New improved succession options close to becoming a reality

The long-awaited bill containing significant improvements to succession planning has just been introduced.

The main elements of the bill are:

1. legal claim for schematic valuation,
2. reduced estate and gift tax, and
3. extending the scope of gift tax to include siblings; and
4. Extended access to transfer real estate businesses with succession.

If the bill is passed in its current form, a number of changes will have retroactive effect. Below we provide an overview of the new opportunities that are on the way.

Background

In July 2024, the government sent the now proposed bill for consultation. We have previously mentioned the consultation draft of the bill on our website both in our article: "Generational change: New rules on the way significant relaxations" and in the article: "Generational change: New opportunities for rental companies".

Originally, it was expected that the bill would be introduced during December 2024.

The bill has therefore taken longer than expected. Overall, the proposed bill is in accordance with the previous consultation draft. However, a few changes have been made to the wording of the proposed new legal provisions, and the comments contain a number of clarifications and elaborations as well as further exemplifications.

Overview of the article sections:

Legal claim for schematic valuation

According to the current rules, the value of a company when calculating estate and gift tax must be set at the market value. If there is no objectively ascertainable value, the value must be determined according to an estimate. Guidelines have been prepared, respectively the goodwill circular and the share circular(TSS circular 2000-9 and TSS circular 2000-10) as well as guidelines in the Legal Guide, section C.C.6.4.1.2, which are typically used in the calculation of the market value when transferring between related parties.

If the proposed rules come into force, the bill's comments state that these circulars will be repealed. This leaves a gap in the valuation system for companies that are transferred between close family members, but where, for example, the succession conditions are not met. The same applies to transfers between affiliated companies, transfers between main shareholders, determination of exchange ratios in tax-free restructurings, and taxation of profits when tax liability ceases.

The bill does not elaborate on this, which creates legal uncertainty in the area.

The current share and goodwill circulars determine the value of the company based on the accounting equity with certain adjustments with the addition of a schematic calculated value of the company's goodwill.

To ensure security and predictability for businesses, it is proposed that family-owned businesses, including both companies and sole proprietorships, will in future have a legal right to use a schematic valuation method to calculate the value of the business in connection with generational change within the immediate family circle. This will give family-owned businesses certainty about the inheritance or gift tax that will be payable in the event of a generational change in the business.

The valuation will be based on the guidelines we know today from the share and goodwill circulars, but with specific changes in relation to the goodwill calculation.

In short, the method is based on the company's book equity plus a capitalized value of the company's excess earnings. The excess earnings are calculated on the basis of the accounting profits for the last 5 financial years prior to the transfer with certain adjustments. The lifetime of the excess earnings is determined based on a schedule that is a combination of the growth in the company's turnover in the last 5 financial years and the return on the company's operating assets. It is proposed that the maximum lifetime can be 15 years.

This entails a change compared to the current schematic calculation rules for goodwill, where only the last three financial years are used as a basis, and the current practice, which is based on a goodwill lifetime of 7 years, will be discontinued.

According to the current circulars, deferred tax is set aside on the calculated goodwill. This is not the case in the calculation examples included in the bill, but it appears from the comments that this should continue to be done.

With regard to book equity, it is also proposed that it should be adjusted when required in order to apply the schematic valuation method on the correct basis. This would be the case, for example, where there have been capital injections or dividend distributions of a significant size or where transactions have been carried out with the purpose of artificially reducing equity. Crucially, the valuation should not be based on the equity in the most recent financial statements if this would be objectively obviously misleading.

Furthermore, it is proposed that equity in a number of other cases must be adjusted. For example, real estate must be valued at market value, fair value in the financial statements or public property value (possibly estimated at the request of the owner). Likewise, the book value of intangible assets and any treasury shares are deducted.

Similarly, it is proposed that the results according to the financial statements for the last 5 years prior to the transfer must be adjusted when required in order to apply the schematic valuation method on the correct basis. This must be done if there have been significant changes in the company's circumstances that would make it manifestly misleading to base the schematic valuation method directly on the results in the historical financial statements. This may be the case, for example, if there have been significant divestments or acquisitions of businesses or the closure or start-up of significant operations. In these cases, the results from previous years are likely to be inaccurate and may need to be restated. In this case, it may be necessary to prepare "pro forma financial statements" for the company that reflect the changed circumstances.

It is also proposed to take into account that not all types of companies may have the same prerequisites for using the schematic method. Therefore, two exceptions should apply, as the following companies are not covered by the legal requirement to use the proposed schematic valuation method:

1. Companies whose activity consists primarily of the development and ownership of intangible assets that have not yet generated a return, and
2. Startups that have been around for less than three years.

