Finnish investment now less taxing

Author: | Published: 1 Apr 2007
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Strong economic growth, liquidity in property markets, a high degree of transparency and a competitive economy are some of the factors that have made Finland an interesting target for real estate investors. The estimated rate of return compared to the risks seems to be at a high level, especially in Helsinki.

With direct ownership in real estate targets, rental income and capital gains are taxable income for a non-resident investor with limited liability to pay tax in Finland, but possible interest expenses can be deducted from the rental income. Applicable tax rates and rules for the country of taxation can be found in national tax laws and tax treaties between Finland and the investor's country of residence. However, the real estate targets in Finland are often organized in the form of real estate companies or mutual real estate companies (MRECs). A MREC is a Finnish special company form, where the rental income from the owned property is taxed directly in the hands of the shareholders of the MREC. The taxation is the same as with direct ownership, but the governance can be organized as with normal limited liability companies. Also, a more favourable overall tax position for a non-resident investor can be achieved through a company structure.

The Finnish tax legislation does not contain any specific rules concerning thin capitalization. However, a heavy intra-group debt financing might cause the Finnish tax authorities to intervene on the basis of general anti-avoidance provisions. The lack of thin-capitalization rules enables tax-efficient financing structures for Finnish real estate investments, for example, debt push down. For Finnish tax purposes, interest expenses on bank loans and intercompany loans can be offset against rental income. In practice, heavy leverages have been used in Finnish investments. Debt financing is made even more attractive by the fact that, in general, no withholding tax is levied on interest payments from Finland.

Dividend withholding tax for the non-resident investor varies between 0% and 15%, depending on the share of ownership and the residence country of the investor. Dividends distributed to an investor resident in a country with which Finland has not concluded a tax treaty are subject to a tax of 28%. However, Finland has a comprehensive tax treaty network and the total number of tax treaties in force is almost 70.

The Finnish transfer tax upon the sale of shares is 1.6% and upon the sale of real estate is 4%, in both cases calculated on the purchase price.

According to Finnish tax legislation and tax treaties, a capital gain deriving from the sale of shares of a Finnish real estate company in which the net assets to 50% or more is real estate will be subject to tax in Finland at a rate of 26%. However, sometimes the real estate investment can be structured in such a way that Finnish tax on capital gains is avoided.

Finnish equity funds

Finnish private equity/venture capital funds have not been attractive objects for foreign investors in the past. This has been due to Finland's unfavourable taxation of foreign investors. Most private equity funds are partnerships. In taxation, partnerships are not treated as a separate tax subjects. They are treated as an accounting unit and so profits are taxed as income of the partners. In previous decisions of the Finnish Supreme Court, a foreign investor as a partner in a Finnish limited partnership was deemed to have a permanent establishment in Finland. This meant that, for tax reasons, there were practically no foreign partners in Finnish private equity/venture capital funds.

To make Finnish private equity funds more attractive for foreign investors, Finnish parliament enacted an amendment to the tax law relating to taxation of non-resident partners. According to this amendment, effective as of January 2006, a non-resident partner's share of profits received through a Finnish partnership is taxed as if the investor had invested directly in the Finnish target company. This means that a foreign partner would be taxed as if it were a shareholder in the Finnish target company and so will not be taxed on capital gains or interest in Finland. Only dividend received by the partnership from Finnish sources may be subject to final withholding taxation in the taxation of non-resident partners. The taxation depends on the tax treaty between Finland and the investor's country of residence. Dividends that a partnership receives from foreign sources are never subject to taxation in Finland in the taxation of non-resident partners.

For the application of the new relief provision, the Finnish fund must practise venture capital business in the manner prescribed in the Finnish Income Tax Act. This means that investments are targeted to companies not quoted on the stock market, investors aim to develop the business of the target companies and investors aim to sell the shares acquired in target companies within a limited timeframe.

This tax relief for non-resident investors makes investing in Finnish private equity funds more attractive. A Finnish limited partnership fund is a tax-feasible solution, for example, for international private equity investments.

Finnish investments in Russia

Russia appears to attract investors due to its growing market, wealth increase, decrease in inflation and currency stabilization. Risk and yield expectations are decreasing but potential gains from investments are still high. Finnish investments in Russia have increased, but Finland can also be used as a gateway to Russia for international investors.

