Norway: Consequence of Tax Bill for Investments in Foreign Limited Partnerships (Corporate Tax)

Last Updated: 29 September 2005

Originally published July 1 2005

Njaal Arne Høyland and Frode Talmo

Background

Norwegian partnerships are regarded as transparent entities for tax purposes. Therefore, the income of partnerships is taxed at the hands of the partners regardless of whether the income has been distributed. In order for partnerships established abroad to be treated as transparent entities for Norwegian tax purposes, at least one of the partners (the general partner) must have an unlimited and personal obligation for the partnership's debts, liabilities and obligations. Moreover, the general partner's ability to meet its obligations must be genuine.

In a January 2005 report, an expert tax committee proposed rules under which, from a tax point of view, it would be less advantageous for Norwegian corporate investors to invest in limited partnerships outside the European Economic Area (EEA). Had it been adopted, the proposal could have had negative consequences for Norwegian investments in limited partnerships outside the EEA. The government reviewed the committee's report and submitted a proposal for new tax rules that deviates from that of the committee on several points. Under the government's proposal, it shall not be less advantageous - from a tax point of view - to invest in foreign limited partnerships.

Expert Tax Committee's Report

The committee suggested that the 'exemption method' for taxation of income from shares should also apply where corporate investors realize ownership interest in a limited partnership. Under the current exemption method, income from shares (ie, dividend payments and capital gains) in a limited liability company is tax exempt at the hands of corporate investors. Correspondingly, corporate investors will not be entitled to deduct costs - save for any interest on debts - attributable to any share income that is tax exempt. Further, losses incurred on shares will not be deductible.

Moreover, the committee proposed that the restrictions of the exemption method in relation to cross-border investments in shares also apply to investments in foreign limited partnerships. As a result, the exemption method would not apply to realization of ownership interest in a limited partnership established in a low-tax country outside the EEA, as well as to 'portfolio investments' (ownership of less than 10%) in a limited partnership outside the EEA.

Government's Proposal

In a white paper on changes in taxes and duties in the revised budget submitted on May 13 2005, the government presented a bill which deviates from the committee's proposal. The Ministry of Finance states that, from a transparency point of view, the place where the limited partnership is established is, in principle, of no significance. According to the bill, the exemption method shall apply to corporate investors realizing ownership interest in a limited partnership, irrespective of whether the partnership is established in Norway or abroad. With regards to corporate investors in limited partnerships that hold share investments, an exemption shall apply if more than 10% of the total share value consists of investments in low-tax countries and/or portfolio investments in companies established outside the EEA. Realization of ownership interest in such partnerships will not be encompassed by the exemption method. The bill is scheduled to become effective as of the 2006 financial year.

This update provides a short outline of the situation for Norwegian corporate investors in limited partnerships, provided that the partnerships are recognized as transparent entities for Norwegian tax purposes.

Taxation of Profits and Losses in the Partnership

The taxable income is calculated at partnership level pursuant to general tax regulations. It is then allocated to investors according to their respective ownership interest in the partnership (the 'net method'). The white paper does not propose any changes regarding the ordinary income taxation.

Under the tax exemption method, income from shares in a limited liability company residing within the EEA or the European Union will be tax exempt at the hands of Norwegian corporate investors. Provided that the partnership is treated as transparent for tax purposes in Norway, the net taxable result at partnership level attributable to Norwegian corporate investors shall be adjusted so as to exempt capital gains on shares and to add costs and losses related to share income. Dividend payments shall be excluded from the net income calculation at partnership level. Instead, they will be attributed to Norwegian corporate investors directly and thus entitled to tax exemption.

The partnership's income from shares which are not subject to the exemption method (ie, share investments in low-tax countries and portfolio investments outside the EEA) will be part of the net taxable result at partnership level attributable to Norwegian corporate investors. Correspondingly, the corporate investors will be entitled to a tax deduction proportional to the partnership's losses and expenses on such investments.

Distributions from the Partnership

The Ministry of Finance supports the committee's proposal that only personal investors be taxed on distributions from a partnership. Corporate investors may still receive distributions from the partnership without taxation. This does not require any changes to the current tax rules.

Realization of Ownership Interest in the Partnership

The ministry took the basic stance that the exemption method should apply to corporate investors in connection with realization of ownership interest in the partnership irrespective of where the partnership is established. Therefore, gains resulting from the realization of ownership interest is exempt from taxation, whereas losses and expenses related to the ownership interest in the partnership are not deductible.

However, the bill contains a restriction on the applicability of the exemption method which depends on where the partnership's share investments are made: if the value of the partnership's share investments in low-tax countries and/or portfolio investments outside the EEA exceeds 10% of the partnership's total share investments, the exemption method shall not apply to corporate investors in connection with the realization of ownership interest in the partnership. If this exception applies, the realization gains will be taxable as ordinary income (at a tax rate of 28%) and any loss will be deductible for the corporate investors. Profit/loss is calculated as the difference between the sale price and the net cost price.

Under the bill, the 10% limit for the applicability of the exemption method will be assessed on the basis of the market value of the partnership's share investments at the time the ownership interest in the partnership is realized. The ministry will assess whether regulations defining the contents of this provision more precisely are needed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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