Judgment summary
This case concerned a loan of DKK 40,800,000 made by A, the sole shareholder, to his wholly owned company H1 on 3 October 2016, with an agreed interest rate of 1% per annum on demand terms and no security provided.
The tax authorities considered the agreed rate did not reflect an arm's length rate under ligningslovens § 2 and fixed the rate at 5% per annum, resulting in increased capital income assessments for A of 1,642,498 kr. for 2018, 1,651,320 kr. for 2019, and 1,625,877 kr. for 2020.
A appealed to Landsskatteretten, which upheld the tax authorities' decision. A then brought the matter before the District Court, seeking either a reduction of his capital income for 2018-2020 or remittal to the tax authorities for fresh consideration.
During the court proceedings it was undisputed that the tax authorities were entitled to fix the interest rate. The dispute concerned only whether A had shown that the discretionary assessment was based on incorrect grounds or led to a manifestly unreasonable result.
Background
A owned 100% of H1, a non-financial holding company. On 3 October 2016, A and H1 entered into a loan agreement for DKK 40,800,000, with an interest rate of 1% p.a., repayable on demand, and no security provided. The loan related to H1's purchase of a 50% shareholding in an associated company.
H1's annual accounts noted going concern uncertainty, recording that A had provided a statement that he would not require repayment of the balance until the company had funds to do so, and that he would provide further funds as necessary. The company had no turnover in any of the relevant years according to VAT filings, and its accounts showed negative equity in several years, with liabilities (including the shareholder loan) exceeding assets.
The tax authorities used credit rating models (S&P Global and Moody's analytics) to assess H1's creditworthiness, resulting in ratings of CCC+ and Caa-C respectively, indicating substantial risk. The tax authorities also referred to Danmarks Nationalbank's interest rate statistics for the last three months of 2016, showing an upper decile effective rate of around 5.02% to 5.218% for outstanding business loans to Danish non-financial companies, compared with a lower decile of around 2.048% to 2.108%.
On this basis, the tax authorities increased the interest rate on the loan to 5% p.a. and correspondingly increased A's taxable capital income for 2018, 2019 and 2020. Landsskatteretten upheld this decision on 25 November 2024.
Core dispute
It was undisputed between the parties that the agreed 1% interest rate did not reflect the market rate between independent parties, and that the tax authorities were entitled to fix the interest rate under ligningslovens § 2.
The dispute was whether A had shown that the tax authorities' discretionary assessment, fixing the rate at 5% p.a. by reference to the upper decile of Danmarks Nationalbank's interest rate statistics, was made on an incorrect or deficient basis, or led to a manifestly unreasonable result.
A argued that the rate should instead be fixed at 3.5%, corresponding to the middle decile between the lower decile (2.108%) and upper decile (5.218%), contending that his position as sole shareholder gave him de facto security over the loan through his control of H1, that the company's negative equity did not reflect its true financial position because subsidiary shareholdings were recorded at cost rather than real value, and that he had diligently researched market rates using Danmarks Nationalbank's average deposit rate of 0.14% before setting the rate at 1%.
The Ministry of Taxation argued that the tax authorities had properly taken into account relevant factors, including the loan principal, H1's financial position, auditor's comments on the annual accounts, credit assessments, the lack of security, and the expected repayment period, and that the discretionary assessment was neither based on an incorrect footing nor manifestly unreasonable.
Court findings
The court found that a loan between a majority shareholder and his company is a controlled transaction, so that prices and terms must be fixed on arm's length terms under ligningslovens § 2. As the agreed rate was not at arm's length, the tax authorities were entitled to fix the rate at their discretion.
The court held that such a discretionary assessment can only be set aside if the taxpayer shows it was made on an incorrect or deficient basis or led to a manifestly unreasonable result.
The court found that the tax authorities had taken into account relevant factors, including the loan's principal, H1's financial position, the auditor's comments on the annual accounts, the credit assessments of the company, the lack of security, and the expected repayment period. The court noted that the credit assessments (exhibits F and G) consistently showed the loan to be quite risky.
