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EC Looks At Danish Tax Treatment Of Alternative Market Investment

by Ulrika Lomas, for, Brussels

29 January 2007

The European Commission announced last Thursday that it has opened an investigation, under Article 88 (2) of the EC Treaty’s rules on state aid, into a planned Danish scheme aimed at facilitating the access of small and medium sized enterprises (SMEs) to risk capital.

The proposed scheme would provide favourable tax treatment for investments made by certain institutional investors in shares traded on alternative markets.

Alternative markets are private entities aimed at companies that cannot be listed on the Copenhagen Stock Exchange, because, inter alia, they have not carried on business for a certain number of years, and they do not fulfil minimum requirements for market capitalisation and shareholder distribution. The requirements to be admitted to an alternative market are less strict than those of regular equity markets. Companies traded on alternative markets are SMEs, mostly in their early stages of development.

The deduction would apply to the tax base of the pension gains tax, which is limited to 5% of the value of shares traded on alternative markets in the period until 2008. The maximum deductible amount could not exceed 0.05% of the institutional investor’s total assets.

It would apply only to some institutional investors, especially pension funds and insurance companies, and the budget foreseen is about EUR10 million in total.

With the proposed measures, Denmark aims at addressing an alleged market failure for SMEs at their early stages of development as regards their access to risk capital. The Danish authorities consider that especially institutional investors are reluctant to invest in such SMEs, as a result of imperfect information and relatively high transaction costs. By encouraging institutional investors to invest in alternative markets, the aid measure would thus provide an extra source of equity financing for this type of companies.

However, the Commission believes that the measure might give rise to disproportionate distortions of trade and competition within the EU's Single Market, and doubts whether the scheme addresses a true market failure.

It argued that the measure could also potentially crowd out other investors and might therefore not be the most appropriate and proportionate instrument to reach the planned objective. The opening of a formal investigation procedure gives interested parties the possibility to comment on the proposed measures.

EU Competition Commissioner Neelie Kroes explained last week that:

“The proposed scheme's objectives are valid, but we need to make sure that, on balance, the positive effects of the measure outweigh the negative ones.”

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