An unambigous tax position combined with a flexible legal regulation of Danish limited partnerhsips will make Denmark attractive for setting up private equity, venture and infrastructure funds, argues Erik Banner-Voigt.
Forseveral years, it has been debated whether non-Danish investors undertaking long-term investment activity in Denmark would be considered as having a permanent establishment in Denmark. The investment activity in Denmark may either be carried out by the investor or through a third party provider, typically in the form of a private equity, venture or infrastructure fund.
Several binding rulings have been issued by the Danish Tax Assessment Council (Skatterådet) regarding Danish private equity, venture and infrastructure funds structured as Danish limited partnerships. The Tax Assessment Council has changed its opinion several times over the years, leading to more and more complex corporate structures to avoid permanent establishments on behalf of the investors.
This legal position is unattractive, and the industry has pushed for a legislative clarification. Some advisory firms have participated in the process, providing recommendations on how the issue may be solved in a way that would comply with the OECD Model Tax Treaty and Danish tax practice.
On February 23 2018, the Ministry of Taxation presented a draft bill that specifically states that long-term investments into securities will not be considered to create a permanent establishment in Denmark for non-Danish investors. It is expected that the bill will pass parliament during spring 2018 and will have effect from the income year 2017.
In the following sections, the draft bill is analysed in further detail.
Long-term investments and permanent establishment
If a non-Danish investor carries out long-term investment activity in Denmark, and this activity is not carried out through a tax-resident Danish company it is relevant to consider, whether the activity may lead to a Danish permanent establishment. Such activity is usually carried out through Danish private equity, venture and infrastructure funds that are structured as Danish limited partnerships.
A Danish limited partnership is tax transparent. Non-Danish investors will therefore not be subject to Danish corporate tax and will not have filing obligations in Denmark, unless the activity of the limited partnership constitutes a permanent establishment in Denmark.
The Danish definition of a permanent establishment refers to the OECD Model Tax Convention art. 5, according to which a permanent establishment is a fixed place of business through which the business of an enterprise is wholly or partly carried on or through which business is carried out through a dependent agent.
Based on case law, it has been the opinion of the Danish National Assessment Council that long-term investment into securities including the activity carried out by private equity and infrastructure funds were a “business of an enterprise” that could potentially create a permanent establishment. However, by setting up independent boards passing the investment and divestment decisions and by not having employees in the limited partnership, it has so far been possible to avoid creating a permanent establishment for non-Danish investors.
However, based on the 2017 version of the Model Tax Treaty, the definition of the agency rule in relation to a permanent establishment has been expanded to also cover anyone that “habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise”. It is unclear whether or not this new and expanded definition of a dependent agent could result in non-Danish investors investing into private equity, venture and infrastructure funds being considered as having a permanent establishment due to the agency rule.
The draft bill
The draft bill proposes incorporating into the Danish Corporate Tax Act that investment in shares, receivables, debt and financial contracts will not be considered to be a “business of an enterprise” that may create a permanent establishment unless:
· the activity may be considered a trading activity (in Danish: “Næring”), or
· the non-Danish investor or related parties already have a permanent establishment in Denmark whereto the non-trading investment activity may be allocated.
Hereby the draft bill resolves the risk of creating a permanent establishment in Denmark for non-Danish investors carrying out long term investment activity in Denmark by stating that such activity will not be considered to be a “business of an enterprise”.
However, a Danish permanent establishment will be created if either:
· the activity in Denmark is trading in shares or other securities, or
· the investor or any related party has a permanent establishment in Denmark whereto the investment activity may be allocated.
It is clear from the case law that the activity of private equity, venture and infrastructure funds will not be considered as trading in shares. Such activity will therefore not create a permanent establishment for non-Danish investors.
However, if the non-Danish investor is trading in shares or other securities in its home country, there may be a risk that such investor will also be considered as trading shares or other securities in Denmark, irrespective of whether the activity in Denmark is trading activity or not.
The new rules are in accordance with the OECD Model Tax Convention as it is up to each member state to define which activities may be considered to be “business of an enterprise” in relation to the definition of a permanent establishment.
Although the Danish National Assessment Council has previously determined that investment in shares and other securities may be considered a business activity, the meaning of a business is not otherwise defined in Danish tax laws.
This draft bill clarifies the tax position for non-Danish investors performing long-term investments in Danish private equity, venture and infrastructure funds. As such, activities will not be considered a business activity creating a Danish permanent establishment, if the bill is passed in its present form. This would be a highly welcomed clarification.
The draft bill facilitates that Danish private equity, venture and infrastructure funds may set up their funds in a simpler manner, and it will be easier to attract non-Danish investors into Danish funds as the legal framework will be clear and simple.
© 2021 Euromoney Institutional Investor PLC. For help please see our FAQ.