The current controlled foreign corporation (CFC) legislation needs amendment and the Finnish Government has issued a government bill on 1 November 2018 to take the first step towards new legislation as part of the implementation of the EU Anti-Tax Avoidance Directive. The amendments are proposed to enter into force on 1 January 2019. If the bill is adopted, the CFC rules will limit the use of foreign holding companies in low-tax jurisdictions.
Finnish CFC regime and current legislation
The Finnish CFC legislation aims to prevent the transfer of taxable income to low-tax countries. The Finnish CFC legislation implies that a Finnish corporation or individual may be subject to income tax for its share of the profit of a CFC regardless of whether these profits are distributed by the CFC to its shareholders or not. Unless a particular exemption applies, a foreign corporation may be regarded as a CFC, if
a) the CFC is controlled by a Finnish tax resident(s). Control is deemed to exist if the Finnish tax resident(s) directly or indirectly hold jointly at least 50% of the capital or voting base of a CFC or have the right to at least a 50% of the profit of the CFC and
b) if the effective income tax rate in its domicile is less than 3/5 of the Finnish corporate income tax (i.e. 12%).
Certain business activities are excluded from the scope of application of the CFC rules. The CFC rules do not, for example, apply to profits mostly arising from industrial production, other corresponding production or shipping activities and sales or marketing activities related to the above-mentioned activities conducted in the entity’s state of residence.
In addition, CFC legislation does not apply to entities that are:
- resident in a tax treaty country (provided that the country is not included in Ministry of Finance’s list of low-tax jurisdictions) assuming that the entity is not subject to any special tax benefits there; and
- resident in an EEA country or a tax treaty country (not included in Ministry of Finance’s list of low-tax jurisdictions) provided that the country has concluded a treaty with Finland providing sufficient tax information exchange and that the entity is actually established in its state of residence and that the entity carries on a substantive economic activity there.
If the corporation is regarded as a CFC, the Finnish resident is liable to tax for its part of the corporation’s profits. However, if the interest of the Finnish resident is less than 25%, the Finnish resident is not subject to tax.
The government bill proposes the following key changes:
- The rules will apply not only to Finnish residents but also to non-resident taxpayers if the control in a CFC is attributed to a permanent establishment of the non-resident taxpayer in Finland.
- The threshold for control (including direct or indirect control of related parties) will be reduced to 25%. Compared to current legislation, the non-resident associated corporations will also be taken into account in assessing the control in the foreign CFC.
- If the 25% control exists, the Finnish resident is liable to tax for its part of the CFC’s profits irrespective of its share of ownership.
- The general exemption for corporations resident in EEA countries will be abolished, and in future, non-application of CFC legislation to EEA corporations requires that a corporation will carry on a substantive economic activity in the country of residence.
- A corporation resident in a non-EEA country may be exempt from the application of CFC legislation as of 2019 under the same conditions as a corporation resident in an EEA country. However, a corporation should also fulfil the following requirements:
- the country of residence is not in a so-called black list issued by the EU;
- the country of residence has concluded a treaty with Finland providing sufficient tax information exchange; and
- profits mainly arise from industrial production, other production or provision of services, shipping activities or sales or marketing activities related to the these activities
The proposed amendments will have a significant impact especially on corporations situated outside the EU. In future, the non-application of CFC legislation to non-EEA subsidiaries requires that:
- the effective income tax rate of the entity is at least 12%;
- entity carries on a substantive economic activity in the country of residence – the corporation should have, for example, office premises, assets and personnel acting independently in the country of residence; and
- the profits of a CFC mostly arise from industrial production, other production or provision of services, shipping activities or sales or marketing activities related to the above-mentioned activities.
The new exemption requirements will target in particular holding company structures and it should be evaluated whether the current structures require reorganisation. For example, a foreign company that mainly operates as an investment company, IP holding company, financing company or management company in a low-tax jurisdiction may be deemed to be a CFC for Finnish tax purposes. Even holding companies in the EU with no or little activities may prove to be problematic.
The amendments are proposed to enter into force on 1 January 2019 and apply to the fiscal year 2019. We will continue to closely monitor the legislative process of this proposal and provide updates if necessary.
Borenius’ lawyers are available to assist in addressing any questions you may have regarding this legal alert. Please feel free to contact any of the Borenius’ attorneys listed in this alert or those with whom you usually work.