This case concerned the Danish company, Swiss Re, Copenhagen Holding ApS, which was wholly owned by the US company, ERC Life Reinsurance Corporation.
In 1999 the group considered transferring the German subsidiary, ERC Frankona Reinsurance Holding GmbH, from the US parent company to the Danish company. The value of the German company was determined to be DKK 7.8 billion. The purchase price was to be settled by the Danish Company issuing shares with a market value of DKK 4.2 billion and debt with a market value of DKK 3.6 billion.
On 27 May 1999, the parent company and the Danish company considered to structure the debt as a subordinated, zero-coupon note. Compensation for the loan would be structured as a built-in capital gain in order to defer recognition of the compensation for the period 1 July 1999 to 30 June 2000. The Danish company would be unable to use a deduction in income year 1999. A built-in capital gain should be recognized in 2000 where payment of the first instalment would be made. If the compensation were structured as interest payments, the compensation should be recognized on an accrual basis. On 17 June 1999, a bank provided the Danish Company with information about market terms for a zero-coupon loan.
On 21 June 1999 the acquisition ofthe German company was approved with effect from 1 July 1999. On 14 September 1999. On 15 October 1999, the parties signed the loan agreement. The principal of the loan was fixed at DKK 4.9 billion corresponding to a market value of DKK 3.6 billion. The effective interest on the loan was 6.1 % per annum. The Capital loss associated with the first instalment on 30 June 2000 was DKK 222 million, which was claimed by the Danish company as a deduction in its tax return for 2000.
The Supreme Court affirmed the opinion of the High Court that section 34(5) (Danish statutes of limitation for controlled transactions) covered all types of adjustments of controlled transactions. The income years 1999 and 2000 were thus not time barred.
The Court further noted the following :
“The Supreme Court notes that the provision in Article 2(1) of the Act, according to which prices and conditions consistent with the ‘arm’s length principle’ are to be used in determining taxable income in respect of controlled transactions, covers, according to the preamble to the provision, all relations between the parties in interest, e.g. the provision of services, loan relationships, transfers of assets, intangible assets made available, etc. The provision allows tax authorities to make adjustments to transactions between connected parties where a transaction is not consistent with what would be obtainable between independent parties. The corrective power covers all economic elements and other conditions relevant for taxation, including for example the maturity, the accrual of interest and exchange losses and the legal qualification of the transaction.
A loan agreement on zero-coupon terms concluded between related parties with retroactive effect may thus be adjusted by the tax authorities on the basis of section 2(1) of the Tax Assessment Act. The Supreme Court further concurs that there is no basis to conclude that a final and binding agreement between Swiss Re Copenhagen Holding ApS and the parent company on the terms of the loan had been concluded before the signing of the loan agreement on 15 October 1999. On this basis the Supreme Court upholds the decision.”
The Supreme Court thus held that the loan agreement infringed on the arm’s length principle as laid down in section 2 of the Tax Assessment Act, and that the adjustment made by the tax authorities was warranted.