New Danish ruling: MIP participants subject to Carried interest taxation

The two binding rulings addressed the question of whether a director and the former owner of the company group being part of the private equity investment ("Target Group") were subject to taxation under the carried interest regime. Both individuals were involved in the management of the Target Group both before and after the investment.

When the private equity investment was made, the director and the former owner subscribed for shares via personal owned holding companies in the Target Group but not through the private equity fund itself. A shareholder agreement was entered between the private equity fund and the director and the former owner. The shareholder agreement governed various aspects, including their investment in connection with the share subscription, the management of the Target Group, and the distribution of returns upon the sale of the investment.

All shares in the group were subsequently sold. Under the terms of the shareholder agreement, the former owner and the director received a larger share of the investment return than their proportional ownership of the participation capital would have otherwise warranted.

The conditions for being subject to the Danish carried interest regime are that the person is 1) fully taxable to Denmark, 2) has a preferential position over other investors, and 3) is investing via a fund qualifying as a private equity fund, a venture capital fund, or an infrastructure fund.

The Danish Tax Council emphasized that the carried interest regime does not depend on whether the investment is made directly or indirectly in the private equity fund (the investment entity) or in a company in which the private equity fund has invested. The key factor is not the individual's specific relationship to the fund such as being private equity partner, or an employee/director of a company in which the private equity fund has invested. Instead, the key factor is whether the individual holds a preferential position compared to other investors.

Given the "clarification" by the Danish Tax Council, participants in management incentive programs ("MIP")/employee share programs in companies where a private equity fund etc. has invested, may face significantly higher taxation. If these individuals possess a preferential position, they will according to the two binding rulings be subject to carried interest taxation, even in cases where the individual has not invested through the fund directly. This development underscores the importance of carefully structuring MIP/employee share programs in the future to avoid unintended tax consequences.

It will be interesting to see whether these binding rulings will be appealed and to follow the outcome of other pending rulings relating to carried interest. For now, the rulings stand and will have effect on already established MIP programs. In addition, there is a risk that the Danish Tax Agency may scrutinize already executed MIP programs, potentially leading to reassessments and additional tax liabilities.

^{[1] On 28 January 2025 the Swedish Ministry of Finance released its delayed memorandum on the taxation of carried interest, which proposes new tax rules for income derived from profit shares in private equity funds. See our newsletter on this matter here.}