The central tax adminstration establishes that remission of a subsidiary company's debt may create taxable capitlal gain

Date 12 feb. 2010

the central tax administration establishes that Remission of a subsidiary Company’s debt may create taxable capital gain

On 25 August 2009, the National Assessment Council endorsed the Central Tax Administration’s recommendation and premises in a query concerning whether a parent company’s remission of a subsidiary company’s debt of DKK 3 million would have tax implications. The Central Tax Administration found that remission could be equated with repayment of the debt, and that the resulting capital gain is taxable pursuant to the Gains on Securities and Foreign Currency Act.

 

 

The case in brief

A parent company with a wholly owned subsidiary made a query to the Central Tax Administration regarding the tax implications of a contemplated remission of debt. Both companies were limited liability companies. The subsidiary was established in 1992 and restructured in 1993. In connection with the restructuring, the subsidiary’s bank converts outstanding debt of DKK 6 million into subordinate, interest-free loan capital, which was later reduced to DKK 3 million In 1995, the parent company acquires the bank’s claim against the subsidiary for the interest-free, subordinate loan capital of a nominal value of DKK 3 million for a price of DKK 1 million without changing the terms of the loan.

 

According to Section 3 of the loan agreement for the subordinate loan capital, payment of the remaining DKK 3 million could be insisted on, if the subsidiary’s equity on 31 December 1995 amounted to less than DKK 4 million, however, with a deduction of the amount by which the share capital exceeded the equity. Also, it was possible to let the loan capital remain unchanged and preserve these rights the following year.

 

In the subsidiary’s financial statements of 31 December 2007, the claim was listed with a value of DKK 3 million as subordinate loan capital. It appeared from the note that payment of the claim was due when the subsidiary reached equity of DKK 6 million In the light of the terms of repayment, the parent company believed that the claim was worthless, and therefore would not net any profit for the parent company.

 

 

Legal background

 

Pursuant to section 2 of the Gains on Securities and Foreign Currency Act, companies must include gains and losses on claims and debts which fall within the act in their taxable income. Instalments on and goodwill sums for claims against affiliated companies fall within the act, pursuant to section 1(3).

 

Section 3 of the Gains on Securities and Foreign Currency Act establishes that gains and losses on claims must be included in the company’s taxable income. Section 4(1) of the Gains on Securities and Foreign Currency Act establishes an exemption hereto, pursuant to which losses on intercompany claims are not deductable, just as section 8 of the Gains on Securities and Foreign Currency Act counterbalances this by establishing that the debtor company does not include gains on debt to affiliated companies if there are no deduction rights.

 

According to section 31D of the Danish Corporation Tax Act, it is possible for a parent company to provide a tax-exempt contribution for a subsidiary. In such situations, the parent company does not obtain deduction rights.

 

 

The Central Tax Administration’s position

 

The Central Tax Administration states that regardless of the terms of repayment of the contract, that the claim is subordinate, and that the parent company has acquired the claim from the initial creditor, the subsidiary is obligated to repay the claim, and that instalments on and repayment in full of the claim, fall within the Gains on Securities and Foreign Currency Act, pursuant to it’s section 1(3).

 

Furthermore, the Central Tax Administration states that remission of the debt is a matter which will falls within section 31D of the Danish Corporation Tax Act. For this reason, such a remission will be a tax-exempt contribution according to the Central Tax Administration, and, consequently, the parent company will have no deduction rights for any potential losses following from the remission, pursuant to section 31D(3).

 

Additionally, the Central Tax Administration perceives the matter as a contribution given for repayment of the claim. If debt remission takes place, the subsidiary will then have paid the claim in full. At the time, the equity of the subsidiary amounts to approximately DKK 1.5 million. And, thus, all debts are covered. For this reason, the Central Tax Administration states that the claim has a value of DKK 3 million, equivalent to a market value of 100, which is, therefore, the market value at which the claim is considered repaid.

 

Pursuant to section 26 of the Gains on Securities and Foreign Currency Act, the gain is calculated as the difference between the acquisition price and the selling price. As the claim has been acquired by the parent company for a price of DKK 1 million with an established value of DKK 3 million, it is the Central Tax Administration’s opinion that a taxable profit will be netted by performing the contemplated remission of debt. The subsidiary has no capital gain as the claim was contracted at the same market value, and is for this reason not tax liable of any such gain.

 

As it is the Central Tax Administration’s opinion that remission of the claim must be considered repayment in full, the parent company will be tax liable for any gain pursuant to Section 3 of the Gains on Securities and Foreign Currency Act.

 

 

Consequences of the decision

 

The decision shows that tax liability can occur in matters of debt remission, regardless of the fact that no actual payment between the involved affiliated companies has taken place. Furthermore, the decision shows how the rules of group contributions interact with the rules of debt remission.

 

 

If you have questions regarding the above or require additional information about taxation of debt remission within a group, please contact attorney Dan Moalem (dmo@mwblaw.dk) or attorney Henning Hedegaard Thomsen (hht@mwblaw.dk).

 

 

The above does not constitute legal counseling and Moalem Weitemeyer Bendtsen does not warrant the accuracy of the information. With the above text, Moalem Weitemeyer Bendtsen has not assumed responsibility of any kind as a consequence of a reader’s use of the above as a basis of decisions of considerations.