Danish Tax Authority (SKAT) Issues Favorable Ruling For Foreign Investors In A Danish Private Equity Fund As Not Having a Permanent Establishment in Denmark By Virtue of Their Investment

By: Jerald David August

In General: The View From the United States on What Constitutes a Permanent Establishment

A U.S. treaty may exempt from income tax computed on a “net basis” the business profits of an individual or company resident in a treaty country unless such business profits are attributable to a “permanent establishment” (PE) maintained in the United States by such individual or company. tax the business profits of a resident of a treaty country unless those profits are attributable to a “permanent establishment” maintained by that resident in the United States. See U.S. Tax Treaties with Canada, Article 7(1); Japan, Article 8(1); Netherlands, Article 3(1); United Kingdom, Article 7(1). [1]

On the other hand, if a foreign resident individual or company derives business profits from U.S. operations but does not have a PE in the U.S., then part or all of such business profits may avoid U.S. income tax. [2] The important issues of course are first what constitutes a permanent establishment and then what are business profits attributable to such permanent establishment.  Business profits attributable to a permanent establishment in the U.S. are taxed as if the resident of the foreign country was a citizen or resident of the United States. Withholding on such PE business profits is avoided or avoidable in accordance with §1441(c)(1) since the foreign resident is required to timely file an income tax return and make all required payments of tax with respect to such PE. Where a non-resident has a PE in the U.S. the rate of tax on business profits will be at maximum rates. Were a PE not involved the same items of gross income, e.g., interest, dividends, royalties, might qualify for exemption or reduced tax rate under a treaty article.

A pass-through entity, such as a partnership or trust, may be treated as maintaining a fixed base or U.S. permanent establishment and subject business profits to U.S. income taxation. In such instances, the income passes through to the foreign partner or beneficiary. [3] In the PE context, courts have held that a foreign partner has a U.S. permanent establishment on account of the partnership's permanent establishment. [4]

In general, for treaty purposes, the term “permanent establishment” means a “fixed place of business” through which the business of a business is wholly or partly carried on. [5] Many tax treaties list the type of facilities or assets that include a PE. This includes a branch,  office, factory, work shop or even sales outlet in some instances. A treaty may add “a warehouse” to the list of assets that make up a PE.  A company’s place of management may also be treated as a PE. [6] It is generally accepted that the ownership of stock in a U.S. corporation by a resident of a treaty country such as a foreign holding company, does not by virtue of such ownership have a PE in the U.S. [7]

On the investor in the U.S. issue, the Service ruled that a foreign trustee that had a bank in the U.S. to hold and invest funds did not have a PE in the U.S. [8] On the other hand, the Service has held that an investment company had a U.S. PE through because it had a U.S. agent with discretionary rights to purchase and sell U.S. securities. [9]

Permanent Establishment Under Denmark’s Tax Law: Application to Foreign Investors In Venture Capital or Private Equity

Under Danish tax law, it is our understanding that the concept of a PE is based in accordance with Article 5 of the Organisation for Economic Cooperation and Development (OECD) Model Treaty both for domestic tax law and treaty purposes. A foreign investor is deemed to have a PE in Denmark where: (i) the investor carries on business through a fixed place in Denmark; or (ii) a dependent agent has the authority to conclude contracts on an investor's behalf that are legally binding on the investor in Denmark. As in the U.S., business profits attributable to a PE in Denmark are subject to Danish taxation on a net basis.

In most instances a foreign investor will not invest in a fund situated in Denmark if it would give rise to source taxation based on the presence of a PE.  Previously the National Tax Board of Denmark had concluded in a number of cases involving venture capital and private equity structures that no PE existed with respect to the foreign investors. However, in 2014, the National Tax Board concluded that a limited partnership of had a PE  in Denmark, and therefore each foreign limited partner would be deemed to have a PE in Denmark, were the general meetings of the partnership were held at the offices of the management company located in Denmark. Furthermore, the management team was active in decision making at all levels through managerial personnel in both of  companies. The Tax Board emphasized the fact that the management team had participated in the investment itself.

This ruling initially was of concern to many investors that foreign private equity investors could be liable to tax in Denmark and frustrate cross-border venture capital and private equity deals in Denmark.

On the heels of that decision in a subsequent National Tax Board decision held foreign investors in a Danish private equity fund were found not to have a PE in Denmark which allayed the fears and concerns from the prior ruling.

Fast Forward to January, 2017: Favorable Ruling Issued by Danish Tax Authority On Foreign Investment in a Danish Private Equity Fund Investment in a Danish private equity fund by foreign investors will not automatically give rise to a permanent establishment, according to a binding ruling  issued by the Danish Tax Authority (SKAT) published on January 6, 2017.

In the January 6 ruling, SKAT found that foreign investors in a newly established Danish private equity fund would not have a PE in Denmark because the fund had no employees of its own, and none of the legal entities involved in its operation constituted agents operating on behalf of the foreign investors.

The ruling was requested by a management company that had established a private equity fund which wanted to attract foreign investors to invest in a portfolio of medium-size Danish companies.  The PE fund was established as a Danish limited partnership with a Danish business foundation serving as the general partner. Quite importantly the fund did not have any employees or an office in Denmark. The foreign investors were to invest only as passive limited partners and had no active role in the fund's management.

