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New CFC Rules Require Review of Corporate Structures
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 General 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. Control 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. Exempted Activities 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. Implications 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.
Government Proposal on New Interest Limitation Rules in Finland
27 Sep 2018 First Step for Implementation of the EU's Anti-Tax Avoidance Directive The Finnish Government has today issued a government proposal on new limitations to the deductibility of interest expenses implementing the interest limitation rules of the EU's Anti-Tax Avoidance Directive (2016/1164). Compared to the draft government proposal which was published in January this year, the new proposal is in some aspects more lenient and addresses some of the concerns raised earlier in public consultation. The most significant changes are the introduction of the so-called grandfathering rule as well as the re-introduction of the current balance sheet exemption and a financial industry exemption. Nevertheless, the new interest limitations significantly expand the scope of the currently applicable rules. Additionally, many uncertainties remain with respect to the interpretation and the exact implications of the newly proposed rules. Limitations to the Deductibility of Interest The proposed rules expand the scope of application to cover both new types of taxpayers and a wider range of interest payments. The key characteristics of the new limitation rules can be summarized as follows: The deductibility of net interest expenses would remain generally limited to 25% of EBITD (taxable business profit added with interest expenses, tax depreciations, and net group contributions); the general threshold of EUR 500,000 would still apply, but a new safe harbor threshold of EUR 3,000,000 would be introduced in relation to net interest expenses on third party debt; the definition of interest is broadened to cover considerations such as guarantee fees; the limitations would also apply to interest paid to third parties, such as interest on bank loans; the limitations would apply to all Finnish resident corporate taxpayers, and also companies taxed under the Income Tax Act, such as real estate companies, that are excluded from the application of the current limitation rules; however, the new rules include a grandfathering rule that excludes third party loans concluded before 17 June 2016 from the scope of application; the exclusion available for financial institutions; and the current balance sheet test exemption remains. Implications The new rules will indirectly increase the cost of debt and therefore impact both business considerations and market practices. New Taxpayers and Structures Covered Groups with centralized external financing may also face new challenges with interest deductibility (e.g. publicly listed parent company bonds). Private equity structures (e.g. including leveraged holding companies and profit participating loans) and real estate investments are among those most significantly impacted by the expansion of the scope of applicability. The new rules are suggested to apply to, inter alia, real estate companies and other non-business companies. Definition of Interest The definition of interest is widened. The new definition covers costs economically equivalent to interest expenses such as guarantee fees. However, according to the government proposal e.g. financial leases are not considered to fall under the new definition of interest, contrary to the draft government proposal. The Grandfathering Rule The exemption of third party loans concluded before 17 June 2016 is welcomed, but raises questions with respect to its interpretation, as the exemption would not apply to any "subsequent modification" of such loans. The potential impact of refinancing activities and other changes to loan terms performed on 17 June 2016 or later should be evaluated in order to determine whether the grandfathering rule would apply. The implications of the grandfathering rule should also be considered in connection with any future modifications of loans or refinancings since those may in some cases significantly increase the indirect costs for refinancing. The grandfathering rule would also apply to interests capitalized in taxation before 1 January 2019. Applicability of the New Rules Parliament is expected to decide on the government proposal later this year. Major changes to the proposed rules are not anticipated. The proposed new rules would be applied already for the tax year 2019 i.e. financial periods ending during 2019. It is recommendable for companies and investors to assess the impact of the new rules to their current financing structures. Since the new rules will be applicable very shortly, and for some companies the rules already apply to the ongoing tax year, we recommend that this assessment is made as soon as possible. We are happy to discuss the proposed changes with you.