The proposal for the legal requirement of a schematic valuation applies to both companies and personally run businesses that meet the conditions for the reduced estate and gift tax. This valuation method only applies to the calculation of estate and gift tax, and thus does not apply to valuation in other contexts, e.g. in the case of capital gains taxation upon cessation of tax liability or transfer in a principal shareholder relationship. In this connection, it is worth noting that if the transfer does not take place with tax succession, but the conditions for reduced estate and gift tax are met, two valuations may be required. In addition, the schematic method cannot be used for the valuation of a tank company that cannot be transferred with tax succession. In practice, however, the schematic method can be used to assess whether the money tank rule is met.

The legal requirement means that the parties have a choice between choosing a value according to the schematic valuation method or a value calculated at market value. If the parties choose a value calculated according to the schematic method, the tax authorities will check the calculation and adjust it if the value according to the schematic method is not calculated correctly. However, it must be expected that a choice to use the schematic valuation method will facilitate the dialog with the tax authorities and reduce lengthy discussions about the value.

Estate and gift tax reduced from 15% to 10%

Gifts given to persons within the gift tax group, including children, stepchildren, grandchildren, parents, etc. are tax-free up to a fixed annual amount, which is currently DKK 76,900 (2025 level). If the amount exceeds the tax-free threshold, it will be subject to a 15% tax. However, gifts to grandparents and stepparents are subject to a tax of 36.25%.

Gifts to siblings are subject to income tax under the current rules.

Inheritances to close family members are currently also subject to an estate tax of 15%. Inheritances to people outside the close family circle are subject to an additional estate tax of 25%, giving a total tax of 36.25%.

A previous government reduced the inheritance and gift tax rate in connection with generational change in businesses, which was to gradually fall from 15% to 5% over a period from 2016 to 2020. However, the uniform inheritance and gift tax of 15% was reintroduced from 2020.

The new bill proposes reducing the inheritance and gift tax rate to 10% for generational transfers in companies within the immediate family circle, provided that the following conditions are met:

1. The conditions for tax succession must be fulfilled (however, it is not a requirement that there is an actual transfer with tax succession)
2. The deceased/donor must have owned the business for at least 1 year prior to the transfer (ownership period requirement)
3. The deceased/donor or his/her close relatives must have participated actively in the business for at least 1 year of the ownership period either by participating in the operation of the business to a not insignificant extent (if personally run business) or by participating in management (if run as a company)
4. The heir/recipient must maintain ownership of the business for a minimum period of 3 years after the transfer (holding requirement)

These are the same safeguards that applied to the reduced estate and gift tax in the period from 2016-2019.

If the heir or legatee directly or indirectly transfers all or part of the business within 3 years of the transfer, the tax is increased to 15%. In the case of a partial sale, the increase in tax is only applied to this part. Furthermore, the increase is only applied to the proportional part of the 3-year period that has not already expired. The increased tax must then be calculated on the basis of the company's trading price and not on the basis of the schematic valuation mentioned above.

Siblings are included in the gift tax loop

As mentioned above, gifts to siblings are currently generally subject to income tax for the recipient. Thus, siblings are not covered by the gift tax.

In the new bill, it is proposed that siblings be added to the circle of close family members covered by the gift tax rules instead of the income tax rules. In the future, siblings will therefore be able to give each other gifts below the tax-free threshold without having to pay gift tax or income tax, and will also have to pay 15% in gift tax on the amount exceeding the threshold. Thus, there is a large saving on gifts between siblings compared to the current rules.

When transferring businesses between siblings, the proposed reduced estate and gift tax rate of 10% could be applied - provided that the conditions for this are met. Similarly, it is proposed that siblings only have to pay 15% in inheritance tax in the case of inheritance in general.

Active rental businesses can now be transferred with tax succession

The so-called "money tank rule" defines which businesses can be transferred with tax succession to close family members and certain employees.

If the transfer is made with tax succession, no capital gains tax is triggered by the transfer. Instead, the transferee assumes the transferor's tax position, including with regard to the acquisition price. The taxation of any profit is deferred to the later time when the acquirer disposes of the business.

However, the money tank rule means that companies that predominantly consist of passive capital investment cannot be transferred with tax succession. The law contains detailed mathematical rules for calculating whether this is the case. It is also directly stated in the text of the law that passive capital investment includes "real estate, cash, securities or similar".

Under current rules, rental businesses are considered passive capital investments. Owners of rental businesses or real estate companies that primarily engage in the rental of real estate have therefore not previously been able to take advantage of the favorable inheritance rules when transferring ownership of the business to the next generation.

With the new bill, it is now proposed to expand the access to succession so that rental business under certain conditions is no longer considered a passive capital investment. This means that owners of this type of business can in future have access to generational change with tax succession. This is provided that the rental business is an active rental business, which requires that a number of conditions are met.

