Finland
Janne Juusela and Einari Karhu
Borenius – Taxand
Finland
The year to date has seen a new government unveil tax reforms, an extension of the tax treaty network and key rulings in the Supreme Administrative Court on losses, exchange of shares and arm's-length interest, explain Janne Juusela and Einari Karhu of Borenius – Taxand
After parliamentary elections and government negotiations led by Jyrki Katainen of the Coalition Party, the programme for the next term of government was introduced on June 17 2011. The government aims to strengthen the public economy by expanding the tax base while sustaining economic growth by moving the focus of taxation from taxing employment and entrepreneurship towards environment and health-based taxation.
To promote Finnish enterprises' operational preconditions the government proposes reducing the corporate income tax rate from 26% to 25%. In addition, a study to reform business income taxation (for example, group tax system, interest deductions and loss balancing rules) will be carried out.
In pursuance of the corporate tax rate reduction, individuals' capital income tax rate is due to increase from 28% to 30%. The rate will be increased to 32% for capital income of more than €50,000 ($55,000). In addition, dividend taxation will tighten as the tax-exempt level of dividend from non-listed companies is to be reduced from €90,000 to €60,000. The proposals mark a moderate transition from taxation of corporate profits for the use of the company to the taxation of distributed profits.
Though the delay to the parliamentary elections have calmed down the legislative tax reforms over the past year, interesting court cases have influenced the Finnish tax environment in 2010 and 2011.
Reverse charge liability introduced for construction
The reverse charge liability in value-added taxation was introduced in Finland in 2011. The liability is applied to construction services sold in Finland if the purchaser is carrying on business activities. The provisions are applied to both resident and non-resident purchasers and sellers.
Under the new rules, the person liable for paying the VAT is the purchaser of the construction service, not the seller. The precondition for this liability is that the purchaser of the service itself sells construction services or rents labour to conduct such services and that these activities are not occasional.
The purpose of the legislative amendment is to prevent the avoidance of VAT liability in long sub-contract chains. The legislation aims to reduce black economy and tax revenue losses caused by unfair business practices.
Latest tax treaty developments
Finland has more than 70 comprehensive double tax treaties in force. As of January 1 2011 new double tax treaties or amending protocols with India, China, Kazakhstan, Poland, Austria and Switzerland have taken effect. Negotiations with Hong Kong on a double tax treaty began in 2010.
The new tax treaty with China reduced the maximum withholding tax for intra-group dividends from 10% to 5%, cutting the effective tax rate of Finnish companies with Chinese subsidiaries as the Chinese withholding tax on dividends has been a final burden to Finnish parent companies.
The new treaty with Kazakhstan expands the Finnish tax treaty network and enables better economic conditions for Finnish business in Kazakhstan and vice versa.
In addition to comprehensive double tax treaties, Finland has continued the Nordic information exchange project to prevent international tax evasion and harmful tax competition. As part of this, Finland has concluded and ratified treaties with many offshore financial centres to exchange information in tax-related matters. Treaties have been concluded with about 30 jurisdictions that are considered as potential financial centres. The treaties on information exchange are, with few exceptions, based on the OECD model tax agreement and OECD model agreement on exchange of information in tax matters.
Recent court decisions
Balancing of cross-border losses
The Finnish Supreme Administrative Court decided on March 7 2011 (KHO 2011:21) to request for a preliminary ruling from the European Court of Justice concerning the question whether a Finnish parent company may deduct the final tax losses of its Swedish subsidiary after a cross-border merger.
The Swedish subsidiary which had incurred substantial losses was wholly owned by the Finnish parent company. The tax losses in question could not be used in Sweden because the operations of the Swedish company were shut down and all the other Swedish group companies were unprofitable as well.
The tax burden of the Finnish parent company could be substantially reduced if the losses of its Swedish subsidiary could be reduced from the profits of the parent company. The Finnish Central Tax Board had denied the right of the Finnish parent company to deduct the losses of its Swedish subsidiary because the losses were calculated in accordance with the Swedish tax legislation. In a comparable situation, if the subsidiary was a Finnish company the tax losses would be transferred to the Finnish parent company. Therefore, in principle, a cross-border merger should be treated in the same way as a purely domestic merger.
