New binding ruling - exit programme considered subject to section 7 P of the Danish Tax Assessment Act
On 27 April 2021, the Danish National Assessment Council confirmed in a binding ruling that warrants granted to a company's employees can be considered subject to section 7 P of the Danish Tax Assessment Act, even if it was only possible to exercise such warrants in connection with an exit event. Plesner advised the company.
Previous practice concerning exit bonuses
The tax treatment of bonuses paid to employees in connection with exit events, including sales and stock market listings, has developed in recent years.
Previous practice has primarily focused on whether a company's expenses associated with the payment of bonus to executive officers in connection with an exit event could be deducted as operating expenses under section 6(1)(a) of the Danish Central Government Tax Act. So far, taxation of the employees has not been addressed by the courts or the tax authorities.
In a binding ruling from 2016, TfS 2016, 573, the Tax Agency (at the time, SKAT) indicated its position on the matter. In the case, SKAT and the Danish Tax Assessment Council considered whether a company's granting of options to a number of employees was subject to the rules on taxation of share-based payment in section 7 P of the Danish Tax Assessment Act. The options could be exercised both when reaching a specific vesting date and in connection with a stock market listing or a change of control.
SKAT concluded that the conditions for taxation under section 7 P were fulfilled, and the Danish Tax Assessment Council concurred in this. SKAT noted, however, that if the options could only be exercised in connection with an exit event, the options would, in SKAT's opinion, not have been granted as remuneration in an employment relationship, and would therefore fall outside the scope of section 7 P of the Danish Tax Assessment Act. The Danish Tax Assessment Council stated in its annual report that in the above-mentioned binding ruling the Council had not addressed the tax treatment of pure exit programmes.
In the specific case, a number of employees had been granted warrants in a Danish company. As far as some of the employees were concerned, it had been agreed that the warrants were to be subject to section 7 P of the Danish Tax Assessment Act for tax purposes. Agreements on the application of section 7 P of the Tax Assessment Act had both been entered into with executive officers and with non-executive officers.
It was particular to the agreement on the granting of warrants entered into with non-executive officers that the warrants granted could generally only be exercised in connection with an exit event, for instance a sale of the company or a stock market listing. As for the members of the management, the warrants could be exercised after a predetermined period of time, regardless of whether an exit was completed.
As the company was close to an exit event, the company wanted confirmation that all the warrants granted could be considered subject to section 7 P of the Danish Tax Assessment Act for tax purposes.
In the case, focus was on whether the warrants granted to non-executive officers could be deemed to be “received as part of an employment relationship” within the meaning of section 7 P of the Danish Tax Assessment Act, regardless of the fact that the warrants could only be exercised in connection with an exit event, as there was no doubt that the other conditions in section 7 P were fulfilled.
It was a fact of the case that warrants had been granted for the purpose of supporting the employees’ ongoing work, and not for the purpose of employees carrying out work targeted at the exit event.
Moreover, the vast majority of the employees subject to the exit programme did not know about of the exit event, just as the employees’ work assignments had been unchanged during the exit procedure.
The Tax Assessment Council's answer
The Tax Assessment Council concurred in the Tax Agency's reasons and its recommendation that all warrants could be considered subject to section 7 P of the Danish Tax Assessment Act.
Overall, the Tax Agency stated in the recommendation that the question as to whether the warrants could be deemed to have been “received as part of an employment relationship” within the meaning of section 7 P of the Danish Tax Assessment Act should be determined on the basis of the existing practice on companies’ right to deduct exit bonuses.
As for the employees who had not known about the exit event, the Tax Agency and the Tax Assessment Council emphasised that the employees had not had direct knowledge of the exit event, nor any knowledge that they were to work for the purpose of the exit event in question. Furthermore, the Tax Assessment Council emphasised that the warrants had been granted for the purpose of supporting the employees’ ongoing work.
As for the employees who had known about the exit event, the Tax Agency and the Tax Assessment Council emphasised that the employees had not only been granted the warrants for the purpose of having to work for the purpose of the exit event in question.
On this background, the Tax Assessment Council confirmed that the warrants granted were subject to section 7 P of the Danish Tax Assessment Act.
The company was represented by a team of Plesner attorneys.
The outcome of the binding ruling is a matter of general public importance, as the ruling appears to be the first intimation that share-based payment, the granting of which is tied to an exit event, can be subject to section 7 P of the Danish Tax Assessment Act.
This is a positive result, as the legislator’s intention by introducing section 7 P of the Danish Tax Assessment Act was to create a stronger basis for companies to attract and retain talented employees, among other things. In particular with respect to start-ups, which are rarely able to offer a market consistent salary, it may make a difference that such companies are able to offer share-based payment. In practice it is seen that the exercise of such share-based remuneration is tied to an exit event for the purpose of ensuring, among other things that the start-up company is not encumbered by the administrative burdens of having a large number of shareholders, and based on the practical consideration that employees can rarely afford nor have any wish to exercise warrants to purchase unlisted shares in a situation where there is no prospect of being able to sell the shares again, and where there is a significant risk of loss.
However, specific reasons are given for the Tax Assessment Council's decision, and the Tax Agency must be expected to continue being sceptical with regard to the possibilities of allowing warrants and options which can only be exercised in case of an exit be subject to section 7 P of the Danish Tax Assessment Act.
Therefore, to the extent that a company has a purely exit-based programme, it should be considered carefully whether such programme may come within the scope of the practice that has now been established, just as it should be considered in general when establishing new programmes to include a possibility of also exercising warrants outside exit situations.