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Especially start-ups and loss-making companies can get a liquidity respite with the tax credit scheme. However, the scheme is based on a complex set of rules.
Danish companies engaged in experimental and research activities that have not yet generated significant revenues have the opportunity to strengthen their liquidity with the tax credit scheme. It provides the opportunity to apply to the Danish Tax Agency for payment of the tax value of losses arising from expenses that are deducted as experimental and research expenses.
The “price” for obtaining the tax credit is that the loss on which the tax credit is paid is forfeited.
What conditions must be met to use the scheme?
It is a condition that the company has had tax losses arising from expenses incurred for experimental and research activities.
Experimental and research activities include, in particular, expenditure on basic and applied research, which is typically incurred by pharmaceutical or biotech companies. In addition, the rules cover the company’s expenditure on development work, i.e. the application of scientific or technical knowledge to produce new or significantly improved materials, mechanisms and products, processes, systems and services.
Development work is a somewhat broad and abstract concept. Whether the developed product is new or significantly better must be assessed in relation to the state of technical or scientific development in society at the time of development. The assessment can be difficult and complicated and often requires knowledge of relevant tax practices and a deep insight and understanding of the company’s development project.
Development work can include both technical and industrial inventions, robotics, improved production or manufacturing methods and the like. Designs can be included if the design itself gives the product new or greatly improved properties.
Software, AI, algorithm and source code development can also be covered by the scheme if the work is beyond routine software development. This means that bug fixes, minor bug fixes in the source codes and customisation to underlying system updates are not covered by the scheme.
In administrative practice, there are stricter requirements for when software development is considered new or significantly improved, as software is now widely used in society after the digitalisation of recent years. Software development is undoubtedly the type of development work that has given rise to the most tax credit cases. Thus, there seems to be a fundamental disagreement between the Danish Tax Agency and companies as to when the company has carried out new software development or when software development is of a routine nature.
The tax law criteria for obtaining a tax credit are therefore mainly based on technical and scientific criteria. The commercial potential of the project or the demonstration of innovation and innovation in the development process is not given more weight in the assessment.
Without a more detailed basis for this, the Danish Tax Agency also emphasises whether the project contains an element of novelty, an element of creativity and an element of uncertainty.
The company must be able to document that the project fulfils the tax law conditions for obtaining a tax credit. As a starting point, the company must be able to provide an adequate account of the functions and characteristics of the development project and be able to present a specification of the expenses or an hourly and case accounting if the expenses consist of labour costs.
It is not enough for the company to claim that the development project is completely new. It must also be demonstrable. Therefore, external verification of the development project must be attached, e.g. patent application, approval of grants or loans, statements or articles from experts, etc.
How do we claim the tax credit, and what is the process?
A tax credit can be claimed via the company’s tax return. There is a separate box for this purpose. At the same time, a statement and documentation supporting the development of new or significantly improved products must be attached (see the section above). If the company is a jointly taxed company, it is the management company that must apply for the tax credit.
If the company has not made a request via the tax return, a reassessment of the tax assessment can be requested. A reassessment can be requested three years back in time.
There are pros and cons to both approaches.
If a tax credit has been claimed via the tax return, the Danish Tax Agency will usually carry out a check of the claim, and this can be done either before or after the tax credit has been paid. In some cases, the check takes place several years after the payment has been made. If the company has not provided sufficient information in the tax return, the Danish Tax Agency will request additional information. If the Danish Tax Agency finds that the conditions are not met, payment will either be refused, or the tax credit paid will be reclaimed with interest. The interest is in the range of 8-9% per annum and is not tax deductible.
This can have major financial consequences for a cash-strapped company and, in the worst-case scenario, lead to bankruptcy proceedings.
If a tax credit is requested via resumption, the Danish Tax Agency will carry out a check from the time of the request. No tax credit will be paid until the Tax Agency has approved the request and finalised the check.
If the company disagrees with the Tax Agency’s decision, it can be appealed to the National Tax Tribunal, which makes a new and independent assessment of whether the Tax Agency’s decision is correct. Costs are reimbursed in appeals to the National Tax Tribunal, but the case processing time is often long, and the costs of the case can be disproportionately high.
Frequently asked questions about the tax credit scheme
Due to the complicated tax credit rules and the many tax cases in this area, a number of questions and myths have arisen among companies about the tax credit scheme:
“We have capitalised development costs in the accounts? Why are we being denied a tax credit?”
Whether development costs can be capitalised for accounting purposes depends on economic criteria. Whether expenses can be included in the basis for tax credits, on the other hand, is based on technical and scientific criteria. This means that the expenses are delimited completely differently.
“Our product is innovative and brand new. Why are we being denied a tax credit?”
Whether a product is innovative or new does not mean that it fulfils the conditions for a tax credit. An assessment must be made as to whether the product is completely new or significantly better than existing products in a technical or scientific context.
“Our competitor has received a tax credit even though we have developed a more complicated product or software than them. Why have we been denied the tax credit?”.
It always depends on a specific assessment of whether the development project fulfils the conditions. However, the Danish Tax Agency’s payment of a tax credit does not mean that they have examined or approved the basis for it. Unless the competitor has had the tax credit approved through an inspection, the competitor will thus bear a latent risk of the credit being reclaimed.
“Why does the tax authority pay out amounts without investigating the basis beforehand?”
It is politically determined that payments are made before the actual verification of the amount. This is because companies that fulfil the conditions and are under liquidity pressure should not have to wait unnecessarily long for the tax credit to be paid out. The consideration that the tax credit is paid to these companies is thus considered to outweigh the consideration that certain companies that do not fulfil the conditions risk having the tax credit reclaimed.
Summarising and advice
In summary, the tax credit is a scheme that can give start-ups and loss-making companies, in particular, a respite from liquidation. However, the scheme is based on a complex set of rules, and the company is often required to submit extensive documentation to the Danish Tax Agency before they can receive payment of the tax credit.
The tax credit scheme only results in a liquidity shift, and the company is, therefore, neither richer nor poorer as a result of the tax credit scheme. Therefore, consider whether the company really needs the liquidity or can manage without it. Reconcile risk appetite and assess whether the company’s finances and solvency can withstand a re-collection of the tax credit.
If you decide to apply for a tax credit, do your homework before applying for a tax credit. Get help from your accountant or tax advisor before you spend valuable resources and time preparing documentation that the Danish Tax Agency will not approve.
If your company has developed software, be extra careful, as the Danish Tax Agency refuses to pay out tax credits in almost all cases involving software projects.
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