New Precedent on Taxation of Work Contribution Dividends

The Finnish Supreme Administrative Court (SAC) issued a precedent last week in a case regarding work contribution dividend taxation. The ruling extended the scope of Section 33 b of the Finnish Income Tax Act beyond its wording to apply to the profit sharing schemes of limited partnerships under the general anti-tax avoidance rule. The SAC was not unanimous in its decision, and after voting 3–2, it concluded that the provision may be interpreted broadly.

Summary of the case

The case concerns the profit sharing of a Limited Partnership (LP) that was established indirectly by doctors. The general partners of this LP were holding companies that were mainly owned by these doctors working for the LP. The LP had a separate profit centre for each general partner. The revenue of each profit centre consisted of each doctor’s work contribution. The profit-share of each general partner was calculated by subtracting the doctor’s expenses, a relative share of LP’s general expenses and administration fees from the revenue of their profit centre. The profit-shares were distributed to the general partner holding companies. The same doctors carried similar business on a limited liability company prior to establishing the LP.

If the profit-share were taxed under the legal form of the structure the income would be treated as capital income when distributed to the shareholder of the holding company. The SAC considered this to be against the object of the provision of the Income Tax Act. According to the SAC, the commercial reasons for using a limited partnership were rather thin and the arrangement was partly artificial, and the benefits achieved were mostly tax related. The SAC argued that when considered the situation as a whole, the legal form used did not correspond with the true nature and object of the arrangement and was considered tax avoidance. The profit-shares were taxed as work contribution dividends i.e. earned income of the doctors instead of capital income.

Effects of the new ruling

From now on, limited partnership (and other) arrangements may be taxed correspondingly to limited liability company arrangements if the profit sharing is based on the partners’ work contribution. However, applying the provision to other corporations but limited liability companies requires the arrangement to be artificial with tax avoidance intention having thin or no commercial reasons.

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