6 Nov 2018
The Finnish Government issued a government proposal on controlled foreign company ("CFC") rules on 1 November. The proposed rules would enter into force at the beginning of 2019 and would apply already for tax year 2019.
Through these rules, the Anti-Tax Avoidance Directive (2016/1164, the "Directive") adopted by the EU is further implemented in Finland. The proposed rules are stricter than the currently applicable CFC rules in particular for Finnish companies with subsidiaries outside of the European Economic Area ("EEA"). In principle, the government proposal follows the main features of the draft proposal published earlier this year with the exception of widening the exempted activities to certain services.
Overview of Proposed Rules
In brief, foreign entity's income is subject to CFC taxation in Finland if a Finnish tax resident, together with its related parties, has sufficient control in the foreign entity, the foreign entity's level of taxation is significantly lower than in Finland, and the genuine economic activities exemption is not applicable. If an entity qualifies as a CFC, the proportion of the income of the CFC controlled by Finnish tax residents is taxed as their income in Finland.
According to the proposed new rules, the type of income received by the foreign entity or the artificial nature of the transactions would not be relevant in the assessment. Thus, Finland would not implement either of the alternative models laid out in the Directive as such but instead the new rules follow similar approach as the current rules.
The new proposal imposes a participation threshold of 25% for the CFC rules to apply. The participation by the Finnish resident's related parties (based on also the 25% threshold) in the foreign entity is included in the assessment. This presented participation threshold is significantly stricter than the 50% threshold adopted by the Directive and the 50% threshold of the current CFC rules.
In practice, the low CFC threshold significantly expands the scope of the rules. It may also prove to be challenging to obtain necessary information to assess potential CFC taxation when the participation in the CFC is e.g. only 25%.
Level of Taxation
According to the proposal, a CFC is an entity with an actual level of taxation of less than 60% of the actual level of taxation the entity would be subject to in Finland. Finland’s current corporate income tax rate is 20%, which leads to an effective tax rate threshold of 12%, when the foreign entity's taxable income is calculated in accordance with the Finnish rules. The level of taxation is assessed separately for each year.
The proposed new rules do not take into account the timing differences, e.g. different depreciation rules. More accelerated depreciation rules than the Finnish depreciation rules may trigger CFC taxation for the years when larger depreciations are deducted even though the level of taxation over the years would not be lower than the above mentioned threshold.
The main exemption in the proposed rules is the genuine economic activities exemption. The concept of genuine economic activities is assessed differently depending whether the foreign entity is a EEA resident company or not.
The proposal follows the Directive’s, as well as the current CFC rules', framework of excluding EEA resident companies with genuine economic activities from CFC taxation. This requires sufficient level of personnel, premises and assets.
Outside the EEA, the concept of genuine economic activities also requires that the entity carries out certain type of business activity. The new rules exempt only companies the income of which mainly arises from industrial or other comparable production activities, shipping activities, as well as sales or marketing activities related to such exempt activities. The government proposal widens the current concept of activities comparable to production activities to include marketable services. However, the proposal lists service activities which are not comparable to production activities, such as certain investment management services, holding and transferring of intangibles, as well as intra-group financing, insurance and management services.In addition, adequate exchange of information procedures need to be in place between Finland and other state, and the other state cannot be listed as non-cooperative tax jurisdiction by the EU, for the exemption to apply.Contrary to the currently applicable CFC rules, which have required that the sales and marketing activities could only be performed in the company’s state of residence in order for the exemption to apply, the new CFC rules would also exempt regional sales and marketing hubs from the applicability of the rules, provided that the operations relate to industrial production or comparable activities. This change will provide more flexibility for companies with regional activities.
The current exemption applicable to tax treaty resident companies would be abolished. Consequently, the effective level of taxation of such non-EEA resident companies, which do not fall under the genuine economic activities exemption, needs to be monitored.
As discussed above, the scope of the application of the CFC rules is significantly widened due to the newly proposed amendments.
The different approaches compared to the Directive, as well as compared to the current rules, will likely cause issues to numerous taxpayers. Pursuant to the new rules, genuine business operations subject to low taxation in non-EEA countries may classify as CFCs. In particular, intra-group and other service activities as well as holding company structures may trigger CFC taxation in situations that have so far not been subject to the current CFC rules.
Inclusion of service activities to the scope of exempted activities is a welcomed feature but the definition in the proposal leaves room for interpretation. An advance ruling on the interpretation in specific cases may be recommendable in order to achieve certainty on the treatment.
Due to the Directive, all EU countries need to implement CFC rules. Also many other jurisdictions have already implemented or will implement CFC rules. This may lead to the taxation of the same company's income as CFC income in several jurisdictions. The proposed Finnish CFC rules do not take this type of double taxation into account at all. Group structures with multiple layers of companies should therefore be reviewed from this perspective.
On the other hand, the new rules introduce new options to enhance the group structure for many operators with regional activities due to the extension of the scope of sales and marketing exemption.
Do not hesitate to contact us with respect to the proposed changes, we are happy to discuss the matter and its implications to your circumstances.