Working Papers,
Copenhagen Business School, Department of Economics

Abstract: As a main principle, income is taxed when earned. This principle is

broken in case of unrealized capital gains (recovered depreciations, unrecorded

intangible assets etc.). Such incomes are taxed when realized or the ‘latent tax’ is

passed on to the new owner (tax succession). In Denmark, tax succession is

allowed only if the new owner is a close relative to the previous owner. However,

recently it has been proposed to extend the access to tax succession to a wider

group of potential purchasers as a means of facilitating generational chances in

small and medium sized firms. One argument is that taxation of capital gains gives

the previous owner an incentive to delay the generational change longer than

appropriate from an efficiency point of view (the ‘lock-in’ effect). Sections 2 and 3

analyse, within a very simple framework, the impact of tax succession on the price

of a firm, the after-tax revenue to the previous owner, and the tax proceeds. The

conclusion is that tax succession has significant effects on before-tax and after-tax

prices and that the associated indirect tax subsidy is an appreciable expenditure.

Sections 4 and 5 address the problem of efficiency losses from tax succession and

‘lock-in. The conclusion is that, most probably, the former efficiency loss out-weighs

the latter one, in particular, if the rules are discriminatory giving the

previous owner an incentive to choose a less efficient purchaser who are allowed

to succeed rather than a more efficient one who is not.

Keywords: Tax succession; Economic efficiency; Taxation

JEL-codes: H21

24 pages, March 1, 1999

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