New advance tax rulings expand the scope of carried interest taxation

According to two new advance tax rulings from the Danish Tax Assessment Council (SKM2025.46.SR and SKM2025.47.SR), under certain circumstances, investments directly in portfolio companies owned by a private equity or venture capital fund may also be subject to taxation under the carried interest taxation scheme.

The carried interest taxation scheme was introduced for the purpose of taxing “private equity partners” who received an above-normal return on their co-investments in the fund as personal income (up to 56%) instead of as capital gains on shares (up to 42%). The rationale for reclassifying capital gains as personal income was that the excess return represented remuneration for the private equity partner’s work in the fund, rather than a return on an investment in the fund as an investor. Accordingly, the rules have generally been understood to only cover a person’s investment in the fund, rather than an investment directly in a portfolio company.

However, two new advance tax rulings from the Danish Tax Assessment Council expand the scope of the carried interest taxation scheme. In these rulings, the Danish Tax Agency concludes that investments made outside the fund directly in an underlying portfolio company may also be subject to carried interest taxation.

The two advance tax rulings concerned the same transaction: Two Danish companies (the target entities) were sold to a buyer entity controlled by a private equity fund. As part of the sale, the seller (Questioner 1) was required to reinvest a part of its sales proceeds in the buyer entity by way of subscribing for shares in the buyer entity. Another person (Questioner 2) was required to subscribe for new shares in the buyer entity as well. Each of the Questioners was part of the management of the target entities and buyer entity. The shares subscribed for by the Questioners had certain preferential economic rights to the effect that, in the subsequent sale of the buyer entity, the Questioners received proceeds exceeding their respective share of the total “participant capital” (in Danish: deltagerkapital), according to the Danish Tax Assessment Council.

As set out in Section 16i of the Danish Tax Assessment Act, the following criteria must be met for the application of the carried interest taxation scheme:

1. The excess return on the investment must be earned by a person who is fully liable to tax in Denmark.
2. The person must have a preferential position in the investment fund.
3. The fund must be a private equity, venture capital or infrastructure fund.

A person is considered to have a “preferential position”’ when it is agreed that the person’s proportionate share of the returns from “investments made through the fund” exceeds the person’s proportionate share of the total “participant capital” (i.e. capital provided to the fund, including both capital contributions and loan capital contributed by participants in the fund).

What is “new” in these rulings is that “investments made through the fund” cover also investments outside the fund and directly in a portfolio company in which the fund has invested, and that the person’s affiliation with the fund is not the decisive factor, but rather whether the person has a “preferential position”.

Further, an investment “through the fund” requires that the investment shall be made in accordance with the fund’s contractual basis (typically a limited partnership agreement). In the two rulings, the Danish Tax Assessment Council specifically emphasizes that it is of no importance that the Questioners had no knowledge of the contents of the fund’s contractual basis, and in this case, it was not substantiated that the investment was not made in accordance with the fund’s contractual basis.

The above indicates that the scope of the carried interest taxation scheme extends somewhat beyond the scenario where a fund manager is compensated by way of carried interest. It is difficult to assess the precise scope of the rules based on these rulings, but they do give rise to concerns with respect to companies with private equity or venture capital funds in their ownership structure, where other shareholders or participants can be said to have invested “through the fund” and have a “preferential position”.

Particularly with respect to incentive programs, which often give the participants the right to subscribe for or acquire shares at a favorable price, the rulings give rise to the question of whether such programs in companies with private equity or venture capital funds in their ownership structure could potentially be covered by the carried interest taxation scheme.

We will continue to closely monitor the development of practice within the carried interest taxation scheme.

The two advance tax rulings can be found here and here.

Tags:  Venture Capital