Proposed changes to limited tax liability and withholding tax obligation on interest and royalty

As a general rule, foreign companies are subject to limited tax liability in Denmark if they receive interest from Danish sources on controlled debt. However, certain exemptions apply, including where the interest is exempt or subject to a reduced rate under Directive 2003/49/EC or a relevant double taxation treaty. The exemptions do only apply if the paying company and the receiving company are associated for a continuous period of at least 1 year within which the time of payment must fall.

The proposed amendment aims to ensure that the rules on limited tax liability for intra-group interest effectively counteract tax planning. This is particularly relevant in cases where intra-group interest is deductible in Denmark while the recipient company pays very little or no tax on the corresponding income.

Under current rules, an interest-receiving company is tax liable in Denmark of intra-group interest if the interest-paying company is either fully tax liable in Denmark or has a permanent establishment in Denmark. Under the same conditions the receiving company is also taxable on certain capital gains from Danish sources allocated to real estate. This could be when a loan is structured to be repaid at a predetermined premium rather than accruing interest. 

Under the proposed new rules, the interest-receiving company will also be subject to taxation if the interest-paying company is limited tax liable on income from real estate in Denmark. Accordingly, the scope of limited tax liability on interest is expanded beyond cases where the interest-paying company is fully tax liable in Denmark or has a permanent establishment. Limited tax liability on income from real estate could for instance be the case, when a foreign company owns real estate in Denmark without having a permanent establishment because the property is managed by an independent representative.

As for royalty payments foreign companies and foreign individuals are subject to limited tax liability in Denmark if they receive royalty from Denmark. However, certain exemptions apply, including royalty that falls under Directive 2003/49/EC. This exemption does only apply if the paying company and the receiving company are associated for a continuous period of at least 1 year within which the time of payment must fall. 

Furthermore, amendments are proposed to the withholding tax rules regarding royalties and interest. 

Under the current the rules the interest paying company (or the company on whose behalf the payment is done) is obliged to withhold the relevant tax on interest if the company has jurisdiction in Denmark according to the Danish Administration of Justice Act. This means that a foreign company that has a permanent establishment in Denmark but is not considered having jurisdiction in Denmark as described, will not have an obligation to withhold tax on the interest. In such a case, withholding tax will only apply if the payment is made by a third party in Denmark, with jurisdiction in Denmark, on behalf of the foreign company. The same rule applies to the aforementioned situation concerning specific capital gains, as well as to royalty payments. For both interest and royalty, the limited tax liability is final with the withholding tax and therefore it is not possible to make a claim against the receiving company when the withholding is not made. 

The proposed amendment to the interest and royalty withholding tax rules means that a foreign company with a permanent establishment in Denmark or limited tax liability due to real estate ownership in Denmark must withhold tax on interest or royalty when making payments to an affiliated foreign company subject to limited tax liability on the interest and royalty. The same is relevant if another entity is paying the interest or royalty on behalf of the mentioned foreign company. This will be the case no matter whether the entity has jurisdiction in Denmark as described above. If withholding tax is not applied, the Danish Tax Administration may collect the tax from the entity responsible for withholding tax. The tax may also be recovered through enforcement against the company's assets in Denmark. If the company is domiciled in an EU country or a country with a mutual assistance agreement on tax collection similar to EU regulations, enforcement may also be pursued in the company’s home country.

Furthermore, it is suggested that when payment of interest or royalty is made by a third party on behalf of the interest/royalty paying company, the third party is joint and several liable for the withholding tax.  This way the Danish Tax Administration may collect the tax from the third party even if they have not tried to collect the claim from the company that is in fact paying the interest/royalty. 

If the draft legislative proposal is passed it will have effect from 1 July 2025.