In this review, we have summarised the main points of the changes to the limitations of the deductibility of interest expenses proposed by the government. We will also discuss the Finnish Supreme Administrative Court’s recent  positions on private equity investing and on the deductibility of expenses arising from restructuring programmes.

You can also read our updates about the place of effective management of foreign corporate entities and about what employees should keep in mind about the taxation of hybrid work.

Finnish Government Proposes Changes to Limitations of Deductibility of Interest Expenses

On 4 November, the government gave its proposal (HE 211/2021 vp)  on amendments to the provisions concerning limitation of the deductibility of interest expenses contained in the Act on the Taxation of Business Income to Parliament. The government has proposed amendments to the balance sheet exemption, the derogation concerning infrastructure projects as well as the deductibility of net interest expenses of income from other operations.

Balance sheet exemption

The current deductibility limitations include a derogation based on a balance sheet comparison. The limitations of deductibility are not applied if the company can provide evidence that the ratio of its equity to its total assets according to its adopted financial statements is higher or as high as the corresponding ratio in the adopted consolidated balance sheet at the end of the tax year.

The government proposal sets tighter conditions for the application of this balance sheet exemption. The goal of the amendments is to limit opportunities to transfer income beyond the reach of Finnish taxation by using the balance sheet exemption in private equity investment and other corresponding structures.

The use of the exemption would be limited to situations where a party with significant holdings has financed the group. In these situations, the consolidated balance sheet forming the basis for the comparison would be adjusted so that debt from a shareholder would be considered equity in the balance sheet comparison. The threshold for significant holdings would be ten per cent. The act would also include a requirement that the taxpayer’s financial statements and consolidated financial statements used in the balance sheet comparison must be audited. 

Derogation Concerning Infrastructure Projects

The current limitation of deductibility is not applicable to interest expenses accruing from loans that finance long-term public infrastructure projects. The government has proposed that application of the provision concerning long-term infrastructure projects be expanded: in future, the limitation of deductibility would not be applied to public infrastructure entities responsible for building or maintaining infrastructure.

Companies within the scope of the infrastructure derogation would also be provided with the opportunity to deduct non-deductible net interest expenses accrued prior to 2020 during 2020–2022.

Deductibility of Net Interest Expenses of Income from Other Operations

The proposal also includes a clarification to the deduction rights of entities from which the income basket of other income was removed as a result of the income tax basket reform that came into effect in the beginning of 2020. It is proposed that these entities may in the future deduct from their business income the non-deductible net interest expenses accrued in the other income basket during tax year 2019.

The act is scheduled to enter into force on 1 January 2022. The amendments proposed to the balance sheet comparison would be applicable as of the taxation for 2022. The amendments concerning long-term infrastructure projects and the deductibility of non-deductible net interest expenses of income from other operations would be applicable retroactively starting from the taxation for 2020.

Recent Case Law

Supreme Administrative Court Takes Position on Private Equity Investing and the Taxability of Share Transfers in a Two-Step Acquisition Structure

In September 2021, the Supreme Administrative Court of Finland published a yearbook decision (KHO 2021:135) concerning private equity investing and the taxability of share transfers in a two-step acquisition structure. The Supreme Administrative Court held that the companies in a two-step acquisition structure established by a private equity investor were engaged in private equity investing. Thus, the sale of the target company was not deemed to be exempt from tax.

A private equity investment company had established a two-step acquisition structure for the purpose of the acquisition of shares. The issue being decided was whether the company acquiring the shares of the target company in a two-step acquisitions structure had to be considered a company engaged in private equity investing, and if not, whether the shares acquired by the target company had to be considered fixed asset shares of the acquiring company that could be transferred free of tax.

Private equity investors cannot by law sell shares free of tax. In practice, private equity investors often acquire their targets using multi-company acquisition structures. The prior case law of the Supreme Administrative Court has held that companies established by a private equity investor to acquire investment targets are engaged in private equity investing. Thus, prior case law set the policy that a one-step acquisition structure is considered to be private equity investing. 

