The Ministry of Finance issues draft proposal on taxation of certain investment products and insurance wrappers
The Finnish Ministry of Finance published its draft proposal on amending the tax rules dealing with different forms of investment products on October 1, 2018. The purpose of the draft is to harmonize the tax treatment of different type of investment products and to reduce the impact tax considerations play when investors choose between different investment products.
The key changes proposed by the draft include:
- The draft proposes a new tax advantageous share savings account regime which would enable private individuals to invest, on a relatively small scale (EUR 50.000), tax efficiently into listed shares. Based on the proposal income that accrues within the account (e.g. capital gains and dividends) would not be taxable before the investor withdraws funds from the account.
- The proposal would replace the FIFO principle currently applied to withdrawals from certain life insurance policies and capitalization agreements with a rule based on which each withdrawal would include a non-taxable recovery of investment in the contract component and a taxable profit component.
- The draft harmonizes the tax treatment of private pension insurance policies so that going forward, all private pension insurance policies would generally be subject to the same rules as apply to life insurance policies and capitalization agreements.
- The draft proposes a special tax regime for investment linked insurance policies and capitalization agreements (so called insurance wrappers) that the draft considers as artificial. These policies would no longer benefit from tax deferral for income that accrues within the policy but the income would be taxed directly as income of the policyholder.
Proposal introduces new share savings account regime
The draft proposes an introduction of a new share savings account regime. Under the proposal gains and dividends from investments within the share savings account would not be taxable to the investor until the investor receives funds from the account. Withdrawals from the account would need to be divided between a taxable profit component and a non-taxable recovery of investment in the contract component. The profit component would be calculated by dividing the total profit from the account (value of the account less net investment in the account) by the total value of the account and multiplying this ratio with the amount of the withdrawal. This profit component would be taxed as capital income to the investor. Potential loss from the investments into the account would only be deductible when the account is terminated.
Only private individuals could invest into a share savings account and the funds in the share savings account could only be invested into domestic and foreign publicly listed shares. An individual would only be allowed to have one share savings account. Further, the amount of funds that could be invested through the account would be limited to EUR 50.000. Taking into account these limitations, the new share savings account regime is clearly geared towards small individual investors.
Proposal harmonizes tax treatment of insurance products
Insurance products such as life insurance policies and capitalization agreements have generally been subject to a favorable tax treatment in Finland. This is because the value buildup in form of e.g. dividends, interest and capital gain, within the policy is not taxed but enjoys tax deferral as long as the policy remains in force. Subject to an important exceptions, discussed in more detail below, the draft does not propose changes to this general rule.
Under the rules currently in force, in addition to the tax deferral benefit, also the taxation of withdrawals from life insurance policies and capitalization agreements have enjoyed favorable tax treatment; withdrawals have been treated first as non-taxable recovery of investment in the contract and only after the full investment has been recovered, as taxable income. The draft proposes changes to this advantageous treatment. Under the proposed rules, as with the share savings account, each withdrawal would include a non-taxable recovery of investment in the contract component and a taxable profit component. Potential losses from these policies would only be deductible when the policy terminates. Further, while generally, only the profit component of a withdrawal, and not the whole amount, would be taxable, if the taxpayer had been allowed a deduction for the premiums paid, the whole amount of withdrawal would be taxable income.
The draft also proposes changes to the tax treatment of private pension insurance policies. Based on the draft, going forward, private pension insurance policies would in general be subject to the same rules as life insurance policies and capitalization agreements.
Proposal repeals deferral for certain artificial insurance arrangements
The most drastic change proposed by the draft is a special taxation regime applied to investment linked insurance arrangements (insurance wrappers) the draft considers artificial. The draft would repeal the tax deferral for these policies and, instead, tax income accruing within the policy directly at the hands of the policyholder as capital income.
Under the draft, an insurance policy (an investment linked life or pension insurance policy or capitalization agreement) would be considered artificial if the policyholder can use certain ownership rights related to the underlying assets in the policy. These rights include e.g. right to use voting rights, right to use the underlying property and right to decide on disposal or acquisition of underlying assets or right to decide on the terms of a loan given through the policy. However, based on the proposal the mere fact that the policy holder can decide on which assets the funds in the policy are invested in or later change the allocation between different assets would not make the policy artificial. Thus, this special regime would likely be applied by the administration to curb the transfer of substantial stakes in non-listed corporations into a tailored insurance product.
Key takeaways from the proposal
The public consultation period for the draft will end on October 28, 2018. Based on the proposal the amendments would come into effect on March 1, 2019 and be applied starting tax year 2020.
As discussed above, taking into account the low investment amount, the share savings account would likely not be attractive to many high net worth individuals and, thus, we expect that savings products in form of insurance will continue to be attractive investment alternatives especially for high net worth individuals. On the other hand, these insurance products will need to be structured very carefully in the future to benefit from tax deferral.
Finally, based on the proposal, insurance policies taken while the current regime has been in force would not be grandfathered and the new rules could apply, as of 2020, to policies already in force. Thus, it is also important to assess existing policies in light of the changes to avoid any unfavorable surprises.