1. Ownership share: More than 50% of the property is owned (directly or indirectly):
   Compared to the draft bill, it is now specified that both direct and indirect ownership shares must be included. In other words, direct or indirect ownership shares in a company that actively engages in rental activities must also be included. When calculating the ownership share, ownership shares owned directly or indirectly by members of the ultimate owner's immediate family are included. This means that generational change in the company is possible even if the controlling ownership share is distributed among several family members. It also allows for a gradual generational change, where the entire company is not transferred at once.
2. Key tasks must not be predominantly delegated to an independent third party:
   The task of entering into agreements of significant financial importance to the operation of the rental business must not be predominantly delegated to an independent natural or legal person who usually enters into the agreements or usually plays a decisive role in the conclusion of the agreements.Compared to the consultation draft, the wording has been changed so that the main focus is not on rental or lease agreements, but on all agreements of significant financial importance to the operation. However, it is still clear from the comments that such agreements include, among other things, lease or tenancy agreements, but also, for example, agreements on renovation or significant maintenance work.Furthermore, since the consultation draft, it has been added that it is crucial whether the agreement is "predominantly" handled by an independent third party. In the case of a residential property with a large number of leases, it will therefore not be sufficient for the family circle to exercise a decisive influence on the content of a single lease agreement of minor importance to the overall finances of the property.It is also specified that succession is not precluded by the fact that the company has entrusted the day-to-day administration and advice on the drafting of lease agreements, etc. to an independent third party, as long as the owners themselves make the key strategic decisions regarding such tasks, e.g. the rent level in the lease agreements.Furthermore, it is not decisive who formally signs the agreements. In other words, the condition will not be met even if the owner formally signs the agreements if the content of the agreement has been negotiated by an independent third party on behalf of the owner. This assumes that the owner's approval by signing the agreement is given without any changes being made to the content of the agreement negotiated by the independent third party. The owner's signature thus becomes a mere formality.An "independent third party" does not exist if the agreements are entered into or negotiated by employees of the rental company or employees of another company or enterprise with the same ownership structure.
3. Requirements for ownership period and duration of rental activity:
   The property must have been owned for at least one year and actively rented out throughout the entire ownership period (or the property must be part of a business that actively rents out real estate and has been owned for at least one year).If rental companies meet the criteria for being an active rental company, they are treated in the same way as other commercial enterprises in relation to generational change. This gives access to transfer with tax succession both during life and upon death, as well as access to the reduced inheritance and gift tax and the schematic valuation method, provided that the conditions for this are otherwise met.

Entry into force

The proposals to reduce the estate and gift tax on succession and the legal requirement for schematic valuation are proposed to be introduced with effect for gifts made on or after October 1, 2024 and for distributions from estates of persons deceased on or after October 1, 2024.

The proposal that rental companies are to be treated in the same way as other businesses in terms of access to succession options in the event of generational change is proposed to be introduced with effect for transfers as of January 1, 2025.

Finally, it is proposed that the change in the circle of close family to include siblings will apply from January 1, 2027.

Possibility to apply the new rules retroactively

It is proposed that the new rules will enter into force the day after publication in the Danish Official Gazette.

After the law comes into force, it will be possible to request a review of the estate or gift tax calculation in order to apply the reduced rate of 10% and of the valuation in order to apply the schematic valuation method.

For gift tax, this applies if the gift is made on or after October 1, 2024, and for estate tax, it applies to distributions from estates of persons who died on or after October 1, 2024.

It is not a requirement that the reopening concerns both the estate or gift tax and the valuation. It is possible to request a reopening of the estate or gift tax calculation only.

In that case, the valuation must be made at market value. It follows from the bill's comments that share and goodwill circulars may be used for the period until the day before the law enters into force.

This must mean that the tax authorities will not regulate a valuation made in accordance with share and goodwill circulars during the period from October 1, 2024 until the Act comes into force, even though these circulars are proposed to be repealed as of the effective date of the Act.

Are you facing a generational change in your business?

The proposed new rules are a significant improvement of the framework conditions for succession options in Denmark. In particular, the proposed relaxation of the possibility of generational transfer of rental properties is a breakthrough compared to current law. Experience also shows that there is a certain risk that the succession rules will be tightened again at a later date, depending on how the political winds blow.

Although this is still only a bill, it would be wise to start planning your succession now.

At CLEMENS, we have in-depth experience with all aspects of a succession - regardless of the type of business - as well as specialist knowledge in the related tax and duty-related areas. We can therefore safely guide you through the process from the initial considerations to the execution of the transaction.

Do you have questions about the bill or your succession planning?