Insights/17 Oct 2022
What is the Mankala model found in Finnish power production?
The Mankala Trilogy – Part 1
A cost-price model that fuels almost a half of Finland’s total energy production is called a Mankala model. You are likely to run into it regardless of the form of the energy production in question. Nuclear, wind, hydro and thermal energy production all rely on the model. If considering or engaged in any transactions, financing arrangements or disputes in the Finnish energy sector, you will need to take the model into account.
But what is this model that is unique to Finland but often strange to foreign investors? In this first part of our Mankala trilogy, we examine the basics and history of the Mankala model. Part II will explore the legal questions specific to the model and Part III will describe the rise of the model into new frontiers and possible threats to its existence.
The early stages of the model
Let’s start with the name. Mankala does not mean anything in Finnish but is the name of a village of about 100 inhabitants in the municipality of Iitti in the South-Eastern Finland. The village loaned its name to a Finnish limited liability power company called Oy Mankala Ab established in 1936.
Oy Mankala Ab was one of the first power companies that operated based on the cost-price model and it acted as the respondent in the first Mankala trial described below. Consequently, people later started calling the model “Mankala” after the name of the company. And by the way, Oy Mankala Ab is still in existence today.
After the World War II, the demand for electricity surged in Finland and there was an urgent need to grow the capacity fast. However, at the same time, Finland was a very sparsely populated country. Finland was foremost an agrarian economy and not the affluent, knowledge-based, welfare society that it is now. Also, the Finnish power companies lacked the financial muscle to engage in power plant investments that are typically extremely capital heavy.
The Mankala model was the key to solving the equation where a sparsely populated country on the verge of industrialisation needed to ramp up its power production capacity.
Benefits of the model
In a nutshell, in the Mankala model, a group of investors, typically smaller power local companies at that time, establish a limited liability company. The investors commit to paying all costs of the limited liability company in proportion to their shareholding. These costs mainly consist of the cost of building a power production facility, such as a power plant, and the costs of operating that facility. In turn, the limited liability company commits to transfer all power produced by the limited liability company to the investors or shareholders likewise in proportion to their shareholding.
Voila, you have a model where the limited liability company, in other words the Mankala company, can make a large-scale power plant investment and call in the necessary funds from its group of shareholders. In practice, the shareholders receive their share of the electricity produced at cost price.
Alternatively, the Mankala company can acquire outside funding for the building of the power production facility. Many institutional financers see the Mankala model as a good security and are more willing to finance the Mankala company than individual investors. If the financing is not paid back, the financer typically has both a mortgage on the Mankala company’s assets and the knowledge that, ultimately, the shareholders of the Mankala company are liable for costs of the Mankala company, including the financing taken by the Mankala company. From the point of view of the financer, the Mankala model resembles having an on-demand guarantee from the shareholders.
All this, of course, requires that there are legally binding commitments in place. We will dive into the detailed legal structure of the Mankala model later in Part II.
The first Mankala trials
The name of the cost-price model, Mankala, became established after the first court proceedings that took place in the 1960s. These first court proceedings were of administrative nature and concerned the taxation of a Mankala company.
Although the Mankala model had enabled the much-needed energy investments, its consequences to the Finnish municipalities were perceived to be not only positive.
When conducting the taxation of 1959, the Tax Board of the Iitti municipality realised that Oy Mankala Ab, operating on the basis of the Mankala model, had transferred electricity to its shareholders at a price that was approximately only half of the price that Iitin Sähkö Oy, the municipal power company, had paid for the same amount of electricity.
In principle, if a company transfers its assets to a shareholder below the fair market price, the difference between the fair market price and the price paid is taxable as a disguised dividend.
In addition, the power company generally never makes a profit or a loss under the Mankala model as it runs as a zero-profit cooperative. Profit is formed only when a shareholder sells the electricity it has received from the Mankala company, since the taxpayer is the shareholder and not the Mankala company.
This was difficult to accept for the municipalities who had gotten accustomed to the fact that they have the right to tax companies and production situated in the municipality. In the Mankala model, the taxable profits were generated only at the level of the shareholders and the shareholders typically were situated in a different municipality than the Mankala company. Thus, the domicile of the Mankala company did not receive any tax income, although the electricity, by the selling of which the profit is generated, was produced in the domicile of the Mankala company.
Ultimately, two cases against Mankala companies reached the Supreme Administrative Court that issued two judgements KHO 1963 I 5 and KHO 1968 B II 521. In the first judgement, it was confirmed that no taxable income was formed, although the Mankala company transferred the electricity to its shareholders at a price that potentially was lower than the market price. In the second judgement, it was ruled that the Mankala company did not pay any disguised dividend to its shareholders when it transferred electricity to these shareholders.
Following the two judgements of the Supreme Administrative Court, the use of the Mankala model became established in the Finnish energy sector. Several decades would roll by before the Mankala model again became under scrutiny. Before we examine the new threats to and possibilities of the Mankala model, we will take a look at the legal aspects of the model in more detail in our next part of this trilogy series.