Legal Alerts/13 Feb 2017
Legal Alert – Ministry of Finance Proposes Changes to the Taxation of Dividends and Earned Income
The Finnish Ministry of Finance set up an expert group last autumn to examine the level of current corporate taxation related to competitiveness, economic growth and productivity. The aim of this was to promote neutral taxation.
The expert group outlines now that the Finnish business taxation system is internationally competitive and decides not to propose any changes to it. However, the expert group proposes changes to the taxation of dividends and earned income in order to increase tax efficiency.
These proposed changes in terms of unlisted companies’ dividends and earned income will have influence on taxation. If realized, these would increase annual tax revenues to the public sector by EUR 44 million, excluding any effects related to taxpayer behaviour. Altogether, these changes will harmonise the taxation of capital income and earned income.
Proposal for the taxation of unlisted companies’ dividends
The key changes proposed by the expert group to the current taxation of unlisted companies’ dividends are:
- Reduce the rate of return used for calculating dividends’ portion on which relief is given to 4% from the current 8%;
- Raise dividends’ taxable portion to 40% from 25%;
- Abolish the threshold of EUR 150,000 in relation to the relief given in dividend taxation; and
- Treat 75% of the portion of the dividend in excess of the rate of return as earned income, as it is at present.
Effects of the proposal
- Taxation would allow the shareholders to withdraw a lesser amount of dividends with relief. This would increase the tax burden for the majority of dividend recipients.
- Removing the EUR 150,000 limit would reduce taxation in certain rare situations where the shareholder withdraws substantial dividends from a high net worth company.
- These changes would simplify the taxation of dividends and encourage companies to grow.
- There would also be less tax-related variation in investment incentives among different businesses, which should encourage companies to allocate their investment more effectively.
- The total tax ratio for dividends attracting tax relief would rise closer to the rate for capital income taxation. As a result of this, taxation would apply more equally to investments in the taxpayer’s own company and those made elsewhere.
Proposal for taxation of earned income
The key changes proposed by the expert group to marginal tax on earned income, i.e. tax applying to extra income, are:
- Lower the marginal tax rate for earned income for those with annual earnings of EUR 82,000–128,000.
- In the long run, reduce marginal tax rates so that they do not exceed 50% at any income level.
The expert group also proposes that the legislation should abolish the current training deduction and add a separate provision to the Finnish Income Tax Act concerning tax exemption for employer-provided training in employee taxation.
Effects of the proposal
- These changes would encourage employees to build up their skills and expertise, which will improve their overall productivity. This would in turn, boost economic growth in the longer run.
- These changes proposed in the taxation of dividends and earned income would narrow the difference between the taxation of capital income and earned income. This would reduce the incentive to operate in the form of a limited liability company as opposed to operating as an employee.
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