Draft Government Proposal on International Tax Dispute Resolution Mechanisms
29 Aug 2018 The Ministry of Finance of Finland has issued a draft government proposal on international tax dispute resolution mechanisms on 27 August 2018. The draft proposal implements the Directive on Tax Dispute Resolution Mechanisms in the European Union (2017/1852, the "Directive"). In addition, the proposed new legislation addresses certain other tax dispute resolution mechanisms related to the interpretation of tax treaties. The aim of the new legislation is to enhance the resolving of international tax disputes and to avoid double taxation in cross-border context. Summary of the Proposed Tax Dispute Resolution Mechanisms The following table illustrates the main changes to the current processes and contents of the draft proposal on a high level.   Timing of the Legislative Process The draft proposal is currently under public consultation. The contents of the proposal are therefore subject to change. The new legislation is proposed to apply to applications filed on 1 July 2019 or thereafter which concern tax years started on 1 January 2018 or later. However, part of the new legislation, such as the obligation to choose between the tax dispute resolution mechanisms and the domestic appeal process, is applicable to all applications filed on 1 July 2019 or thereafter. Reflections on the Draft Government Proposal Many of the proposed changes provide long-awaited procedural rules for tax disputes relating to the interpretation of tax treaties. Currently, most of the relevant procedural provisions are outdated and not explicitly applicable to international tax dispute resolution processes. Implementation of the Directive provides more effective means for taxpayers to eliminate double taxation between EU countries since the threat of binding arbitration can be expected to encourage the competent authorities to negotiate, and ultimately double taxation should be eliminated through arbitration. This type of process is currently only applied in transfer pricing disputes involving EU countries. The draft proposal also includes certain changes to the current processes which can in many cases limit the taxpayers' legal remedies. The taxpayers would in practice need to choose whether to refer the case to a tax dispute resolution process under the proposed legislation or the domestic appeal process. This would increase the importance of the strategic decisions taken during a tax audit phase regarding potentially threatening cross-border tax disputes. Since this provision is proposed to apply to all applications filed on 1 July 2019 or thereafter, regardless of the tax year the application covers, the draft proposal may have great relevance in many of the cross-border tax disputes pending today. One aspect which the draft proposal seems to ignore is the extension of the suspension of tax enforcement to the tax dispute resolution processes under the proposed legislation. Currently, it is possible to request the temporary postponement of the payment of taxes only during domestic appeal processes. If this discrepancy is not fixed, it may render the use of tax dispute resolution mechanisms a less attractive alternative in many cases. We are happy to discuss the implications of the proposed legislation in concrete situations as well as keep you updated on the legislative process.
Draft Goverment Proposal on CFC Rules and General Anti-abuse Rule
8 Aug 2018 The Draft Proposal Ministry of Finance has issued a draft government proposal on controlled foreign company ("CFC") rules, implementing the CFC rules of the Anti-Tax Avoidance Directive (2016/1164, the "Directive"). Additionally the proposal addresses the general anti-abuse rule ("GAAR") of the Directive. The proposed CFC rules, which would enter into force at the beginning of 2019, are in many ways stricter compared to both the requirements of the Directive and to the currently applicable CFC rules. Overview of Proposed CFC Rules Controlled foreign company rules effectively re-attribute the income of a low-taxed controlled subsidiary to its direct or indirect parent company. Control Whereas the current CFC rules require that at least 50% of the CFC is controlled by Finnish taxpayers (related or unrelated), the Directive requires that a Finnish taxpayer together with its associated enterprises (foreign or domestic) holds at least a 50% participation in the CFC. The Finnish proposal takes this requirement further and proposes a participation threshold of 25% for the CFC rules to apply. Level of Taxation The Directive would classify entities with an effective tax rate ("ETR") of less than 50% of the domestic tax rate as being subject to low taxation (calculated in accordance with the rules of the Member State of the controlling company). The Finnish proposal imposes a stricter threshold of 60% (resulting in an ETR threshold of 12% with Finland's current corporate income tax rate of 20%). Taxable CFC Income The Directive provides member states with two alternative frameworks for determining the taxable CFC income, which would include: (a) specific passive income (such as interest, royalties and dividends); or (b) income arising from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage. The draft proposal does not directly follow either of the models proposed by the Directive but instead applies a combination of the non-genuine arrangements rule with the currently applicable Finnish CFC rules. In brief, any low-tax entity that is controlled by Finnish taxpayers may be subject to the CFC rules, unless one of the exemptions applies. Exempted Activities The draft proposal follows the Directive's framework of excluding EEA resident companies with genuine economic activities from CFC taxation. However, outside the EEA, all genuine business arrangements are not outside the scope of CFC rules. The new rules would 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. In addition, adequate exchange of information procedures need to be in place between Finland and other state for the exemption to apply. It is important to note that the current exemption applicable to tax treaty resident companies would be abolished. Consequently, the effective level of taxation of such non-EEA resident companies would need to be monitored. 