In 2004 Finland introduced new tax provisions on participation exemption for capital gains arising from the sale of shares held by a Finnish company, to ensure the international competitiveness of the Finnish tax system after similar developments in many other EU member states.
Under the participation exemption, capital gains arising from the sale of shares that are classifed as fixed assets of the selling company are not considered taxable business income and, correspondingly, capital losses incurred on the sale of these shares are not tax deductible, provided:
- the selling company has directly and continuously owned the shares for at least one year;
- the selling company owns at least 10% of the share capital in the company whose shares are sold;
- the company whose shares are sold is a resident of Finland, another EU member state as specified in Article 2 of the EEC Directive 90/435/EEC, or of another state with whom Finland has entered into a tax treaty; and
- the company whose shares are sold is not a real estate or housing company.
The participation exemption does not, however, apply for the benefit of investment companies.
Recently, the Finnish tax authorities issued guidelines for the interpretation and application of the participation exemption in various circumstances, including the sale of a company's own shares.
Acquisition and sale of own shares
Under Finnish company law, a Finnish company may purchase its own shares only with funds available for profit distributions. Own shares do not entitle the company to vote at meetings of shareholders, nor do they entitle them to any return. Own shares must generally be disposed of or redeemed within three years of their acquisition. Public limited companies may not acquire more than 10% of their share capital and are subject to additional limitations.
Finnish tax laws do not contain any provisions on the tax treatment of the acquisition of own shares. In taxation practice prevailing before the introduction of the participation exemption, any gains arising from the sale of own shares were considered as normal business income of the company and the acquisition cost was deemed deductible upon the sale. Obviously, this taxation practice did not need to address the classification of own shares as fixed assets – or other assets – which is decisive for the application of the participation exemption.
According to the guidelines now issued by the Finnish tax authorities, own shares cannot, because of their special characteristics under Finnish company law, be classified as fixed assets for the purposes of the participation exemption. Fixed assets are, according the tax authorities, intended for the permanent use for the business of the company – characteristics that own shares evidently are lacking. Accordingly, the participation exemption does not apply to the sale of own shares.
Tax-deductible capital losses
Capital losses incurred on the sale of fixed asset shares that do not benefit from the participation exemption are generally deductible for tax purposes. However, as the participation exemption applies only to the sale of fixed asset shares, the Finnish tax authorities have taken the view that such capital losses may only be deducted from capital gains arising in the same taxation year and the subsequent five years from the sale of fixed asset shares that, accordingly, do not benefit from the participation exemption.
The participation exemption does not apply to investment companies (such as private equity companies and other similar equity investors). This is mainly because, according to tax policy, the core business activities of a company should not be tax-exempt. As the participation exemption regime does not, in any circumstances, apply to investment companies, all capital gains realized from the sale of shares, including own shares, are taxable and capital losses incurred by such companies are fully deductible for tax purposes.
By Niklas Thibblin