of such adjustment. In addition, a surcharge and interest will be levied on underpaid tax related to any income increase.
The size of the penalty will be determined ultimately by the courts. However, recent case law has confirmed the penalty of DKK 250,000 per year per company where the documentation is missing, declared inadequate, or has not been prepared on a contemporaneous basis. Trial cases are currently running at the courts regarding the penalty amounting to 10% of the income adjustment imposed by the tax authorities.
The overall purpose of the transfer pricing documentation is to give the Danish tax authorities an opportunity to assess the prices and conditions used in order to determine whether inter-company transactions are conducted in accordance with the arm’s-length principle.
With the Executive Order on Documentation from 2016 and updated in 2018, Denmark has implemented the updated transfer guidelines (July 2017) from the OECD under which the following documentation must be prepared:
The master file must contain standardised information relevant for the entire group, whereas the local file(s) must contain specific information on the local affiliate(s). It follows from the Executive Order on Documentation that a local file must be prepared for each legal entity even though the group has several entities in the same country.
The Danish tax authorities may request the taxpayer to obtain an independent auditor’s report. The Danish tax authorities can request the statement seven days after receiving the transfer pricing documentation. The circumstances for requesting an auditor’s statement are:
- The group has controlled transactions with entities in countries outside the EU/EEA or in countries without a DTT with Denmark.
- The group has had a negative average operating profit/EBIT over the past four years.
The auditor’s statement must conclude on awareness of facts that suggest that the group’s transfer pricing documentation does not give an accurate portrayal of the actual terms and conditions of the controlled transactions. The deadline for submitting the statement to the Danish tax authorities is at least 90 days after the request. The Danish tax authorities are not bound by the conclusion of the statement.
Information submitted to the Danish tax authorities (e.g. CbC report, master file) can be exchanged automatically or spontaneously with countries that Denmark has concluded an exchange of information agreement with and has accepted confidentiality of the information. Correspondingly, the Danish tax authorities can receive information regarding Danish companies that are part of a group resident in another country.
Thin capitalisation and interest relief limitations
Danish resident companies and Danish branches of foreign companies are subject to three sets of restrictions, each of which may seriously limit or disallow Danish tax deductions for financing costs.
Firstly, there is the thin capitalisation rule. This rule works to disallow gross interest costs and capital losses on related company debt to the extent the overall debt-to-equity ratio based on market values exceeds 4:1. Related company debt includes external bank debt if group member companies have provided guarantees to the bank. This rule only applies if the controlled debt exceeds DKK 10 million. When calculating the 4:1 ratio, a special consolidation rule applies if two or more companies are considered affiliated (note that the definition of affiliated companies differs from the definition under the Danish rules on joint taxation). There is no recharacterisation of interest as dividends.
Secondly, there is an asset-based rule that applies in relation to financing costs that remain after the thin capitalisation limitation. To the extent a Danish company on a stand-alone basis or, if part of a joint tax group, together with group companies has net financing costs in excess of DKK 21.3 million, the deductibility of the remaining financing costs can be limited to an amount equal to 2.9% for tax year 2018 of the tax basis of certain assets of the group. Net financing costs consist of, among other things, interest income/expenses, taxable gains/losses on debt, receivables and financial contracts, taxable gains/losses on shares, and taxable dividends.
Thirdly, there is an EBITDA-based rule that works to limit the deductibility of financing costs that remain after the thin capitalisation test and the asset-based rule to an amount equal to 30% of the Danish company’s/tax group’s taxable EBITDA income. This rule applies the same definition of net financing costs as the asset-based rule, and it allows for a minimum deduction of DKK 22.3 million. Financing costs that are limited in accordance to this rule do not lapse but can be carried forward to the next tax year.
If a Danish resident company has a debt to a non-Danish resident creditor (person or company) that considers the payments as dividends on a contributed capital (hybrid financing), the debt will also, in accordance with Danish rule, be requalified as equity. The Danish debtor company is then cut off from deducting the interest cost and/or capital losses on the requalified debt.
Controlled foreign companies (CFCs)
According to the Danish CFC rules, a Danish company has to include in its taxable income the total taxable income of a subsidiary, foreign or Danish, if such subsidiary qualifies as a CFC. A subsidiary qualifies as a CFC if all of the following criteria are met:
- The Danish company, together with other group member companies, directly or indirectly owns more than 50% of the capital or controls more than 50% of the voting rights in the subsidiary.
- More than half of the subsidiary’s taxable profits, as hypothetically assessed under Danish tax laws, are predefined CFC income types (mainly interest, royalty, capital gains, etc.).
