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Danish Tax Authorities Prevail in New Remarkable Beneficial Ownership Ruling

21 Mar 2011

On 27 January 2011 a ruling from the Danish Tax Tribunal considering the concept of beneficial ownership was published. The ruling is the third ruling from the Tax Tribunal regarding beneficial ownership, all of which were issued in 2010.

While the facts of the case suggest that the financing structure was suitable to allow interest payments to be up streamed to an ultimate owner resident in a deemed tax haven jurisdiction, the ruling appears to have little regard to the subtleties inherent in the beneficial ownership requirement under the Nordic Tax Treaty and the EU Interest and Royalty Directive.

Accordingly, there is reason to believe that the ruling will be brought before the Danish Courts. Ultimately, the concept of beneficial ownership as applied in Denmark must be addressed by the Danish Supreme Court in order to - hopefully - establish the legal guidelines currently lacking. Taxand Denmark and Taxand Netherlands discuss this remarkable beneficial ownership ruling.

Factual circumstances
In July 2002, the company G1 Ltd., Jersey, acquired a Danish group through a Danish company G2 A/S ("DK Group")_. One year later, in June 2003, the ownership structure was changed. A Danish holding company, H1 A/S, owning the Danish group G2 A/S, was established. Ownership of the Danish holding company H1 A/S was vested in two Swedish holding companies G4 AB (lower tier, direct owner of H1) and G5 AB (upper tier, direct owner of G4). G1 Ltd., Jersey was the direct owner of G5 AB, which created the following ownership structure:

Final corporate structure

As part of the financial restructuring of the group, two identical instruments of debt were issued. One was issued by the top Danish holding company, H1 A/S, to the lower tier Swedish holding company G4 AB. The other was issued by the top Swedish holding company, G5 AB, to the ultimate holding company, G1 Ltd.

No instruments of debt were issued between the two Swedish companies G4 AB and G5 AB. Instead, financing of the loan granted by G4 AB to H1 A/S was obtained by payment of a so called "ovillkorat aktie?gertillskott" (unconditional shareholders? contribution) from G5 AB.

Interest payments from H1 A/S were made to G4 AB and from G5 AB to G1 Ltd. Payments identical to the interest payments were made from G4 AB to G5 AB in the form of group contributions.

Upstream financing structure

The only activity of the Swedish companies G4 AB and G5 AB has been to own shares in the immediate subsidiary companies. The companies G4 AB and G5 AB are administered by a management company, G7 AB, whose employees constitute management boards and boards of directors in both companies.

The Legal Framework
Under sec. 2 of the Danish Corporate Income Tax Act applicable at the time, a foreign related lender was subject to Danish withholding tax on interest income. However, a possibility for exemption existed if the foreign related lender was protected, either under the Directive or under a tax treaty with Denmark. In both instances a test of beneficial ownership of the interest paid was required in order for tax exemption to be obtained.

The Reasoning of the Parties
The principal argument presented by the tax payer is that as the Swedish lender G4 AB is considered to be the entity taxable on the interest from H1 A/S under Danish domestic tax law, which was also confirmed by the tax authorities in the case, G4 AB should therefore also be considered the beneficial owner of the interest under the Tax Treaty and the EU Directive. As beneficial owner, G4 AB would qualify for tax exemption of interest income from H1 A/S in Denmark.

The Danish Tax Authorities on the other hand argued that when determining whether Danish withholding tax would apply on interest paid under sec. 2 of the Danish Corporate Income Tax Act it is only relevant to determine:

(i) that the interest is paid from Denmark
(ii) that it is paid to a company resident outside Denmark
(iii) that this company is not entitled to claim reduction under the Tax Treaty as it is not the beneficial owner of the interest paid.

As such, the Danish Tax Authorities argue that the Danish law concept of true recipient is different from the concept of beneficial ownership under the tax treaty and the EU Directive.

The Ruling
The Tribunal agreed that the concept of beneficial ownership is a prerequisite for Danish taxation of the interest paid from H1 A/S to G4 AB and in this respect refers to article 1 paragraph 8 in the 2003 comments to the OECD model treaty regarding the concept of beneficial ownership, in particular with regard to the commentary?s remarks on companies acting as conduit companies.

As the cash flow through the Swedish companies, G4 AB and G5 AB, did not generate any taxable income in the Swedish companies G4 AB and G5 AB, these companies should be regarded as conduit companies and therefore not beneficial owners of the interests from H1 A/S.

The Tribunal further found that the aim of establishment of the Swedish companies and the concurrent raising of identical loans and shareholders? contributions was to evade any type of taxation in Denmark and in Sweden of the interest payable from the Danish company H1 A/S on the loans raised without affecting the right for H1 A/S to deduct interest for tax purposes in Denmark.

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Taxand's Take

The ruling validates the tax authorities? contention that the benefits of the Directive can be denied on the basis of a beneficial ownership requirement. The Tribunal denied G4 AB the right to invoke the Directive by finding that the G4 AB and G5 AB group essentially acted as "conduits" in a transaction designed to: (a) avail themselves of the directive to eliminate the Danish withholding tax, (b) avoiding any tax in Sweden, (c) obtaining a deduction in Denmark.

Clearly, the predetermined cash flow played a central role in the assessment of the Tribunal, in particular in a situation where the substance of the structure does not immediately suggest any particular uncertainty with respect to the anticipated cash-flow.

The Tribunal emphasized the final outcome of the structure whereby income received by G4 AB de facto is paid to G1 Ltd., albeit via the Swedish holding companies. The Tribunal, without offering a specific reason, disregards the legal form of the Swedish holding companies, including the fact that no legal obligation exists for G4 AB under Swedish law to make a payment to G5 AB.

The Tribunal is less than convincing when it argues that because no taxable income is left in the Swedish companies, they must be considered as conduit companies. The existence of taxable income does not appear from the OECD commentary to play any role in determining beneficial ownership.

Further, the ruling in many respects lacks convincing legal analysis and reasoning and a number of questions remain outstanding with respect to Danish withholding tax until further legal precedence has been established.

Pending the outcome of a Supreme Court decision - or additional rulings from the Tax Tribunal providing a more thorough analysis of the critical issues set out above, it would be advisable to show significant caution when setting up a financial structure involving a Danish company or - as a Danish company - when making payments of inter group interests, dividend or royalty to a group company which will ultimately make payments to other entities not themselves entitled to elimination of Danish withholding tax.

"This court case falls into the trend that tax authorities are scrutinising international structures closely to determine whether the foreign recipient of a payment or distribution qualifies for the reduced treaty rate as the beneficial owner. Multinationals could consider implementing structures with added "substance" by for example combining their various holding and finance companies in a single company with real substance. With regard to financing companies it is important to note that the Netherlands in 2001 issued a decree on the necessary equity at risk and substance requirements for financing and royalty companies. Luxembourg issued a similar decree in January 2011." Marc Sanders, Taxand Netherlands

We await the outcome of the case.

Your Taxand contacts for further queries are:
Anders Oreby Hansen
T. +4572273602

Arne Riis
T. +4572273322

Marc Sanders
T. + 31 20 301 66 33

Taxand's Take Author