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The Danish courts set limits as the Danish tax authorities continue to challenge deductibility of business expenses

In recent years, the Danish tax authorities have significantly increased their attention on deducibility of business expenses.

This increased attention has inter alia materialized in a number of court cases whereby the Danish tax authorities have sought to narrow the scope of deductible expenses via case law. Several of these cases have come as a surprise for taxpayers. Firstly, because they have concerned types of expenses that have been accepted as deductible by the tax authorities for years. Secondly, these cases have been conducted as tax reassessments for individual taxpayers concerning previous income years rather than as published changes of interpretation with future effect.

The latest example in this respect is two High Court judgements concerning payroll costs for Danish banks. In its judgements the High Court ruled that it was a change of practice when in 2012 and 2013 the Danish tax authorities refused two Danish banks the right to deduct payroll costs paid in connection with the acquisition of other banking activities. The High Court clearly and unambiguously rejected the Danish tax authorities' attempt to tighten the practice with retroactive effect. However, at the same time the High Court allowed for a change of practice going forward, but in this way Danish taxpayers will be allowed to adapt to the change and to spark an upfront political debate in parliament. Plesner represented the taxpayers before the High Court.

Commencement of the cases

By decisions in 2012 and 2013 the Danish tax authorities refused two Danish banks to deduct payroll costs that they had paid in connection with the acquisitions and attempted acquisitions of other banking activities in connection with the financial crisis.

Both cases were appealed to the Danish National Tax Tribunal which ruled in favor of the banks. The Danish Ministry of Taxation brought the cases before the courts where, at the Ministry's request, they were heard by the Danish Eastern High Court as the court of first instance because they were of general public importance.

The Danish tax authorities made similar decisions in respect of other banks and at this point in time nine of those decisions have been brought before the Danish National Tax Tribunal. One case is pending before the courts but it has been stayed pending the outcome of the two cases in which the High Court has now passed judgment.

Right to deduct payroll costs

Until now, payroll costs have been considered to be the typical example of a deductible operating expense under section 6 of the Danish State Tax Act. However, the provision of section 6 does not authorise deducting expenses used to expand a going concern. The Danish Ministry of Taxation therefore argued that the part of the banks' payroll costs covering work in connection with the acquisition of branches and banking activities as well as attempts at such acquisitions in the years 2008-2010 was not deductible.

The judgments by the High Court

The High Court found - as claimed by the Ministry of Taxation - that deduction for the part of the payroll costs covering work performed in connection with an expansion of a business can be refused. It was taken into account in both cases that the banks' acquisitions of other banking activities were expansions of the banks' activities as defined in the Danish State Tax Act.

But the High Court ruled for the banks in that the Danish tax authorities' decisions were such a material change of practice that it could not be made without a prior, publicly available notice. The reason was that in the relevant income years there was a general conception of the law also within the tax authorities corresponding to the banks' claims. Thus, the banks had a justified expectation that the part of the banks' ordinary payroll costs relating to the acquisition of banking activities was not to be calculated separately and that deduction for this part of the payroll costs would not be refused.

Judgments in favour of the banks were consequently passed.

The future importance of the judgments

By passing the two judgments the High Court has established that the Danish tax authorities' reinterpretation of section 6 of the Danish State Tax Act including a limitation on the right to deduct the businesses' ordinary payroll costs, even if it could be covered by the wording of the provision, is such a clear deviation from previous administration of the law that it could not have retroactive effect.

The breakdown of the businesses' ordinary operating costs into a deductible and a non-deductible part as wanted by the Danish tax authorities entails a large number of practical problems and problems of general public importance to be clarified if such breakdown is to be made on a justifiable basis in terms of the due process of law. It is therefore important that any future guidelines are not determined based on the results of a few cases selected by the Danish tax authorities but based on a thorough analysis of all relevant issues.

In this connection it should also be borne in mind that if the situation should occur, the Danish tax authorities' reinterpretation does not only affect the deduction for payroll costs but also all other traditional operating costs such as expenses relating to rent, electricity, heating and telephone and that the reduction in the businesses' right to deduct will not only affect expansions in the form of acquisitions but also all other activities not included in the individual business' actual operation.

It is therefore extremely important to the future determination of the businesses' operating cost deduction that the High Court clearly and unambiguously has rejected the Danish tax authorities' attempt to tighten the practice with retroactive effect.

The two judgments mean that the businesses have been ensured a procedure where it will be possible to involve all relevant parties to discuss the future concept of operating expenses and where more political issues such as the increased effective taxation of businesses, which a limitation of the right to deduct payroll costs etc. will entail, can also be brought into play.

Just before deadline of this article the Minsitry of Taxation has appealed the two judgements to the Supreme Court.