Originally published in IFLR the 2007 Guide to Private Equity & Venture Capital
Real Estate Investments in Finland
Strong economic growth, high liquidity in property markets, high degree of transparency and highly competitive economy are some of the factors that have made Finland an interesting target for real estate investors. The estimated rate of return compared to the risks seems to be at a relatively high level especially in Helsinki.
With direct ownership in real estate targets, rental income and capital gains are taxable income in Finnish taxation for a non-resident investor with limited liability to pay tax in Finland, but possible interest expenses can be deducted from the rental income. Applicable tax rates and rules for the country of taxation can be found in national tax laws and tax treaties between Finland and the investor’s country of residence. However, the real estate targets in Finland are often organized in the form of real estate companies or mutual real estate companies ("MREC’s"). A MREC is a Finnish special company form where the rental income from the owned property is taxed directly in the hands of the shareholders of the MREC. While the taxation occurs like in direct ownership, the governance can be organized as with normal limited liability companies. In addition, a more favourable overall tax position for a non-resident investor can be achieved through a company structure in comparison with direct ownership.
The Finnish tax legislation does not contain any specific rules concerning thin capitalization. It should be noted, however, that very heavy intra-group debt financing may cause the Finnish tax authorities to intervene on the basis of general anti-avoidance provisions. The lack of thin capitalization rules enables tax efficient financing structures for Finnish real estate investments, e.g. debt push down. In other words, for Finnish tax purposes interest expenses on bank loans and intercompany loans can be offset against rental income. In practice, very heavy leverages have been used in Finnish investments. Debt financing is made even more attractive by the fact that in general, no withholding tax is levied on interest payments from Finland.
Dividend withholding tax for the non-resident investor varies between 0-15 % depending on the share of ownership and the residence country of the investor. Dividends distributed to an investor resident in a country with which Finland has not concluded a tax treaty are subject to a tax of 28 %. However, it should be noted that Finland has a very comprehensive tax treaty network and the total number of tax treaties in force is nearly 70.
The Finnish transfer tax upon the sale of shares amounts to 1.6 % and upon the sale of real estate to 4 %, in both cases calculated upon the actual purchase price.
According to Finnish tax legislation and tax treaties a capital gain deriving from the sale of shares of a Finnish real estate company in which the net assets to 50 % or more is real estate will be subject to tax in Finland at a rate of 26%. However, there are certain possibilities to structure the real estate investment in such a way that Finnish tax on capital gains could be avoided.
Finnish Equity Funds Have Become Tax Feasible Investment Vehicles For Foreign Investors
Finnish private equity/venture capital funds have not been earlier very attractive objects for foreign investors. This has been due to the unfavourable taxation of foreign investors. Most of the private equity funds are partnerships. In taxation partnerships are not treated as a separate tax subjects. They are treated as an accounting unit and thus profits are taxed as income of the partners. According to previous decisions of Finnish Supreme Court, a foreign investor as a partner in a Finnish limited partnership is deemed to have a permanent establishment in Finland. Actually, this meant that for tax reasons there were practically no foreign partners in Finnish private equity/venture capital funds.
To make Finnish private equity funds more attractive for foreign investors, Finnish parliament enacted an amendment to the tax law relating to taxation of non-resident partners. According to this amendment, effective as of January 2006, a non-resident partner’s share of profits received through a Finnish partnership is taxed in the same way as if investor had invested directly in the Finnish target company. This means that a foreign partner will be taxed as he would be a shareholder in the Finnish target company. Thus a foreign partner will not be taxed on capital gains or interest in Finland. Only dividend received by the partnership from Finnish sources may be subject to final withholding taxation in the taxation of non-resident partner. The taxation depends on the tax treaty between Finland and the investor’s country of residence. Dividends that partnership receives from foreign sources are never subject to taxation in Finland in the taxation of non-resident partner.
For the application of the new relief provision it is required that the Finnish fund practises venture capital business in the manner prescribed in the Finnish Income Tax Act. This means that investments are targeted to companies not quoted on the stock market, investors aim to develop the business of the target companies and investors aim to sell the shares acquired in target companies within a limited timeframe.
