How to handle illegal shareholder loans

Definition of a shareholder loan

If a company advance funds to, make loans to, or provide security for a capital owner, a management member, a capital owner, or management member of the parent company or another company that has control over the company providing the loan etc., it is called a shareholder loan. The term also includes financial assistance to people who by marriage or lineal consanguinity are related to a shareholder or management member, and other people who have close affiliations to such owner or management member.

Until 2017, shareholder loans have not been legal in Denmark, but in 2017 the Danish Companies Act was amended and since then it has been legal to grant shareholder loans if certain conditions are met.

Legal shareholder loans

The conditions for a legal shareholder loan are found in article 210-212 in the Danish Companies Act and are as follows:

• The loan must be held within the company's distributable reserves, which are amounts stated as retained earnings in the company’s latest adopted financial statements, and reserves that are distributable under statute or the company’s articles of association, less retained losses.
• The loan must be granted on market terms, meaning that the interest, payment plan, security etc. must be on the same terms as if the loan was granted by a bank.
• The decision to grant a loan must be made either by the general meeting or the company's central management body with an authorization from the general meeting.
• The decision to grant a loan cannot be made before the presentation of the company’s first annual report.

Additionally, it is, regardless that the above-mentioned requirements are not met, possible for a company directly or indirectly to advance funds to, make loans to, or provide security for the obligations of Danish or certain foreign parent companies, so called parent company loans. Read more about parent company loans here.

It is also legal for a company to make advances funds to employees in connection with the employees' acquisition of shares in the company or in a subsidiary.

Finally, it is legal, regardless that the requirements for legal shareholder loans are not met, that a company for the purpose of a usual business transaction advances funds to make loans to or provide security for the above-mentioned people. Such a transaction could e.g. be that the company sells a product or service to a shareholder etc. on credit under the same terms as the company sells the same product or service to third parties.

Although a shareholder loan fulfils the above-mentioned conditions, it is important to remember that the Danish Companies Act contains a ban against self-financing, i.e. that the company lends money to a person for the purchase of shares in the company. Therefore, the company must know for which purpose the shareholder asks for financial assistance.

The taxation of a shareholder loan

If you want to provide shareholder loans, or if you become aware that the company has provided illegal shareholder loans, it is important to be aware of the tax treatment of shareholder loans.

Under the Danish tax rules, a loan to a major shareholder, with a few exceptions, must be taxed as dividends or wages. This applies regardless of whether it is a legal or an unlawful shareholder loan and whether the shareholder loan bears interest and is repaid to the company.

According to the Danish tax rules, a principal shareholder is a natural person who, directly or indirectly, alone or with its relatives holds more than 50 percent of the shares and/or votes in the company. Loans to people who are not considered to be a major shareholder under that definition, but who are defined as a shareholder governed by the provisions for shareholder loans in the Danish Company Act, are not covered by this tax rule and the loan will, therefore, for tax purposes be treated as a loan. However, if the loan lapses e.g. because the company gives up the loan, the amount will also be taxed as dividend or wages.

How do you handle an unlawful shareholder loan?

If the company becomes aware of unlawful shareholder loans e.g. in connection with preparing the annual report, it is important that the problem is resolved correctly in relation to the applicable company law and tax law as well as the rules for accounting. 

The challenge in this situation is that the unlawful shareholder loan is treated differently in the applicable company and tax law.

According to the applicable rules in the Danish Companies Act an unlawful shareholder loan must be repaid and terminated. The shareholder who received the loan must pay interest from the time the loan was incurred until the loan is terminated. The interest rate is stipulated in the Danish Interest Act, which currently is 8.05% plus 2.0% according to the Danish Companies Act, i.e. a total interest of 10.05% p.a. Additionally, the loan must be terminated as it is not possible for the company to give up an unlawful shareholder loan. Termination of the loan can be done in various ways, either by repaying the loan to the company or to distribute the loan as dividend, salary or bonus. Under all circumstances the company must be mindful that all formalities are complied with.

The tax treatment depends partly on who the unlawful shareholder loan was granted for and how the loan is terminated. In all cases, however, the loan will be taxed as either dividend or salary, regardless of whether the loan is terminated by repayment to the company.

The company must also be aware that it makes a difference in accounting, how the unlawful shareholder loan is terminated, and that the company can be fined. Additionally, the management of the company can be held liable for the disposition.

Finally, the auditor of the company is since November 2019 obliged to notify the State Prosecutor for Serious Economic and International Crime of the illegal shareholder loan.

IUNO’s opinion

At IUNO, we believe that there are many pitfalls associated with shareholder loans. This applies to both legal and unlawful shareholder loans. It is, therefore, crucial that the company receives the right advice before embarking on a shareholder loan or trying to repair illegal shareholder loans. At IUNO, we can help companies ensure that all conditions are met, we work closely with tax advisors to ensure advice all the way. Call us to talk about your options.