In this new decision, the Supreme Administrative Court confirmed the same policy for two-step acquisition structures. The Supreme Administrative Court held that the companies in a two-step acquisition structure established by a private equity investor were engaged in private equity investing. Thus, the sale of the target company was not deemed to be exempt from tax. The court’s assessment gave no weight to the fact that some of the key persons of the acquired company were transferred to the service of the company that acquired the shares, which led to the company charging the acquired company for management services.

The decision creates uncertainty with respect to situations in which fixed asset shares can be transferred free of tax in a group partially owned by private equity investors. It is advisable to confirm the tax treatment of any arrangement with the Finnish Tax Administration through a preliminary tax discussion or by applying for an advance ruling.

Central Tax Board Takes Position on Deductibility of Expenses Arising from Restructuring Programmes

The Central Tax Board (CTB) gave two advance rulings on the deductibility of expenses arising from a restructuring programme in the taxation of personal income and business income. The rulings confirm the concepts of securities and capital loss in the context of taxation.

Both decisions concern investments made by creditors in the bond programme of a Finnish limited liability company, Company B. The administration of the bonds in the programme took place through a register maintained by the bond broker. The bonds were in the form of ‘ordinary’ bonds. Company B had encountered financial difficulties, and the company’s restructuring proceedings had been initiated by a district court decision in 2020. The district court had approved the company’s restructuring programme in which receivables that formed part of the investors’ restructuring debts had been cut and interest accruing on Company B’s debts had been reduced.

Decision KVL 2021:28 also took a position on the deductibility of expenses in personal income taxation. Person A had invested in the aforementioned bond programme.  The bonds were anonymous, and Company B did not know Person A’s identity, and the creditors could also have freely transferred their bonds by notifying the transfer to the broker. The CTB held that Person A’s identity remained unknown to Company B in the bond investments, and the applicant was, therefore, entitled to transfer its investment by only notifying the broker. In reference to this, the CTB held that the investments in question had to be considered securities in taxation as defined in the Income Tax Act. As the capital of Person A’s debt receivable had been cut in the manner described in the restructuring programme approved by the district court, the loss was deductible in the applicant’s taxation.

Decision KVL 2021:30 also took a position on the deductibility of expenses in business income taxation. A creditor that was a limited liability company had given Company B a loan for the production of income in the aforementioned bond programme. The CTB held that, because the capital of this loan given for the production of income had been cut as described in the restructuring programme approved by the district court, the incurred loss had to be considered a final loss in value as referred to in the Act on the Taxation of Business Income. This being the case, the expense was deductible in the creditor’s taxation.

Supreme Administrative Court: Company’s Time-Barred Dividend Debt to Shareholders Deemed Taxable Income

In yearbook decision KHO 2021:150, the Supreme Administrative Court held that a company’s time-barred dividend debt to shareholders became taxable income when the amounts of time-barred debt were entered into the company’s equity. This decision is in line with the Supreme Administrative Court’s prior case law under the old Limited Liability Companies Act.

In this case, some of A Plc’s shareholders had not transferred their shares into the book-entry system. As a result, A Plc was unable to pay them the dividends and equity repayments resolved on in the general meetings held in 2010–2014. The payable amounts of dividends and equity repayments were held as debt of the company that later became time barred. A Plc had entered the amounts of time-barred debt directly into its equity.

The issue decided in the case was whether the company’s dividend and equity repayment debts that had become time barred, and which had, thus, reverted to the company, had to be deemed taxable business income of the company or whether they were tax-free items. 

The Supreme Administrative Court stated that the funds reverting to A Plc due to being time barred could not be deemed correction items relating to dividend payments and equity repayments or as equity investments made into the company by the shareholders.  Because the funds reverting to the company due to the dividend debt equity refund becoming time barred were not prescribed by law or otherwise as being tax free, the payments that reverted to the company were benefits with monetary value that were taxable income of the company.

These decisions were not final at the time of writing.