The court considered that the risk was underscored by A's statement that he would not require repayment until H1 was able to pay, despite the company having no turnover or positive equity, meaning there was no timeframe for repayment. It followed that the demand feature in the loan document could not be given weight.
The court agreed with the Ministry that it made no difference that A was sole shareholder, since in the event of the company's insolvency he would rank as an ordinary unsecured creditor, not as one with genuine security such as a mortgage institution. It held that reliance on the tax authorities' use of the upper decile of Danmarks Nationalbank's interest statistics was neither an incorrect basis nor manifestly unreasonable, noting the comparison with the average mortgage lending rate of 2.727% on secured loans over DKK 7.5 million with maturities over 10 years at the end of 2016.
The court found A had not shown that irrelevant factors were included or relevant factors omitted, nor that the result was manifestly unreasonable, noting the difference between the assessed 5% rate and A's claimed 3.5% rate was only 1.5 percentage points. The court also noted that A had withdrawn his request for an expert valuation (syn og skøn) before it could be answered, and had not submitted evidence on the value of the shareholdings in the subsidiary that would alter the picture of the company's equity.
The court concluded that A had not discharged his burden of proving that the tax authorities' discretionary assessment of a 5% rate was made on an incorrect or deficient basis or led to a manifestly unreasonable result.
Outcome
The Ministry of Taxation was acquitted (frifundet). A was ordered to pay costs of 57,500 kr. to the Ministry of Taxation, payable within 14 days, with interest under rentelovens § 8 a. The court noted the costs took into account that the case had been heard together with a related case brought by the company, which had been withdrawn with a separate costs award.
Tp method highlighted
The tax authorities fixed the arm's length interest rate by reference to Danmarks Nationalbank's interest rate statistics (DNRUPPPI) for outstanding domestic effective lending to Danish non-financial companies, using the upper decile for October to December 2016, which ranged from approximately 5.018% to 5.218%, and set the rate at 5% p.a.
The tax authorities also had regard to credit ratings of H1 produced using S&P Global and Moody's analytics models, which rated the company CCC+ and Caa-C respectively, categories described as 'Substantial risks', 'Extremely speculative' or 'In default with little prospect for recovery'.
Other factors taken into account included the loan's principal (40,800,000 kr.), the absence of security, H1's negative equity in several years, the auditor's going concern note, the lack of turnover, and the indefinite repayment horizon arising from A's undertaking not to demand repayment until H1 had the funds to pay.
A argued for a rate of 3.5%, being the midpoint between the lower decile (2.108%) and upper decile (5.218%) of the same statistics, contending this better reflected the de facto security arising from his control of H1 as sole shareholder.
Major issues / areas of contention
- Whether a loan between a sole shareholder and his wholly owned company constituted a controlled transaction requiring arm's length pricing under ligningslovens § 2.
- Whether the tax authorities were entitled to fix the interest rate on the loan by discretionary assessment given the parties agreed the 1% rate was not at market level.
- Whether the tax authorities' discretionary fixing of the rate at 5% p.a. was based on an incorrect or deficient factual basis.
- Whether reliance on the upper decile of Danmarks Nationalbank's interest rate statistics, rather than the middle decile, was appropriate given the risk profile of the loan.
- Whether the absence of security should be discounted because the shareholder, as sole owner of the company, had indirect control over the underlying assets.
- Whether the company's negative equity, arising partly from recording subsidiary shareholdings at cost rather than real value, undermined the credit assessment used by the tax authorities.
- Whether the taxpayer's own market research based on average bank deposit rates was a sufficient benchmark for setting the interest rate on a large unsecured loan.
- Whether the resulting difference between the assessed rate (5%) and the taxpayer's claimed rate (3.5%) was so small as to preclude a finding that the assessment was manifestly unreasonable.