The court procedure is suspended in Finland until ECJ render its preliminary ruling.
Should the ECJ agree with the taxpayer, the Finnish rules and practices on cross-border tax consolidation are to be amended.
Tax neutral exchange of shares in EEA
The Finnish Supreme Administrative Court (SAC) decided on January 31 2011 (KHO:2011:10) to ask for a preliminary ruling from the ECJ concerning the question whether a tax-neutral share exchange can be completed between a company residing in an EU country and a company residing in the European Economic Area (EEA) (Norway, Iceland and Liechtenstein).
Despite a previous positive ruling by the Finnish Central Tax Board, it is therefore unclear whether acquisitions can be made or whether group structures may be reorganised through tax-neutral exchanges of shares, when the either the target or the acquiring company is located in Norway, Iceland or Liechtenstein but the other one is in EU.
The Council Directive 2009/133/EC (the Merger Directive) provides for a possibility to carry out tax neutral share exchanges between companies being tax resident in EU member states, provided such companies are subject to general corporate taxation in that country and have certain specified company forms. The directive is implemented in Finnish domestic tax law so that tax-neutral share exchanges are allowed equally for domestic and EU companies. Thus, companies residing in EEA countries (not belonging to EU) seem to fall outside the scope of the directive and the Finnish domestic law provisions concerning tax-neutral share exchanges.
A ruling from the ECJ is needed to clarify whether exchanges of shares with Norwegian companies could be ruled out by the mere fact that the tax neutrality was allowed by a directive which does not bind countries outside the EU. Should this not be sufficient, the ECJ would need to take into account that restrictions to the basic freedoms have only exceptionally been approved, if a legitimate objective or an overriding reason in the general interest capable of justifying such a restriction has occurred without going beyond what is necessary to attain it.
The ECJ preliminary ruling is highly anticipated also from the EEA and Norwegian perspective and could enhance cross-border restructurings between EEA countries.
Arm's-length interest in group financing
The SAC issued a precedent in November 2010 on the determination of the level of arm's-length interest in intra-group financing structures. According to the ruling the level of interest rate in intra-group financing should be based on company-specific analysis of the financial position. Hence, the internal arm's-length interest rate may differ between companies of the same group.
In the case, a Finnish limited liability company had settled its external debts in connection with the reorganisation of the group's financing. As a consequence the company refinanced its business activities with internal debt from a Swedish group company. The interest rate of the external debts had been from 3.125 to 3.25% whereas the interest rate of the new intra-group debt was 9.5%. This rate was determined based on interest rates in group's external loans, bonds and shareholder loans.
In its ruling the Supreme Administrative Court stated that the arm's-length interest rate of the Finnish company's debts to the Swedish company was 3.25% because the financial position of the Finnish company had not changed in the refinancing and neither had it received any financial services from the Swedish company that could have been taken into account when determining arm's-length interest rate. Also it should be noted that overall financing need or capital
structure of the Finnish company had not changed either. Consequently neither the average interest rate of external group financing (7.04%) nor the interest rate in the company-specific financing conditions of the Finnish company (9.5%) were accepted in taxation.
In its reasoning, the SAC stated that the financial position and credit rating of a separate group company may differ from the overall financial standing and credit rating of the group. In case the credit rating and other circumstances of a company enable substantially more profitable financing terms, the arm's-length interest cannot be determined based on the financing terms of external loans of the whole group.
Based on the ruling, it seems obvious that the financial terms of the external loans of the whole group no longer fix the arm's-length loan terms, especially interest rates, between group companies. The internal rates have to be determined separately for each relation considering the arm's length-principle. As a result of the ruling the internal financing terms of international group companies may have to be reassessed.
Janne Juusela (janne.juusela@borenius.com) and Einari Karhu (einar.karhu@borenius.com)
Attorneys at law Borenius Ltd