The structure of the private equity fund was carefully tailored to obtain a favorable ruling most particularly the fact that the general partner in the fund is a Danish business foundation with a board of directors that is independent from the management company and the limited partners. The board of directors make the investment decisions and are not subject to direction by anyone, but do receive a fee for their services.

The daily administrative work of the fund is outsourced to the management company, which also made a direct investment in the fund. However,  the management company's roles as investor and administrator were legally separate, and the management company was paid an arm's-length fee for its administrative work.

The ruling evaluated whether a PE exists under Article 5 of the relevant (unidentified) income tax treaty which was identified as corresponding to the OECD model convention. The first item was whether the limited partnership (fund) had a fixed place of business in Denmark. The answer was no as the mailing address for the limited partnership is its attorney's offices. Next, SKAT addressed with the general partner, the board of directors of the general partner, or the management company would constitute agents on behalf of the foreign investors resulting in a PE.  The SKAT dismissed that a general partner’s presence in Denmark would impute PE status to the foreign investors. That’s not quite the U.S. position on the subject is it? See §875(1).  Similarly, the SKAT rationalized that the management does not constitute a PE of the limited partners because the management company, in its administrative capacity, is legally and financially independent of the limited partnership. The management company had no authority to conclude contracts on behalf of the limited partners but only provided advisor and administrative services.  The SKAT further held that the board of directors of the foundation general partner was not a dependent agent resulting in PE status under Article 5(6).

Implications to U.S. Investors To Denmark Private Equity Fund?

So the favorable ruling was obtained but it is not binding on the Internal Revenue Service. It simply shields U.S. limited partners in the fund from “full” income taxation on business profits from the private equity investments in Denmark. Nevertheless, the investors from the U.S. benefit from the SKAT ruling where they should feel more certain about their tax exposure to Denmark, i.e., it will be limited to FDAP items which are subject to treaty rate reductions or exemptions. [10]

Postscript on Another Recent Tax Development in Denmark

The Danish Tax Authority announced last Fall that it had acquired data in the Panama Papers containing tax information on as many as 600 Danes. SKAT stated that it paid approximately $1.3M (U.S.) for the papers, including documents, contracts and correspondence purchased from an anonymous source. The Danish authorities did a “sampling” of the data to be produced so that they would be confident the information would be authentic and accurate.  They were and the purchase was consummated.

So there presumably are some new tax investigation files opened in Denmark.   The Panama Papers which were revealed last Spring from the database of the worlds fourth biggest offshore law firm, Mossack Fonseca, , uncloaked concealed assets of hundreds of government officials, national leaders and other politicians, celebrities and sports stars who presumably evaded thru the use of shell companies, foundations, trusts and tax havens.


[1] Rev. Rul. 85-60, 1985-1 CB 187 (U.S. tax applied to foreign beneficiary of foreign trust that was limited partner in partnership with U.S. permanent establishment). Rev. Rul. 91-32, 1991-1 CB 107 (gain of foreign partner from disposition of an interest in a partnership with U.S. permanent establishment subject to U.S. tax under applicable treaty based on foreign treaty resident’s potential distributive share of unrealized gain of the partnership attributable to partnership's permanent establishment); Rev. Rul. 90-80, 1990-2 CB 170 (foreign person engaged in barter transactions in U.S. deemed to have permanent establishment in U.S. and subject to income tax on distributive share of gain);  Rev. Rul. 2004-3, 2004-1 CB 486 (IRS held service partnership's fixed base in U.S. was attributed to nonresident alien partner who performed no services in the U.S. by application of §875(1) and the case law and revenue ruling applying that provision in the treaty context).

[2] See, e.g., Rev. Rul. 86-156, 1986-2 C.B. 297 (equipment rentals paid by U.S. lessees to Netherlands company which did not have PE in the U.S.).

[3] See §1446 (withholding on distributive share of partnership income).

[4] See Donroy, Ltd. v. U.S., 301 F.2d 200 (9th Cir. 1962), aff’g 196 F. Supp. 54 (ND Calif. 1961)(Canadian corporations subject to US tax on distributive share of income of a California limited partnership engaged in business operations in the U.S.); Accord. Robert Unger, P-H TC Memo. ¶90,015 (1990), aff’d 936 F.2d 1316 (DC Cir. 1991).

[5] See, e.g., Canada, Article 5(1); Japan, Article 9(1); Netherlands, Article 2(1)(i)(A); United Kingdom, Article 5(1).  

[6]  Compare Elizabeth Herbert v. Comm’r, 30 T.C. 26 (1958), acq. 1958-2 CB 6 with Inez de Amodio v. Comm’r, 34 T.C. 894 (1960), aff’d, 299 F.2d 623 (3d Cir. 1962).

[7] See, e.g., Rev. Rul. 75-454, 1975-2 C.B. 512 (Article VI(2) of the U.S.- Swiss Income Tax Treaty).

[8] Rev. Rul. 55-200, 1955-1 C.B. 633.

[9] Rev. Rul. 55-282, 1955-1 C.B. 634.

[10]  See Article 5,  Denmark-U.S. Income Tax Treaty (1999); Treasury Explanation to Denmark-U.S. Income Tax Treaty and Protocol dated October 27, 1999.

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