Loan agreements between businesses

Businesses lend money to each other far more often than many think, from loans within groups and shareholder loans to loans between business partners. But even when the parties know and trust each other, the loan should be documented in a written loan agreement. A lack of documentation can create tax problems, disputes and evidential challenges.

This guide goes through the rules for loan agreements between businesses in Denmark.

When does the need for a loan agreement arise?

Typical situations where businesses lend money to each other:

• Parent to subsidiary: financing operational or investment needs
• Shareholder loan: a shareholder borrows money from the company (see the separate section below)
• Sister-company loan: a loan within a group
• Loan from an investor: a business angel or investor makes a loan before or instead of subscribing for shares
• Supplier credit: the supplier grants credit beyond the normal payment deadline
• Loan between partners: for example in a joint venture or project collaboration

In all these situations: make a written agreement. It protects both parties and documents the nature of the loan (rather than, for example, a capital contribution, a gift or a disguised dividend).

What should a loan agreement between businesses contain?

1. The parties

Full business identification: name, CVR number, address and any contact person. For loans within a group, it is important to state the exact legal entities.

2. Loan amount and currency

State the precise loan amount and currency. For a tranche loan (disbursement in instalments), describe the disbursement schedule.

3. Purpose

It is good practice to state the purpose of the loan, especially for loans within a group, as it can have tax and accounting relevance.

4. Interest

A market rate is decisive. Loans between related parties (for example a shareholder and a company, or a parent and a subsidiary) must bear interest on market terms, otherwise the tax authorities can adjust the terms and possibly reclassify the loan with tax consequences.

State:

• The interest rate (fixed or variable)
• The basis of calculation (outstanding debt, simple interest, monthly accrual)
• The payment term (for example quarterly in arrears)

5. Term and repayment

• Set a term (for example 3 years, 5 years or ongoing)
• State the repayment plan: monthly instalments, quarterly, half-yearly or a single repayment at maturity (bullet)
• The right to early repayment and any fee for it

6. Security and guarantees

Does the lender require security for the loan? Possible forms of security:

• A charge over assets (property, machinery, inventory, receivables)
• A guarantee from a third party or parent company
• A negative pledge (the borrower may not grant security to others)
• A positive pledge (further security is provided if a certain event occurs)

A charge over real property requires registration. A charge over movables can be registered in the Personal Register (or the Car Register for vehicles).

7. Covenants

Professional loan agreements often contain covenants, ongoing obligations on the borrower:

• Financial covenants: for example a minimum equity or a maximum debt ratio
• Information covenants: a duty to provide annual accounts
• A negative covenant: a prohibition on certain dispositions (selling assets, further loans)

8. Default and acceleration

When is the loan in default (an event of default)? Typical default events:

• Missing interest payment for a number of days
• Missing an instalment
• Insolvency or filing for bankruptcy
• A breach of covenants

On a default, the agreement should give the lender the right to accelerate the loan (demand the whole outstanding debt paid immediately).

9. Termination

Even though loans typically have a set term, the agreement should state:

• Whether the loan can be terminated (by one or both parties) before maturity
• The notice period
• The terms on termination

10. Choice of law and dispute resolution

State that Danish law applies, and set the dispute-resolution mechanism (courts or arbitration).

Shareholder loans: special rules

Shareholder loans (kapitalejerlån, previously called aktionær- or anpartshaverlån) are loans made by a company to one of its shareholders, to management or to related parties. The area is regulated on two levels that must be kept separate.

Company law (section 210 of the Companies Act)

Until 2016, shareholder loans were as a rule unlawful. With effect from 1 January 2017 the rules were changed, so a company may lend to shareholders and management if the following conditions are met:

• The loan can be contained within the company's free reserves and is on ordinary market terms
• The decision is made by the general meeting or by management with the general meeting's authorisation
• The decision is only made after the company's first annual report has been filed

If just one condition is not met, the loan is unlawful under company law. A loan can also be made without these conditions if it is part of an ordinary business transaction.

Tax law (section 16 E of the Assessment Act)

Even a loan that is lawful under company law is not necessarily advisable, because the tax rules are separate. Under section 16 E of the Assessment Act, a shareholder loan to a natural person with controlling influence (as a rule more than 50% of the capital or the votes) is regarded as pay or dividend and taxed as such, regardless of whether the loan is lawful or unlawful under company law. The taxation is not reversed simply because the loan is repaid.

An exception applies to loans that are an ordinary business transaction. Shareholders without controlling influence (typically minority owners) are as a rule not covered by section 16 E.

Shareholder loans are a complex area. Always seek specific advice from a commercial lawyer and an accountant.

Transfer pricing and internal loans

Loans within a group (intercompany loans) are subject to the transfer-pricing rules in section 2 of the Assessment Act. That means the interest and other terms must be set on an arm's-length basis, as if the borrower were an independent third party.

A lack of arm's-length pricing can lead to a tax adjustment of interest income and interest expenses.

Tax and VAT on interest

Interest income at the lender is taxable.

Interest expenses at the borrower are as a rule deductible, though with limits on the deduction at high leverage (the interest-deduction limitation rules, including sections 11 B and 11 C of the Corporation Tax Act).

VAT: interest is VAT-exempt. Neither the lender nor the borrower charges VAT on interest.

Loan agreement or capital contribution?

It is not unimportant whether a transfer of capital is recorded as a loan or a capital contribution (a share subscription):

Aspect	Loan	Capital contribution
Repayment	Yes, at maturity	No
Interest	Yes (at market)	No (but possibly dividend)
On bankruptcy	Creditors paid first	Shareholders paid last
Tax treatment	Interest deduction	Dividends taxed differently

The classification matters greatly for both tax and insolvency law.

Frequently asked questions about loan agreements between businesses

Can two companies freely lend money to each other?

Yes, two independent companies can freely lend to each other. For related parties, however, the arm's-length requirement applies.

What is the risk of not having a loan agreement?

The tax authorities can reclassify the payment, for example as pay, dividend or a gift. The parties can disagree about the terms, and the auditor can have objections at the preparation of the accounts.

Does a loan agreement have to be registered?

Not mandatory. But security that is to have legal effect against third parties must be registered.

Can a company lend money to its director or shareholder?

Yes, it is possible under the rules on shareholder loans (section 210 of the Companies Act) if the conditions on free reserves, market terms, a general meeting decision and a filed first annual report are met. Be aware, however, that under section 16 E of the Assessment Act the loan can be taxed as pay or dividend if the borrower is a natural person with controlling influence.

Conclusion

A written loan agreement is indispensable when businesses lend money to each other. It documents the terms of the loan, prevents disputes and supports correct tax treatment. Especially for loans between related parties, it is critical that the terms are at market and correctly documented, and that the rules on shareholder loans are observed.

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The content of this article is for guidance only and does not constitute legal advice. Consult a commercial lawyer and an accountant for advice on your specific situation.