New Danish landmark ruling on exit taxation

The case concerned an Indian married couple who in May 2016 obtained residence and work permits in Denmark under the Start-up Denmark scheme. The spouses rented accommodation in Denmark, obtained a registered address here and were registered as fully tax liable in Denmark from 15 May 2016.

However, the spouses reported their global income in India, as they had no income in Denmark. They stayed in India for 8 and 10 months respectively in 2016 and 2017, where they operated a business with an annual turnover exceeding DKK 4 million. They also held savings and investment accounts in India, while there was only minimal activity on their Danish bank accounts.

It was documented by a certificate of residence from the Indian tax authorities that the spouses were tax residents in India in 2016 and 2017, where they had the strongest personal and economic ties (centre of life interests).

In March 2018, the spouses relocated their actual base to Denmark. From that point, income from the Indian business ceased, and income was instead generated in Denmark. They were considered tax resident in Denmark from that time.

The spouses intended to leave Denmark before the end of 2023 and expected their full tax liability to Denmark to cease in that connection. At that time, they had been fully liable to tax in Denmark for more than 7 years but had only been tax resident in Denmark for slightly more than five years.

The appellant's representative argued that section 38(1) and (3) of the Danish Capital Gains Tax Act (Da. "Aktieavancebeskatningsloven" or in short "ABL") must be interpreted in conjunction.

It follows from ABL section 38(1), third sentence, that a change in tax residence under a DTT is equated with cessation of tax liability. At the same time, 38(3) provides that the rules in 38(1) only apply to persons who have been liable to tax for at least 7 years within the preceding 10 years.

The representative argued that section 38(3) must be regarded as an exception to section 38(1), and that there should accordingly be symmetry between the provisions. Periods during which a person is not tax resident in Denmark should, according to this view, not be included in the seven-year period.

It was further emphasised that such an interpretation is consistent with the purpose of the provision, to ensure Danish taxation of gains accrued in periods where Denmark has the right to tax any gains on shares. Since Denmark only has the right to tax capital gains on shares as long as the person is resident in Denmark, it would make sense that only periods during which the person is resident in Denmark are counted towards the seven years.

The Danish Tax Agency emphasised the wording of the provision. It follows directly from ABL section 38(3) that the decisive factor is whether the person in question has been liable to tax under section 1 of the Danish Withholding Tax Act (or section 2 in respect of gains on shares) for a total period of at least seven years within the preceding ten years.

They stated that there is no basis in the wording of the provision or its preparatory works for taking into account to which country the right to tax capital gains on shares is allocated.

The Danish Tax Agency further emphasised that a distinction must be drawn between:

• the criteria for whether a person is subject to exit taxation, and
   
• the calculation of which values are to be taxed.
   

The Danish Tax Agency therefore disagreed with the appellant, which the Tax Council endorsed.

The case was brought before the National Tax Tribunal, which established that the appellant had been fully liable to tax in Denmark for seven years and seven months, while the appellant had only been tax resident in Denmark for five years, ten months and 16 days.

The Tribunal found that ABL section 38(3), according to its wording, encompasses all periods of tax liability under sections 1 (or 2 in respect of gains on shares) of the Danish Withholding Tax Act, regardless of tax residence.

The Tribunal referred, inter alia, to the fact that:

• there is no basis in the wording of the provision or its preparatory works for reading in a requirement of tax residence in Denmark, and
   
• previous legislative amendments did not intend any change in the legal position on this point.
   

The fact that a person was simultaneously tax resident abroad is therefore irrelevant for the fulfilment of the seven-year rule.

As the appellant had been fully liable to tax in Denmark for more than seven years, the condition in ABL section 38(3) was satisfied. The appellant's unrealised capital gains on shares were therefore subject to taxation upon emigration.

The National Tax Tribunal thus upheld the Tax Council's decision.

The decision is of fundamental importance and clarifies a question that in practice has given rise to considerable uncertainty.

It may seem paradoxical that a period during which a person is only fully liable to tax in Denmark – but tax resident in another country – should count towards the seven years, given that Denmark's right to tax a capital gain on shares is conditional on the person being tax resident in Denmark. However, this is how the rules are to be interpreted according to the latest case law.

The decision is highly relevant for persons who have already established or are establishing a residence in Denmark, but who under a DTT remain tax resident in another country. If such persons give up their residence abroad or are considered having a stronger connection to Denmark etc. and thereby become tax resident in Denmark, exit taxation may become a reality sooner than otherwise expected, as it is not only the period of tax residence that counts. This means that they will need to consider leaving Denmark again earlier than otherwise to avoid the exit taxation, and that it may already be too late at the moment they become tax resident in Denmark.