1. Introduction

The Danish rules on dividend and interest withholding tax are currently subject to much debate and several tax disputes. This is due to the Danish tax authorities’ decision to impose a beneficial ownership condition as a requirement for withholding tax exemption.

This memorandum provides a high level description of the Danish interest and dividend withholding tax rules and the current interpretation thereof. The memorandum concerns only the withholding tax position of corporate entities.

2. The Danish interest withholding tax rules

Unrelated lenders are unconditionally exempted from Danish withholding tax on interest payments received from a Danish corporation.

In contrast, a foreign related lender is according to the general rule subject to Danish withholding tax on interest income derived from a Danish resident corporation. The Danish withholding tax is charged on a gross basis at the rate of 25%.

For purposes of the said rule, a “related lender” generally means:

(1) a lender which is controlled, directly or indirectly, by the Danish corporation; or
(2) a lender which controls, directly or indirectly, the Danish corporation; or
(3) a lender which is under common control with the Danish corporation.

In the above context, “control” means the possession of a 51% ownership share of the capital or votes of a corporation. However, control may also be deemed to exist where an agreement has been entered into by two or more minority shareholders for purposes of exercising joint control over a corporation.

A foreign corporation meeting the above definition of a “related lender” is according to the general rule subject to Danish withholding tax on Danish source interest.

There are however two major exceptions to the general rule: The “Treaty Exemption” and the “Directive Exemption.”

Under the Treaty Exemption, a foreign related lender is fully exempted from Danish interest withholding tax if the foreign related lender resides in a jurisdiction that has a tax treaty with Denmark and the foreign related lender is entitled to a waiver or reduction of the Danish withholding tax pursuant to that tax treaty.

Under the Directive Exemption, a foreign related lender is fully exempted from Danish interest withholding tax if the foreign corporation resides in an EU jurisdiction and is entitled to a waiver or reduction of the Danish withholding tax pursuant to the EU interest and royalties directive.

The interpretation of the Treaty Exemption and Directive Exemption is currently being tested by the Danish tax authorities who have taken the position that the said exemptions only apply to interest recipients that qualify as the beneficial owner of the interest received. See Section 4 below.

3. The Danish dividend withholding tax rules

The Danish dividend withholding tax regime applies to all foreign shareholders. According to the general rule, a foreign corporation is thus subject to Danish withholding tax on dividends received from a Danish corporation. The Danish withholding tax is charged on a gross basis at the rate of 27%.

Similar to the interest withholding tax regime, there are however two major exceptions to the general rule, namely the Treaty Exemption and the Directive Exemption.

The Treaty Exemption and the Directive Exemption may be invoked by a foreign corporation which holds directly at least 10 % of the nominal share capital of the dividend distributing Danish company (hereafter referred to as a qualifying shareholder).

Under the Treaty Exemption, a qualifying shareholder is fully exempted from Danish withholding tax on Danish source dividends if the qualifying shareholder resides in a jurisdiction that has a tax treaty with Denmark and the qualifying shareholder is entitled to a waiver or reduction of the Danish withholding tax pursuant to that tax treaty.

Under the Directive Exemption, a qualifying shareholder is fully exempted from Danish withholding tax on Danish source dividends if the qualifying shareholder resides in an EU jurisdiction and is entitled to a waiver or reduction of the Danish withholding tax pursuant to the EU parent- subsidiary directive.

The interpretation of the Treaty Exemption and Directive Exemption is currently being tested by the Danish tax authorities who have taken the position that the said exemptions only apply to dividend recipients that qualify as the beneficial owner of the dividend received. See Section 4 below.

4. Interpretation of the Treaty Exemption and Directive Exemption

4.1. Interpretation by the Danish tax authorities

Around 2007 – 2008, the Danish tax authorities decided to apply a new interpretation of the Danish dividend and interest withholding tax rules entailing that foreign related lenders and qualifying shareholders must now meet a beneficial owner condition in order to qualify for the Treaty Exemption and the Directive Exemption.

The Danish tax authorities argue that a beneficial owner condition applies because the Treaty Exemption and the Directive Exemption are subject to the explicit condition that the income recipient must qualify for a reduction or waiver of the Danish withholding tax pursuant to a tax treaty or EU directive (the parent-subsidiary directive and interest-royalty directive respectively). Most tax treaties concluded by Denmark and the EU interest – royalty directive provide for a reduction or waiver of withholding tax but only if the recipient is the “beneficial owner” of the income received. This entail, according to the Danish tax authorities, that a condition of beneficial ownership is transposed into the Danish withholding tax regime.

The Danish tax authorities’ application of a beneficial owner condition is directed against conduit companies and is intended to curb treaty and directive shopping. The Danish tax authorities have thus applied the condition to impose withholding tax in cases where interest or dividend has been paid to a foreign holding company which is held, directly or indirectly, by an entity resident in an offshore jurisdiction. In such cases, the Danish tax authorities have alleged that the foreign interest / dividend recipient does not qualify as the beneficial owner of payment received and that the payment therefore is subject to Danish withholding tax.

While there have been some developments in the Danish tax authorities’ interpretation of the beneficial owner condition, it is clear that their interpretation is centered around the OECD Commentary to the term beneficial ownership as used in tax treaties. The commentary thereto says, inter alia, that an intermediary recipient of interest or dividend may disqualify as the beneficial owner if it has “very narrow powers which renders it, in relation to the income concerned, a mere fiduciary or administrator acting on account of interested parties.” The Danish tax authorities are attempting to construe this commentary to mean that a company which has no other activities than the holding of the shares generally must be considered a conduit company which cannot claim beneficial ownership in respect of dividends or interest received.

