As a general rule, Danish tax law distinguishes between operating costs on the one hand, and capital and establishment costs on the other. Operating costs are, for tax purposes, deductible, while capital and establishment costs are not. Acquisition costs generally do not fall within the category of operating costs and are therefore generally not deductible. Because Danish tax law is based on a net income principle, under which only net income or net gain is taxable, such non-deductible acquisition costs are instead added to the purchase price of the asset in question and therefore may be depreciated or may reduce any taxable capital gains realised upon a subsequent sale of the asset.

However, pursuant to section 8J of the Danish Tax Assessment Act (TAA), acquisition costs paid to lawyers and auditors in connection with the establishment of a new business or the expansion of an existing business may be deductible, unless the costs are to be considered an addition to the purchase price or a deduction from the sales price of an asset. TAA section 8J does not provide for deductibility of costs paid to advisers other than lawyers and auditors.

At the beginning of the new millennium, a practice emerged pursuant to which the tax authorities distinguished between transactions structured as share deals and transactions structured as assets deals. Pursuant to the tax authorities, the mere holding of shares did not constitute a 'business' within the meaning of TAA section 8J and costs paid to lawyers and auditors in connection with such transactions were therefore – in the opinion of the tax authorities – not deductible pursuant to TAA section 8J.

However, this practice was set aside by the Danish Supreme Court in the Johnson Holding case (published in the Danish Journal of Tax Law (TfS) 2004, 542).

In Johnson Holding the Supreme Court stated that it followed from the Danish Act on Public Limited Liability Companies and the Danish Act on Private Limited Liability Companies that public and private liability companies must be conducting business, and that this corporate law requirement is also considered to be met in relation to a company which has no activity other than holding shares in another company. Accordingly, the starting point from a tax law perspective should also be that the holding of shares constitutes 'business'. The Supreme Court then stated that neither the wording of TAA section 8J, nor the preparatory works to the provision, supported an interpretation where the holding of shares did not constitute 'business' and held that the costs for lawyers and auditors incurred in connection with the incorporation of Johnson Holding were incurred in connection with the "establishment or expansion of a business" and were therefore deductible under TAA section 8J.

However, following the Supreme Court's ruling in Johnson Holding the tax authorities have established a new practice where most types of costs for lawyers and/or auditors in a share deal transaction are to be regarded as an addition to the purchase price paid for the shares and therefore may not be deducted under TAA section 8J. So far this practice has been upheld by the courts. For example in the ruling published in TfS 2006, 325, the Eastern High Court considered whether a company could deduct costs for lawyers and auditors incurred in connection with three separate share deal transactions. The services rendered by the lawyers and auditors consisted of assistance in negotiations with the sellers, due diligence, advice regarding transaction and corporate structure, tax advice and drafting of share purchase agreements and other transaction-related documents. The Eastern High Court held that such costs are typical in share deal transactions and therefore had such a "direct and close connection" to the purchase of the shares that they were to be regarded as an addition to the purchase price under TAA section 8J. Consequently, in the opinion of the Eastern High Court the costs were not deductible.

At least two cases dealing with the tax authorities' new interpretation of TAA section 8J are pending before the Supreme Court.

Other typical types of acquisition costs are fees and commissions paid to the lenders financing the acquisition. Pursuant to TAA section 8 (3), the following financing costs are deductible when due:

- periodical commissions and premiums; and

- commitment fees and similar non-recurring fees to the extent such fees do not exceed 2.5% of the principal of the loan in question, provided that the term of the loan is less than two years.

Commitment fees and similar non-recurring fees attributable to loans with a term of two years or more are not deductible pursuant to TAA section 8 (3). Such financing costs may instead be added to the cost base of the loans. Pursuant to the Danish Act on Capital Gains on Claims, Debt and Financial Instruments, losses on debt are deductible in the income year in which the loss is incurred, i.e. when the debt is paid wholly or partly. Thus, any financing costs that are not deductible pursuant to TAA section 8 (3) and which are added to the cost base of the loans may therefore be deductible indirectly as a loss on debt upon repayment.

The deductibility of management fees depends on whether such fees have been incurred in order to earn, secure or maintain the income of the company in question. In this regard, the distinction drawn in the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines between:

- the rendering of management services to a group company even though the group company does not need the services (shareholder costs); and

- the rendering of management services which are useful for the group company and which it would be willing to pay for were it an independent enterprise, has also been applied by the Danish courts in a number of cases.

This above distinction has been applied in a recent ruling from the Western High Court (not yet published in TfS) concerning a transaction bonus paid to a company's management in connection with the sale of the company. The ruling concerned a bonus agreement between the company and members of the company's management, under which the managers were to receive a cash bonus in the event of a sale of the company. The bonus would be calculated as a certain percentage of the sales price for the company, and the bonus would become payable only if a sale of the company were completed. The Western High Court noted that only costs incurred by a company in order to earn, secure or maintain the income of the company are deductible for tax purposes. The Western High Court found that the bonus agreement had been entered into in the interests of the shareholders of the company rather than in the interest of company, and therefore held that the company could not deduct the payment of the transaction bonus.

Danish transfer pricing legislation is based on the general arm's length principle and, consequently, any management fees paid to an affiliated entity will be allowed as a deduction only to the extent that the fees have been determined on the basis of the arm's length principle.

In the ruling published in TfS 2006, 634, the tax authorities claimed that a management fee paid by a parent company to its subsidiary did not reflect an arm's length consideration. Under a management agreement between the parent company and its subsidiary, the subsidiary received a management fee calculated as 6% of the parent company's turnover as consideration for making management resources concerning production, administration, marketing and sales, available to the parent company. The tax authorities claimed that the real purpose of this management fee was to reduce the taxable income of the parent company by way of transfer of profit to the (loss-making) subsidiary, and argued that the arm's length principle had not been complied with. However, an expert appointed by the National Tax Tribunal stated that, in his opinion, the management fee did in fact reflect an arm's length consideration. As a result, the tax authorities withdrew the case after the Eastern High Court indicated that its ruling would be based on the expert's statement.

Arne Mollin Ottosen is a partner and Michael Norremark an attorney at Kromann Reumert in Denmark.