- During the income year, the subsidiary’s CFC assets (assets, where the return is characterised as a CFC income type) make up more than 10% of the subsidiary’s total assets.
There is no black or white list that exempts subsidiaries resident in certain countries.
Proposed implementation of the EU Anti-Tax Avoidance Directive (ATAD)
The following changes have been proposed to the CFC rules:
- Adjustment of the control test for determining when a subsidiary is comprised by the CFC rules.
- Reduction of the threshold under the income test from 50% to 1/3 CFC income in order for the income of a controlled company to be comprised by CFC taxation.
- Abolishment of the asset test.
- Expansion of the CFC income definition to also include 'embedded royalties' from intellectual property (IP) and royalty income received from unrelated parties. Comments in the explanatory notes to the bill provide some guidance on how to interpret the term 'embedded royalties', which is income derived from IP, but which is embedded in the cost of goods and services sold. Many issues related to embedded royalties remain unclear at this point in time.
- Income from IP developed by the subsidiary entity’s own R&D activities is excluded as CFC-income if the IP is developed after the point in time where the Danish parent entity became acquired control over the subsidiary. It is uncertain whether contract R&D activities are also covered by the exemption.
- IP acquired from an unrelated party may obtain a tax base under the CFC assessment equal to the value of the IP at the point in time when the Danish parent entity obtained control over the subsidiary. The IP can then be amortised for CFC tax purposes and thus reduce the CFC income of the subsidiary. There are both transition rules and general rules that may provide a tax base, but certain requirements must be fulfilled to obtain the tax base.
- If shareholding in a subsidiary held directly or indirectly by a Danish parent entity is sold to an entity that is not directly or indirectly owned by a Danish entity (e.g. to an unrelated party or to another part of the group), a fictive disposal of any assets or liabilities generating CFC income would need to be included in the calculation of whether the CFC income threshold is exceeded. A credit for the foreign taxes that would have been payable upon an actual transfer of the assets and liabilities is available against the Danish CFC tax.
The proposed Bill L28B (2018-19) regarding the implementation of the CFC tax rules of the EU ATAD in Danish tax law has been postponed with no expected adoption date, as certain technical points in the proposed rules need to be clarified in order for the rules to apply as intended.
Adopted implementation of the EU Anti-Tax Avoidance Directive (ATAD)
General anti-avoidance rule (GAAR)
One of the main components of the adopted rules is the introduction of a GAAR, which applies not only to cross-border transactions, but also to domestic Danish transactions, where benefits may be denied if tax avoidance is a key purpose of the transactions and the transactions do not have real substance.
The rules may apply when hybrid mismatches arise in situations where a risk of tax avoidance exists (e.g. between an entity and its PE, between associated entities).
The definition of an associated person is, as a starting point, a person that has an influence over another person of at least 25% voting rights, profits, and share capital, but can range to a requirement of 50% ownership for specific hybrid mismatches.
The scope of the thin capitalisation rule, as mentioned above, regarding tax exemption for the creditor to cover the circumstance when a foreign subsidiary’s interest deductions are limited under other EU/EEA member states’ thin capitalisation rules, is expanded.
Exemption cannot exceed the interest deduction restriction in the case where both companies would have been Danish tax residents.
Earnings before interest, taxes, depreciation, and amortisation (EBITDA)
The existing EBIT rule that might restrict the deduction of financial expenses has been substituted by a new EBITDA rule according to which the deduction of net financial expenses exceeding DKK 22.3 million is limited to an amount equalling 30% of the company’s EBITDA. The EBITDA rule applies to interest expenses that are not disallowed by either the interest rate cap rule or the thin capitalisation rule. Foundations and associations are covered by the EBITDA rule, while financial institutions are not. The EBITDA rule provides, among others, that:
- deduction for exceeding borrowing costs is reduced to 30% of EBITDA
- however, the exceeding borrowing costs up to DKK 22.3 million can be fully deducted (subject to restriction under the thin capitalisation rule)
- exceeding borrowing costs that are disallowed by the EBITDA rule can indefinitely be carried forward for potential, and
- unutilised interest deduction capacity can be carried forward for the five following income years.
The new rules regarding exit taxation will apply for income years starting 1 January 2020 and thereafter. The new rules imply that the maximum period of deferral of exit taxes is reduced from seven years to five years. Furthermore, with the new rules, assets that are brought under Danish tax jurisdiction will, as a general rule, obtain a fair market value basis for tax purposes.