Thin Capitalization: What does it mean for a Danish Company?
- 3 minute read
- Legal & Corporate Law
Thin capitalization is a complex tax concept that can have a significant impact on your company’s finances. Let’s explore the thin capitalization rules in Denmark and their potential impact on your company.
What is thin capitalization?
Thin capitalization occurs when a company has a disproportionately large proportion of debt in relation to equity.
In Denmark, a company is considered thinly capitalized when:
- It has controlled debt
- The company’s total debt – measured in relation to the company’s equity calculated at market value at the end of the income year – exceeds a ratio of 4:1.
These rules are set out in Section 11 of the Danish Corporation Tax Act to prevent the misuse of interest deductions to reduce taxable income.
Key elements in thin capitalization
Controlled debt.
Think of controlled debt as debt to your group-affiliated companies – this could be your parent company, subsidiaries or affiliates. However, there is a triviality limit: If your controlled debt does not exceed DKK 10 million, your company is exempt from the rules regarding thin capitalization.
Debt-equity ratio.
If the total debt (controlled and non-controlled) at the end of the income year exceeds equity x4 (i.e. equity is less than 20% of the balance sheet total calculated at market value) AND there is controlled debt of more than DKK 10 million, the right to deduct interest and capital losses on intra-group loans will as a rule be cut off or limited.
However, the deduction reduction only takes place for that part of the controlled debt that would have to be reclassified as equity in order for the ratio between debt and equity at the end of the income year to be 4:1 (corresponding to equity that constitutes 20% of the balance sheet total).
Calculation of equity and debt
It is important to understand how equity and debt are calculated in relation to the rules on thin capitalization. The equity that forms the basis for assessing the debt-equity ratio is typically significantly different from the company’s accounting equity:
- All assets and debt in the company must be calculated at market value.
- Unrecognized intangible assets, such as accrued goodwill, must also be calculated and included in the assessment.
- Land and buildings may have a higher value than the book value and must be assessed on the balance sheet date.
Debt and thin capitalization
The term ‘debt’ is defined here as debt in accordance with claims covered by the Capital Gains Act. Furthermore, the debt must exist on the balance sheet date. This means that, for example, provisions for deferred tax do not count as debt in this context. Equity then constitutes the difference between the calculated assets and debt items, incl. convertible bonds issued by the company.
Contributed equity is only included as equity to the extent that it remains in the Danish company for at least 2 years. If it subsequently turns out that contributed equity does not remain in the Danish company during that period, the tax authorities will be able to resume the previous tax assessments in order to implement a deduction limitation.
How to avoid deduction limitations
The deduction limitation will be limited to an amount corresponding to interest and capital losses on the part of the controlled debt that would have been converted to equity if the deduction reduction had been avoided. That is, the part that must be reclassified before the debt-to-equity ratio reaches 4:1 (with equity representing at least 20% of the balance sheet total).
To avoid the deduction limitation, here are some good tips:
- Keep an eye on the debt-to-equity ratio
- Consider converting debt to equity, if necessary
- Please note that contributed equity must remain in the company for at least two years to be counted.
