The Finnish Supreme Administrative Court has on 30 December 2011 issued a ruling (SAC 2011:118) regarding the dispensation procedure relating to the possibility of use of tax losses despite a qualified change in ownership in a company. In the ruling SAC did not issue a final resolution but with votes 52 instead decided to request a preliminary ruling from the European Court of Justice (ECJ).
The currently applicable tax loss dispensation procedure is based on section 122(3) of the Finnish Income Tax Act (30.12.1992/1535). Based on the provision, the tax authorities may grant a dispensation based on which the company may deduct the losses despite a qualified change in ownership that would otherwise lead to the forfeiture of tax losses. The dispensation may be granted if the company presents special reasons based on which the deduction of losses is needed from the point of view of continuing the business activities of the company. In addition, the company must show that the tax losses have not been the motive of the transfer in ownership but the transfer has sound business motives instead. Based on the provision, the tax authorities have been able to use discretion when considering whether the prerequisites for granting the dispensation have been fulfilled in the light of court practice and guidance given by tax authorities.
Argumentation in SAC 2011:118
In the ruling of SAC, the majority stated that the current dispensation procedure may be against Article 107 of the Treaty on the Functioning of the European Union (TFEU) concerning state aid. In the article, any aid granted by a member state or through state resources in any form, distorting or threatening to distort competition by favouring certain undertakings or the production of certain goods is deemed to be incompatible with the internal market. According to the majority, should the position of the companies which received a dispensation in the tax loss dispensation procedure be compared with the companies which were refused a dispensation, the dispensation procedure including the discretion element can be deemed such state aid incompatible with the internal market as stated in Article 107 of the TFEU.
By contrast, according to the opinion of the minority, evaluation of the questions relating to state aid in the case at hand would not be compatible with domestic legislation, and EU law would not require ex officio evaluation of the possible state aid character of the tax loss discretion provision, either. The minority justified its view by the unnecessity of the ex officio evaluation in the light of principles of reciprocity and efficiency. In addition, the lack of legal certainty and consistency of the legal practice relating to the application of dispensation provision were seen by the minority to be against the request for a preliminary ruling from ECJ.
Dispensation practice after the ruling
As a consequence of the request for the preliminary ruling, SAC will not solve any applications for amendment regarding dispensation applications before ECJ issues its ruling regarding the applicability of the dispensation application regulation in the light of the TFEU. The average handling time of ECJ is approximately 1.5 years. The ruling may lead in difficulties in receiving a dispensation, and in the case of an appeal, receiving the decision may be postponed for several years.
From taxpayers point of view, the worst alternative would be the legal uncertainty to continue for several years, during which the treatment of dispensation applications in tax authorities and administrative courts is not functioning as planned. This would lead to a drastic weakening of the possibilities of the use of tax losses dated in the beginning of the 21st century in case a change in ownership has occurred. This may affect both the number of mergers and acquisitions and the feasibility of investments and ownership restructurings.
Changes in regulation are also possible
However, it is also possible that the dispensation provision will be amended before the ruling of ECJ will be issued. The dispensation system may be totally abolished, as a consequence of which the confirmed tax losses would be forfeited only if the tax losses exceeded the time limitations set for carry forward of tax losses or if a company having tax losses was acquired only to utilise the tax losses. In the latter case, intervention in the acquisition lacking business purpose could be executed with the general anti-avoidance provision. In our understanding, this kind of alternative would require the smallest amount of administrative duties and harm least the development and rationalisation of the business operations of the loss-making companies. This kind of procedure is applied in several EU member states.
Alternatively, the government could attempt to codify the current dispensation-related case law and administrative guidance in the regulation level, which would lead to the abandonment of the discretion element of the tax authorities. A major risk present in this alternative is that most of the special reasons required for granting the dispensation are subject to interpretation, the applicability of the special reasons depends on the relevant conditions of the company in question.
The request for the preliminary ruling to ECJ made by SAC drastically affects the use of tax losses from previous years if qualified changes in ownership of the loss-making entity have occurred. Furthermore, the uncertain regulation situation strongly affects the tax planning possibilities. Receiving dispensations can become more difficult and issuance of the final rulings may be postponed for several years. Due to the requested preliminary ruling, the amount of uncertainty relating to the amount of utilisable losses in changes in ownership will increase significantly. Attorneys at law Borenius Ltd is glad to help in evaluating the amount of utilisable tax losses and charting the possible alternatives relating to the utilisation of tax losses from previous years both before and after the change in ownership.