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. This change will provide more flexibility for companies with regional activities. All in all, the new rules extend the scope of the current CFC rules and also include stricter rules than those required by the Directive. General Anti-Abuse Rule General anti-abuse rules feature in tax systems to tackle abusive tax practices that have not yet been dealt with through specifically targeted provisions. Pursuant to the GAAR of the Directive, for the purposes of calculating the corporate tax liability, Member States shall ignore an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstances. Finnish domestic legislation includes a GAAR which, despite its different wording and structure, has broadly the same purpose as the GAAR of the Directive. Despite ongoing discussions regarding the comparability of the two GAAR provisions, the Finnish Ministry of Finance concluded that the currently applicable domestic GAAR meets the requirements of the GAAR of the Directive, acknowledging that the domestic GAAR may be stricter in certain situations. Therefore no changes are proposed under the draft to the currently applicable GAAR due to the Directive. Implications Proposed amendments significantly expand the scope of application of the CFC rules and could lead to somewhat arbitrary CFC implications e.g. to companies with genuine business operations outside the EEA. Especially the inclusion of a specific list of exempted activities compared to the Directive's approach of exempting all genuine activities will likely cause issues to numerous taxpayers as in some cases also genuine business operations subject to low taxation in non-EEA countries may classify as CFCs under the new rules. The extension of the scope of the sales and marketing exemption would enhance structuring options for many groups operating with regional activities. The proposed rules, which would enter into force on 1 January 2019, are currently under public consultation and are subject to change. It is recommendable for companies to assess the impact of the proposed changes to their current structures. We are happy to discuss the proposed changes with you and keep you updated with the development of the legislative process.
Transfer Pricing Related Tax Disputes - Significant Risk for Multinational Enterprises
18 Jun 2018 During the past years, the Finnish Tax Administration has carried out a number of tax audits focusing on transfer pricing. The tax audits have lead to significant adjustments to the taxable income of the Finnish entities. The Tax Administration has recently published statistics which reveal that the taxable income has been adjusted in 34 out of the 63 transfer pricing tax audits carried out in 2012–2017. The total amount added to taxable income in these tax audits is astonishing EUR 3.048 billion. This means that on average the additional taxable income added based on a transfer pricing tax audit has been close to EUR 90 million. As a consequence, the amount of additional taxes and other payments, such as late payment consequences and potential punitive tax increases, subject to a dispute can often be tens of millions – or even hundreds of millions.                   Some of these transfer pricing disputes have already been resolved in courts. However, many of the above mentioned disputes are still pending due to the length of the appeal processes. Respecting the Chosen Form of Transaction Is Often the Core Legal Question in the Disputes One of the most significant legal questions in the transfer pricing disputes is the borderline between recognition of the actual transaction and re-characterization of a transaction. Recognition means respecting the form chosen and followed by the taxpayer and assessing whether its pricing is at arm's length. In contrast, when a transaction is re-characterized, taxation is based on the form unrelated parties would have chosen (e.g. sale is considered an arm's length transaction form instead of lease). The Supreme Administrative Court has confirmed that re-characterization is unlawful in the context of transfer pricing adjustment (KHO 2014:119; requirement to respect the chosen business model was confirmed in KHO 2017:145). Re-characterization is only allowed when the general anti-avoidance provision is applicable which requires e.g. that there is an intention to achieve inappropriate tax benefit through an arrangement which is not supported by sufficient business reasons. Since this is usually not the case in the transfer pricing disputes, the Tax Administration's authority is often limited to assessing the pricing of the actual transaction carried out between group companies. Regardless of the Supreme Administrative Court's published case law, disputes around the concepts of recognition (or delineation) and re-characterization continue to surface. When Facing Litigation the Taxpayer Needs to Prepare for a Complex and Lengthy Process Litigation phase in a transfer pricing dispute is often complex and the processes tend to last for several years. There are often several areas subject to dispute; understanding of the facts, legal basis for the transfer pricing adjustment, pricing and valuation, and often also tax procedural questions. The challenge is to present the multidimensional case, usually following extensive correspondence with the Tax Administration in the tax audit, in an understandable way to the Board of Adjustment and the courts. In many of the major transfer pricing disputes the case has ultimately been decided fully or partly in favor of the taxpayer in the appeal process. Prudent planning and good argumentation are essential to overturn the Tax Administration's position. In transfer pricing cases there is also possibility to refer the case to a Mutual Agreement Procedure between the countries involved. This can take place instead of or after the domestic appeal process. In the Mutual Agreement Procedure the authorities from both countries negotiate how the double taxation can be eliminated. The process is most effective between EU Member States whereas with other countries there is no guarantee that the authorities reach a conclusion at all.
