In order to fund an improved early retirement pension scheme, the Danish government has proposed to introduce mark-to-market taxation of property gains as from 2023. However, the underlying deliberations seem to be both sketchy and made without analysing consequences or control options.
Today, capital gains on real estate owned by companies are subject to taxation at a rate of 22% based on the profit realised from a sale. As the capital gains on stocks in principle are exempt from tax when selling subsidiaries, it is today not uncommon that investment properties are placed in companies in order that a sale may take place as a tax-free sale of shares, with the buyer being compensated for assuming the latent tax liability.
Apparently, Danish politicians are now taking exception to the fact that so-called “property speculators” carry out sales without becoming liable to pay tax. In their deliberations they seem to have overlooked the fact that this phenomenon is not related to property investments. When a company sells shares in a subsidiary to a buyer that continues to carry on the operations of the subsidiary, this generally does not trigger a liability to pay tax on the difference between the taxable value of the assets and the market value – just as in numerous areas of the tax system it is deemed acceptable, e.g. to promote investments, that taxable values are different from market values.
Who will be affected by a future mark-to-market taxation regime?
The way the preliminary ideas are worded, the mark-to-market taxation regime will apply to all properties owned by companies, that is, both owner-occupied properties and investment properties.
Mark-to-market taxation of non-realised profits on industrial, retail and office properties as well as hotel properties used by the owner will substantially increase the tax burden of Danish businesses, and seriously impair liquidity – even if you own a property and operate a business from the property, which has seen a market-driven value increment, you have in actual fact not earned the money to pay the tax. Such tax payment will therefore lead to higher indebtedness, putting a dampener on investments in business expansion schemes and new jobs.
Moreover, the determination of the market value of many of the properties owned and used by companies will be subject to a very high degree of uncertainty. And do we really want to tax Danish manufacturing, trade and service businesses on money they have not made, if – in addition – the calculation of the tax payment is associated with quite substantial uncertainty?
Finally: On production and storage facilities, on retail properties and on hotels and educational facilities, depreciation for tax purposes may be made today, partly justified by potential wear and tear, partly to incentivise investments. Will it still be possible to make depreciation for tax purposes and at the same time pay tax on a potential non-realised profit? Or is it a foregone conclusion that the depreciation for tax purposes on property assets must cease – as it has for pension funds, which today are liable to pay mark-to-market tax on property investments? If so, this will seriously dampen the Danish business community’s propensity to make investments, and the decision-making basis for investments made over the past 25 years stands to crumble completely.
Will latent tax liabilities arising before 2023 be subject to taxation?
The Danish government has not even bothered to describe how it intends to treat the deferred tax burden that already exists because some properties in the balance sheets are entered at a book value that exceeds the taxable acquisition sum plus depreciation for tax purposes.
However, it is safe to assume that the basis for possible future taxation of non-realised gains on real estate will be the market value as of start-2023.
Today, the two Danish property companies Jeudan and DADES alone have deferred tax liabilities of some DKK 1.5 billion each on their books, and when the government’s projections of annual tax revenues are DKK 850 million, it is obviously not assumed that historical deferred taxes will become liable for payment.
Accordingly, even post-2023 it will be possible to effect a sale of shares where the buyer is compensated for assuming a deferred tax liability.
Busy schedules in the property valuation industry as from 2022
Against the backdrop outlined above, investors and businesses will need to ensure that the book value of their properties as entered in the balance sheet at start-2023 will be as high as may possibly be justified in order to secure a high initial value, which will form the basis for future mark-to-market taxation.
At the same time, in particular businesses that hold property assets via separate subsidiaries should consider renegotiating lease agreements between parent company and subsidiary so as to secure a high market value – e.g. by agreeing on a long non-terminability period – with this value to serve as initial value.
Looking ahead, there is plenty to do for those engaged in market valuations of commercial and investment property. And it is easy to imagine the colossal control effort it would require were the tax authorities to assess tens of thousands market valuations of illiquid assets annually, with every market valuation associated with often quite substantial uncertainty.
At the same time, one can only hope that we are not headed for a renewed property crisis in 2022. Fortunately, there are no signs to this effect – but such a crisis could exacerbate the tax burden quite significantly from 2023 onwards, and not necessarily for any logical reason.
The question of whether to use mark-to-market taxation on properties owned by companies hardly has any broad voter appeal. From a political perspective, it is therefore safe to propose that higher retirement benefits, which do have broad voter appeal, are to be funded by means of such taxation.
Nevertheless, it is disappointing that the Danish government resorts to tabling such a populistic proposal with potentially devastating implications for Danish businesses and Danish jobs in exchange for fairly uncertain proceeds – and considering the fact that it is virtually impossible to exercise reasonable tax control measures, even at very substantial costs, because the basis of taxation is subject to great uncertainty.