So far, the beneficial owner condition has been considered by a Danish appeal body in two cases concerning dividend withholding tax and three cases concerning interest withholding tax. All cases concern payments made to an intermediary holding company resident in an EU member state which is held directly or indirectly by a company resident in an offshore jurisdiction.

Below is a brief outline of these cases and their outcome.

4.2. Tax cases concerning withholding tax on dividend payments

The first beneficial owner case raised by the Danish tax authorities in relation to dividend payments was tried by the Danish Tax Tribunal (which is an administrative appeal body) in March 2010. Subsequently, the case was tried by the Danish high court which rendered its decision in December 2011.

Both instances of appeal held that the Danish tax authorities were wrong to decide that the foreign dividend recipient – which was a Luxembourg parent / holding company – was not the beneficial owner of dividends received from a Danish subsidiary. Consequently, both instances of appeal found that the Danish tax authorities were wrong to deny application of the treaty Exemption and the Directive Exemption.

This case did however not concern a typical flow of funds as no dividend payment received by the Luxembourg company from the Danish subsidiary had been paid over to the shareholders. Instead, the Luxembourg company had reinvested the dividend payments into the Danish subsidiary. The outcome of this case does therefore not set any precedence for the treatment of dividend payments in a typical holding structure where dividends are passed on to the ultimate shareholders.

However, in reaching its decision, the Danish high court stated that the beneficial owner condition as applied in tax treaties must be construed to mean that a recipient of dividend can only be denied beneficial owner status if the dividend payment has been passed on - or with certainty will be passed on – to persons in third countries which do not have a tax treaty with Denmark.

Furthermore, the Danish high court stated that in order for an intermediate holding company to be denied status as beneficial owner, the owners of the intermediate holding company must “exercise a control of the holding company that goes beyond the planning and management usually occuring at group level in multinational groups."

These statements reflect the high court’s understanding of the general meaning of the beneficial ownership condition and therefore provide an important contribution to the interpretation and application of the beneficial owner condition in other cases.

The Danish Ministry of Taxation has announced that the decision will not be appealed.

The second beneficial owner case concerning dividend payments was decided by the Danish National Tax Tribunal in December 2011. The case concerned dividend payments made by a Danish company to its parent company in Cypress. The Cypress parent company was an intermediary holding company held directly by a company resident in Bermuda.

The Tax Tribunal found that the Cypress company did not qualify as the beneficial owner of the dividend received within the meaning of the Danish – Cypress tax treaty and that the Cypress company therefore could not invoke the Treaty Exemption.

The Tax Tribunal also found however that the Directive Exemption as regards dividends could not be made subject to a beneficial owner condition since the relief from dividend withholding tax granted under the EU parent-subsidiary directive is not subject to a beneficial owner condition and since such a condition cannot be inferred from Danish domestic law either. Consequently, the Danish tax authorities could not, in the view of the Tax Tribunal, impose a beneficial ownership condition on a dividend recipient covered by the EU parent-subsidiary directive.

This decision is a major blow to the Danish tax authorities as it excludes the imposition of withholding tax on all dividend payments made to intermediary holding companies which are tax residents in an EU/EEA member state.

However, it remains to be seen whether the Danish courts will apply the same interpretation. The benefits of the EU parent-subsidiary directive may be denied by member states pursuant to domestic as well as “agreement based anti-abuse provisions”. While the Tax Tribunal expressly considered - and rejected – the existence of any relevant domestic anti-abuse provisions, the Tax Tribunal ignored the question of whether the beneficial owner condition found in most tax treaties concluded by Denmark qualifies as an “agreement based anti-abuse provision” which may be invoked by Denmark to deny benefits under the EU parent-subsidiary.

The Danish tax authorities have appealed the decision to the Danish courts.

4.2. Tax cases concerning withholding tax on interest payments

As stated above, three beneficial owner cases concerning interest payments have so far been tried by an appeal body. One case was lost and two cases were won by the Danish tax authorities.

The case that was lost by the tax authorities was decided by the Danish Tax Tribunal in 2010 and concerned interest payments made to a Danish company to a Luxembourg parent / holding company. The Luxembourg company had not passed on the interest payments but had instead reinvested the payments into the Danish company (the case concerns the same parties as involved in the first dividend withholding tax discussed in Section 4.1 above). Given the fact that the interest payments had not been passed on to the owners of the Luxembourg company, the Tax Tribunal found that the Luxembourg company could not be denied beneficial owner status under the Danish – Luxembourg tax treaty and therefore could not be denied exemption from Danish withholding tax pursuant to the Treaty Exemption.

Similar to the first beneficial owner case concerning dividends (discussed in Section 4.1), the facts of this case are distinguishable from the typical holding structure where funds are passed on by the intermediary holding company to a related entity. The conclusion reached in this case does therefore not set general precedence for the tax treatment of interest paid to foreign related parties.

The decision has been appealed by the Danish tax authorities to the Danish courts where the case is now pending.

The two cases won by the Danish tax authorities were both considered by the Tax Tribunal in 2011. Both cases concerned interest payments made by a Danish company that were channelled through holding companies resident in the EU to a controlling shareholder resident in an offshore jurisdiction (Jersey and Bermuda respectively).

In both cases, the Tax Tribunal found that the intermediary holding company did not qualify as the beneficial owner of the interest received within the meaning of the relevant tax treaty or within the meaning of the EU interest – royalty directive. This conclusion was mainly based on the Tax Tribunal’s finding that the intermediary holding companies in question had very narrow powers over the interest payments received and that the onward payment of the interest was predetermined (i.e. built into the structure). On this ground, the Tax Tribunal held that the Danish tax authorities were right to deny exemption from Danish interest withholding tax pursuant to the Treaty Exemption and the Directive Exemption.

Both decisions have been appealed to the Danish courts where the cases are now pending.

For further information, please contact:
Anne Becker-Christensen