Draft Government Proposal on International Tax Dispute Resolution Mechanisms

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29 Aug


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Dittmar & Indrenius > Insight > Draft Government Proposal on International Tax Dispute Resolution Mechanisms

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 Currently, most of the relevant procedural provisions are outdated and not explicitly applicable to international tax dispute resolution processes.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.

Latest Insights

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.

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