Due to this tax relief for non-resident investors investing to Finnish private equity funds becomes more attractive. In general, a Finnish limited partnership fund is a tax-feasible solution for example for international private equity investments.
Finnish Investments in Russia
Russia appears to attract investors due to its growing market, wealth increase, decrease in inflation and currency stabilization. Risk and yield expectations are decreasing but potential gains of the investments are still high. Finnish investments in Russia have increased but Finland can also be used as a gateway to Russia for international investors.
Investments in Russia can be structured in many ways depending e.g. on the target assets, countries involved and the investors’ countries of residence. The targets in Russia may be owned directly or through holding companies. In some cases also holding companies in other countries, usually in EU, are incorporated in the structure. In these cases the idea is to locate the holding company in such a country that the tax treaty between it and Russia allows lower taxation of the income flows than between Finland and Russia. Some countries, for example, have adopted participation exemption regimes with which capital gains are broadly exempt. Repatriating the income to Finland must also occur without adverse tax effects. For example, dividend payments are tax exempt according to the parent-subsidiary directive when the parent company owns at least 15 % of the shares in the EU-subsidiary.
A fund structure with a Finnish limited partnership may work as a feasible vehicle to invest into Russian companies and real estate targets. A limited partnership is not treated as a separate tax subject in Finland. It is treated as an accounting unit i.e. the partnership itself is not taxed, but its calculated profit is allocated to its partners and taxed as income of the partners. Thus, the taxation of the investors has to be individually considered in order to achieve the optimal tax for the different countries of residence. With a carefully planned structure, basically no Finnish tax consequences arise for a non-resident investor.
Finnish Group Contribution System Under The Pressure Of EC Law
At the moment it is not possible in Finland to consolidate the profits and losses of certain group of companies for tax purposes. However, profits and losses may be balanced between Finnish corporations belonging to the same group of companies through an open group contribution. A group contribution may be deducted from the taxable profits of the contributing company and added to the taxable income of the recipient company. Both giver and receiver of a group contribution has to be resident companies in Finland. The parent company has to have owned at least 90 % of the capital of the subsidiary during the whole financial year. The same possibility for a group contribution does not concern multinational groups of companies.
It is common that a multinational group of companies include both profitable and unprofitable companies. The fact that balancing of losses between a Finnish company and a foreign company is not possible makes it disadvantageous in tax purposes to have subsidiaries abroad. Thus international groups are treated less favourably than purely domestic groups. This is contrary to the principle of neutrality. Due to the possible violation of non-discrimination provisions of EC Treaty Finnish group contribution legislation has been under discussions during last years. The discussions began especially with case C-446-03 Mark & Spencer.
Finnish Supreme Administrative court has referred a question concerning the applicability of the Finnish group contribution regime in cross-border situations to ECJ for an advance ruling. This is so called Oy AA case (formerly known as the Oy Esab case) where Finnish resident company Oy AA contemplated to give a group contribution to its great-grand-parent company AA Ltd. resident in UK. According to the opinion of Advocate General the EC Treaty or Parent-Subsidiary Directive do not preclude Finland from requiring that both the giver and the receiver company to be Finnish residents. The final decision on this case will probably be given during this year.
Due to the possible breach of EC law and other problems with Finnish group contribution rules there has been appointed a working group to clarify the future of Finnish contribution rules. According to the report of the working group Finnish contribution rules has to be renewed. In the future also cross border situations need to be taken into consideration so that the purposes of common market can be realized. In the renewal the systems used in other Nordic countries and in some EC member countries is said to be used as a model. Presumably in the new system the group of companies will be treated as a fiscal unity.
Due to the case Cadbury & Schweppes 196/04 and the possible violation of the freedom of establishment also Finnish legislation concerning controlled foreign companies will be revised in the future. Revision of both group contribution legislation and CFC legislation will offer new attractive tax planning opportunities for Finnish companies and foreign investors investing into Finland.
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.
