Legislative Proposal to Ease Establishment and Fundraising of Domestic Private Equity Funds — Tax Treatment of foreign Funds of Funds to be Clarified

On 13 December 2018, the Finnish Government published a legislative proposal aimed at eliminating problems in tax legislation relating to the establishment of private equity funds in the form of limited partnerships.

The taxation of investors in private equity funds operating in a form of a Finnish limited partnership has, in certain respects, been based on established case law and tax practice. The taxation of foreign investors was originally eased through a special provision enacted in 2005 (Income Tax Act section 9(5)). When the special provision applies, an investor, having limited tax liability in Finland and being a limited partner in Finnish PE fund operating in a form of a limited partnership, is taxed for its share of the income of the fund only to the extent the income would be taxable if received directly by that investor.

However, the case law relating to the special provision deemed that the special provision did not apply to partners in foreign, tax-transparent limited partnership funds, i.e. foreign funds of funds. This watered down key features of financial purpose of the provision.

Legislative Amendment

According to the new government proposal, the special provision could in future also be applied to entities with limited tax liability in Finland investing in limited partnership PE funds through one or more domestic or foreign partnerships. This requires, among other things, that the ultimate investor is subject to a tax treaty between Finland and the investor’s home state and that a partnership investing in a Finnish limited partnership is registered in a jurisdiction with which Finland has an agreement on the exchange of tax information in place.

The special provision also requires that an investor in a Finnish limited partnership is a domestic or foreign partnership—for example, the special provision does not apply to foreign contractual funds. The special provision applies to alternative investment funds in accordance with the Act on Alternative Investment Funds regardless of whether the alternative investment fund manager is licenced or obligated to register.

Impact

The purpose of the legislative amendment is to make it easier for domestic PE funds to raise foreign capital. The achievement of this goal is being sought through an expansion of the existing special provision. Though the special provision still has the limitations described above, these limitations can be considered materially justified.

The concrete practical impact of the amendment remains to be seen. In any case, it removes one artificial and unnecessary obstacle to foreign investments in domestic PE funds.

This amendment has been on the wish list of the investment field for quite some time, and it is believed that is will increase foreign investment in domestic PE funds.