Danish Government issues new report on taxation of Danish investment funds and tax reporting rules

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1 13 November 2015 Global Tax Alert Danish Government issues new report on taxation of Danish investment funds and tax reporting rules EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Executive summary A newly published report on the Danish tax regime for investment funds (the Report) does not appear to meet the expectations of market participants for simplification of the current Danish rules. Many market participants regard the current rules as a barrier to entry in the Danish retail market for mutual investment fund products. Both Danish and foreign market participants have over the years been pushing for new rules in order to both open up the country s retail market and allow Danish funds better access to export their fund products. The purpose of the Report has been to analyze the market impact of the current rules as well as the consequences of potential amendments to the rules. Key factors that should be addressed by legislative changes in order to ease access to the Danish retail market for foreign mutual investment funds are: Tax reporting rules Tax impact form applying certain share classes on the Danish tax classification of an investment fund On both issues, the recommendations of the Report are to not change the current rules. Even though the Report more or less addresses and analyzes all the relevant themes within Danish investment fund taxation, it does not address the perspective of both Danish and international market participants at least at the level of the government officers.

2 2 Global Tax Alert However, the Danish Minister of Taxation in his commentary to the Report said that he is willing to look at possibilities of designing a more appropriate and better functioning tax system and he looks forward to discussing this with the market participants. This Alert summarizes the content of the Report that is of special relevance to nonresident mutual investment funds interested in the Danish market and also highlights the conclusions of the Report in the other areas. Detailed discussion The Report was initiated back in May 2012 by a former Minister for Taxation and government officers have spent over three years on the work. The Report analyzes the three main criticisms of the current Danish tax rules including: Tax calculation and reporting rules are too complex for foreign investment funds to enter the Danish retail market Danish dividend withholding tax rules are a barrier for Danish investment funds to distribute their products abroad Danish tax qualification of common funds (a Danish contractual based fund type referred to as værdipapirfonde) as transparent for Danish tax purposes implies that such funds are unattractive for Danish retail investors Further, the Report addresses whether a foreign investment fund that is managed by a Danish Fund Management company will be liable to tax in Denmark as a consequence of the place of effective management principle. Tax calculation and reporting rules From a Danish tax perspective, most foreign investment funds should generally be qualified as investment companies as per the default Danish rules. Danish retail investors (individuals) holding units or shares in investment companies are taxed according to a mark-to-market principle implying that both realized and unrealized gains/losses are taxed annually and included as capital income. Danish retail investors have a tax preference of investing in distributing investment funds (Danish: investeringsinstitutter med minimumsbeskatning hereafter referred to as IMBs) as investments in IMBs are taxed at the calculated annual minimum income rate and upon sale of the fund units (realization principle). Income from equity based IMBs are further taxed as equity income that may lead to more favorable rates than capital income. To meet the requirements set to obtain IMB-status, the investment fund must calculate and report the annual minimum income. The minimum income is calculated according to a net income principle in accordance with Danish calculation and income inclusion principles. There is no requirement that the minimum income is distributed to the unit-holders implying that both distributing and accumulating funds have the possibility to opt for IMB status. Report conclusions The Report concludes that the minimum income calculation and reporting rules were already simplified a few years ago and there is nothing in the current rules that should stop foreign funds in applying the rules supported also by the fact that some foreign funds actually apply the rules. The Report analyzes five models to simplify the rules, but concludes that there is no room for changing the current rules if the balance between investing through mutual investment funds and investing directly in equities and bonds should be preserved. Further, the Report speculates that lack of competition from foreign investment funds on the Danish retail market must be caused by other obstacles than the tax rules. The Report suggests that a harmonization of the tax rates of Danish personal income types ( capital income which is typically bond-related income and equity income which is typically equity-related income) would be the appropriate manner to solve the mutual investment fund import barrier instead of changing the specific investment fund rules. Implications The Report conclusions do not indicate that changes to the rules are imminent. Mutual investment funds with a desire to market their fund products should therefore still proceed on the assumption that the Danish calculation and reporting rules need to be adhered to. It is correct, as stated in the Report, that the rules were eased with effect as of 2013 and also that there are examples of nonresident mutual investment funds applying the rules. To date, however, only a very small number of foreign funds have actually elected IMB status As the Report notes, an important first step in shaping a new set of rules could be to harmonize the tax rates of equity and capital income as this could also be the catalyst for simplifying the Danish investment fund income calculation and reporting rules. A harmonization of tax rates can, however, not stand alone as new rules should e.g., also address the challenge of certain share classes on the Danish tax classification of investment funds.

3 Global Tax Alert 3 The Danish Minister for Taxation has expressed willingness to enter into a dialogue with market participants so it appears that there now is an open window for participating in the decision process in order to seek the solutions that the Report does not commit to. Other content of the Report Danish dividend taxation The investment fund community has over a long time contended that the Danish dividend withholding tax rules need to be relaxed in order to bring Danish funds to a more competitive position in the international context. The Report concludes that the Danish withholding tax rules presumably should not be regarded as the barrier for Danish funds marketing their products abroad. The Report suggests that no such changes should be implemented and among other things sets forth that a relaxation of the withholding tax rules may lead to private equity investors being able to take advantage of such changes. Denmark is one of a few nations still holding the position that the Danish dividend withholding tax rules are not in conflict with European Union (EU) law even though Danish domiciled funds are in a position to receive dividends from Danish shares while foreign funds are not. It is likely that the Danish Ministry for Taxation will maintain this position until a case against Denmark is addressed by the Court of Justice of the European Union. Tax qualification of common funds The regulatory framework for Danish domiciled common funds (contractual based investment fund named værdipapirfonde in Danish legislation) was established in The Danish Ministry for Taxation has until now held the position that such funds should be regarded as transparent for Danish tax purposes. This tax qualification has been a barrier against marketing these funds to Danish retail investors. The Ministry for Taxation has in connection with the Report reevaluated the tax qualification and has changed their position that common funds should be regarded as a non-transparent separate taxable entity for Danish tax purposes. The new position regarding tax qualification should facilitate that common funds can be marketed to Danish retail investors. It remains to be analyzed what implications if any the new position on Danish contractual based funds may have on the tax authorities view on the Danish tax qualification of foreign contractual based funds. Until now, the position typically has been seen as transparent for Danish tax purposes noting though that Danish case law in this area has not been consistent. The Report mentions that this must be analyzed on a case-by-case basis taking into consideration the specific organization and legal structure of the investment fund. Managing foreign funds in Denmark The analysis of the tax qualification of common funds also addresses the separate issue of the tax consequences of administrating a foreign investment fund from Denmark. The Report reaches the conclusion that where a foreign common fund does not have its own decision making bodies and decisions are made by the Danish administration company on behalf of the fund, this will lead to the foreign fund being tax liable to Denmark through the effective place of management principle. The interpretation of the effective place of management principle laid down in the Report preserves the barrier for managing nonresident investment funds from Denmark which would appear not to be fully aligned with the intent of the UCITS V directive on cross border management.

4 4 Global Tax Alert For additional information with respect to this alert, please contact the following: Ernst & Young P/S, Copenhagen Jesper Frøkjær Inge Heinrichsen Ernst & Young LLP, Scandinavian Tax Desk, New York Nina S Brodersen nina.brodersen1@ey.com Susanne Skoglund susanne.skoglund@ey.com

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