In Search of the New Normal
18 Jun 2018 Despite market actors' and central banks' valiant efforts to divine the future trends of interest rates, the only key discovery still remains that past rules governing their behaviour no longer apply. With new rules still unwritten and the future legal and economic environment shrouded in uncertainty, businesses deciding upon their financing structures have been presented with an extraordinary conundrum. These are the key takeaways from the seminar on the future of interest rates organised by D&I on 14 February 2018. With an aim to presenting an audience of industry and business figures with a concise view of present macroeconomic trends, insight was provided by Mr Olli Rehn, former European Commissioner for Economic and Monetary Affairs and current member of the Board of the Bank of Finland, as well as by Mr Risto Murto, President and Chief Executive Officer of Varma Mutual Pension Insurance Company. A primer on the future deductibility of interest expenses was also provided by Mr Kai Holkeri, Partner and Head of Tax & Structuring at D&I. Economizing the Economy With inflation in the Eurozone having remained conspicuously low for several years even after the peak of the financial crisis, the ECB has continued to pursue a policy of record-low interest rates and quantitative easing in the form of asset purchases. While the central bank's active role is to be credited in the recent recovery of the financial system and the overall economic uptick, it is still all but clear whether – and if, when – the economy at large can be trusted to keep inflation at target levels without the ECB's intervention. None of this, however, is to say that the economy has not recovered on a sound basis. Given that the recent Finnish recovery – current estimates indicate growth of three per cent in the year 2017 – is largely based on reliable investment expenditures and export demand while Eurozone lending to both households and businesses has seen a healthy acceleration without reaching pre-crisis levels, it can be said with confidence that the market has finally begun to find its feet again. Nevertheless, until such time that European business and finance have hit their stride without need for the crutch of cut-rate money from the central bank, market participants will need to continue paying close attention to the ECB's monthly intentions. Deducted Interest in Interest Deductions Presented with this scenario of both cheap cash abound and potential economic boom in the horizon, one would assume that businesses would be quick to join the growing ranks of borrowers hungry to finance their investments. European regulation, however, has found itself a sizeable spanner in these future works, as the European Union's Anti-Tax Avoidance Directive (ATAD) is to obligate the Union's Member States to limit the deductibility of interest expenses. Provisions in the ATAD extend far beyond the initial goal of curbing tax base erosion and profit shifting (BEPS) in multinational corporations, mandating Member States to also reduce the deductibility of interest expenses even to third parties. "The winning formula may just be to make the very best of the abnormal." The rationale of regulating such external debt without any tax planning aims has been called into question, and rightly so. Alas, businesses navigating the present uncharted economic waters amid simultaneous legislative turmoil have no choice but to get used to perpetually rethinking their financing conventions and business models. With signs of the new normal still awaiting discovery, the winning formula may just be to make the very best of the abnormal.  

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