Regulatory obstacles #4: Convertible loan notes – a Danish tax nightmare

In Denmark, convertible loan notes have for years been the preferred instrument in bridge round and many early rounds.

Typically, a convertible loan is structured as a loan, where a lender can elect to have the loan repaid at the maturity date or converted (typically at a discount or valuation cap) in the next qualified financing round, upon an exit or at the maturity date. Convertibles offer flexibility, closing speed, low costs and no determination of valuation; however, the disadvantages of convertibles are that they are a debt instrument, carry interest and subject to repayment.

Whereas there are no consequences for the company in obtaining a convertible loan note, neither upon issuance, conversion or repayment, the taxation on Danish investors is significantly more complicated:

For Danish investors, there is a distinction between “genuine convertibles”, typically where the right to convert is implemented into the articles of association, and “agreement-based” convertibles:

• As for “genuine convertibles”, the overall principles for Danish investors (companies) are the following:

• • No taxation upon issuance of the Genuine Convertible
  • Upon conversion, proceeds are taxed as the Genuine Convertible changes from being a taxable portfolio share to a tax exempted portfolio shares. This means that if there is a valuation cap or discount, this could well be taxable for Danish investors. Important to note that also content-wise changes to the Genuine Convertible may trigger such taxation.
  • Interests on the Genuine Convertible are taxed as all other interests, even if converted.
  • If the convertible is repaid, taxation depends on whether the loan is repaid before or upon maturity date.
• As for “agreement-based convertibles”, proceeds for Danish investors are taxed as gains and losses on debt on conversion.

In my view, convertibles should be an efficient and low-cost instrument, but even for trained people, the rules are overwhelmingly complicated and nontransparent for Danish investors.