Exit tax on individuals and other tax changes proposed by the Finnish Government
The Finnish Government has published the key figures and policies, including tax policies, of its proposed budget for 2022. The tax policies in the budget proposal aim to promote sustainable development, promote growth and investment, widen the tax base and defer aggressive tax planning. In this article, we give an overview of some of the key tax policies in the budget proposal.
The budget proposal contains changes to certain energy taxes, introduces new subsidies for low carbon emission vehicles, increases deductions for certain R&D expenses and machinery depreciations, increases the tax credit for households and introduces a mining tax. In addition, some anticipated policies in the budget proposal aim to defer aggressive tax planning. These include the introduction of an exit tax, the expansion of the scope of the interest barrier rules, and the broadening of the tax base for cross-border real estate investments. These three policies are discussed below in more detail.
Proposal introduces exit tax on individuals
Under the current Finnish tax system, Finnish capital gains tax is generally only collected when an individual is a tax resident in Finland at the time of the disposal of the asset. The budget proposal introduces material changes to this principle through an exit tax on capital gains. Under the proposal, Finland would expand taxation to the appreciation in value enjoyed by an individual while a tax resident in Finland even if the capital gain would only be realized when the individual lives abroad. Thus, the purpose of the exit tax would be to disincentivize high net worth individuals with inherent capital gains from moving from Finland and realizing the gains after the move.
The budget proposal does not contain any specifics on the exit tax and it is still unclear, for example, what kind of assets would be subject to the tax, whether the tax will apply to all Finnish tax residents irrespective of the duration of their tax residency in Finland, and how unrealized capital losses upon expatriation are accounted for.
The potential exit tax was discussed in detail in a February 2020 report by the Ministry of Finance. Although the Ministry of Finance did not recommend introducing an exit tax for individuals because of all the challenges involved, the report gives some insight into what the new regime could look like. For example, we would expect that the exit tax will have an application threshold to target the higher net worth individuals.
Further, due to EU law considerations, the exit tax provisions are expected to at least allow for some kind of deferral of tax payment. The report suggests that the deferral could follow a so-called taxpayer friendly model rather than a tax recipient friendly model. Under the taxpayer friendly model, the tax would be imposed upon expatriation but there would be automatic deferral of actual payment, with no interest, until the asset is disposed of.
According to the proposal, the exit tax will be effective as from 2023 and the government expects to collect approximately EUR 25 million annually from the tax.
Proposal tightens the Finnish interest barrier rules
The budget proposal also proposes changes to the Finnish interest barrier rules that limit the amount of interest that can be deducted in business taxation. Under the current rules, net interest expenses are generally deductible up to 25% of taxable EBITD subject to certain de minimis thresholds.
The current rules also contain an escape clause in a form of a balance sheet test, whereby companies are generally permitted to deduct interest when a sufficient balance sheet ratio can be presented showing that the company has an equity to total balance sheet ratio that is higher than the consolidated ratio for its group.
According to the budget proposal, the current balance sheet test would be amended to specifically target profit shifting by private equity investors. This reform is expected to take effect as early as in the beginning of 2022 and the Government Bill is estimated to be issued later this fall. The exact content of the reform is still unknown. However, due to the way in which the rules operate, there has been limited scope for private equity investors to benefit from the balance sheet test even under the current system.
Under recently published Supreme Administrative Court decisions, private equity investors can currently benefit from the balance sheet test mainly in cases where the target is owned by a private equity consortium or other structures are used where none of the parties has control, and in cases where the private equity investor has been willing to draft full consolidated financial statements at the level of the private equity fund.
It is possible that the amended rules will now target specifically the structures recently accepted by the Supreme Court or, alternatively, completely exclude private equity investors from the balance sheet test in a similar manner as the current Finnish participation exemption rules for capital gains (even though this could be problematic from an equal treatment perspective).
Proposal aims to tax profits from real estate investments by foreign investors
Finally, in line with previous statements by the Government, the budget proposal aims to tax (as broadly as possible) income from real estate investments by foreign investors that currently constitute tax-exempt income in many cases. Again, the budget proposal does not contain any details on the changes except that the changes will be made starting from 2023 and the changes are expected to raise approximately EUR 15 million in additional tax revenue.
This proposal follows work performed by a working group set up by the Ministry of Finance and, thus, the working group’s June 2021 final report provides some clues as to what is to be expected from this reform.
First, the working group suggested that the rules concerning the tax treatment of special investment funds investing in real estate could be amended either by introducing a flow-through model under which the investors would be taxed directly for their share in the fund’s income or by abolishing the tax exemption from all real estate funds.
Secondly, the working group suggested changing the national regulations dealing with indirect transfers of real estate to enable a broader right to tax capital gains. This would entail changing the definition of Finnish source income to include (in addition to capital gains from sales of shares in companies that directly own Finnish real estate) capital gains from sales of shares in companies that indirectly own Finnish real estate. This change would, however, be relevant when Finland has a similar broad right to tax under an applicable tax treaty (e.g. the tax treaty between the Nordic countries) and would not apply, without changes to the applicable tax treaty, when Finland’s right under the tax treaty follows the current, more limited scope, of the national regulations (e.g. the Luxembourg tax treaty).
Key takeaways from the proposal
If and when implemented, the above changes could have a material impact on the taxation of very high net worth individuals and private equity and real estate investors (especially Nordic investors) looking into investing in Finland. With respect to the balance sheet test, we should have more details about the new provisions in the coming months.
With respect to the exit tax and taxation of real estate income, even though the contemplated reforms are expected to take effect in the beginning of 2023 and possible Government Bills are expected to be issued only in 2022, it is possible that some of the tax changes will be introduced retroactively, for example from the date the Government Bills are issued. Therefore, it is important to start preparing for these changes well in advance to mitigate any negative consequences from these reforms.
We are currently carefully monitoring these legislative developments. We would be happy to discuss the new possible regimes and their potential effects on your tax position in Finland.