Investments into Russia can be structured in many ways depending for example, on the target assets, countries involved and the investors' countries of residence. The targets in Russia may be owned directly or through holding companies. In some cases holding companies in other countries, usually the EU, are incorporated in the structure. The idea is to locate the holding company in such a country that the tax treaty between it and Russia allows lower taxation of the income flows than between Finland and Russia. Some countries, for example, have adopted participation exemption regimes with which capital gains are broadly exempt. Repatriating the income to Finland must also occur without adverse tax effects. For example, dividend payments are tax-exempt according to the Parent-Subsidiary Directive when the parent company owns at least 15 % of the shares in the EU subsidiary.

A fund structure with a Finnish limited partnership might work as a feasible vehicle to invest into Russian companies and real estate targets. A limited partnership is not treated as a separate tax subject in Finland. It is treated as an accounting unit, that is, the partnership is not taxed, but its calculated profit is allocated to its partners and the taxed as their income. So the taxation of the investors has to be individually considered to achieve the optimal tax for the different countries of residence. With a carefully planned structure, there could be no Finnish tax consequences for a non-resident investor.

Finnish group contribution system

At the moment it is not possible in Finland to consolidate the profits and losses of certain group of companies for tax purposes. However, profits and losses may be balanced between Finnish corporations belonging to the same group of companies through an open group contribution. A group contribution may be deducted from the taxable profits of the contributing company and added to the taxable income of the recipient company. Both giver and receiver of a group contribution must be resident companies in Finland. The parent company has to have owned at least 90% of the capital of the subsidiary during the whole financial year. The same possibility for a group contribution does not concern multinational groups of companies.

It is common that a multinational group of companies include both profitable and unprofitable companies. The fact that balancing losses between a Finnish company and a foreign company is not possible makes it disadvantageous in tax purposes to have subsidiaries abroad. So international groups are treated less favourably than purely domestic groups. This is contrary to the principle of neutrality. Due to the possible violation of the EC Treaty's non-discrimination provisions, Finnish group contribution legislation has been under scrutiny in recent years. The discussions were particularly sparked by the Marks & Spencer case (C-446-03).

The Finnish Supreme Administrative court has referred a question concerning the applicability of the Finnish group contribution regime in cross-border situations to the ECJ for an advance ruling. This is so called Oy AA case, where Finnish resident company Oy AA contemplated to give a group contribution to its great-grand-parent company AA Ltd, resident in UK. According to the opinion of the Advocate General, the EC Treaty or Parent-Subsidiary Directive do not preclude Finland from requiring that both the giver and the receiver company be Finnish residents. The final decision on this case will probably be given during this year.

To avoid a possible breach of EC law and other problems with Finnish group contribution rules, a working group was appointed to clarify the future of Finnish contribution rules. According to the working group's report, the Finnish contribution rules must be renewed. Cross-border situations also need to be taken into consideration so that the purposes of a common market can be realized. In the renewal, the systems used in other Nordic countries and in some EC member countries should be used as a model. Presumably, in the new system the group of companies will be treated as a fiscal unity.

Prompted by the Cadbury Schweppes case (196/04) and the possible violation of the freedom of establishment, Finland will also revise its legislation concerning controlled foreign companies in the future. Revision of both group contribution legislation and CFC legislation will offer new attractive tax planning opportunities for Finnish companies and foreign investors investing into Finland.

Author biography

Janne Juusela

Borenius & Kemppinen

Doctor of Laws Janne Juusela is the head of Borenius & Kemppinen's tax practice. He advises on domestic and international tax matters in corporate and personal income taxation. Juusela specializes in tax issues related to M&A, corporate restructurings and financing. He also has wide experience in advising on EU tax law issues.

Before joining B&K in 2005, Juusela acted as a tax consultant at KPMG. Previously he has worked for the Ministry of Finance and the University of Helsinki. Juusela also acted as a secretary in the committee engaged in preparing for the Finnish corporate tax reform and served as a representative of the Finnish government in the preparation of the EU tax directives.

Juusela has written books on tax law and published several articles in Finnish and international publications. He is co-author of the renowned Corporate taxation I-II (Yritysverotus I-II, Tikka, Nykänen, Juusela). He also lectures regularly on tax-related issues. Juusela is a member of the board of Finnish branch of IFA and he acts as a docent of tax law at the University of Helsinki.