Introduction:
On 1 November 2018 the Finnish Government took the first step towards new legislation on Controlled Foreign company (“CFC”) as part of the implementation of the EU Anti-Tax Avoidance Directive(2016/1164) through issuance of a government bill. The bills amends the CFC rules to the Finish legislation. The amendments are proposed to enter into force on 1 January 2019. If the bill is adopted, the CFC rules will further limit the use of foreign holding companies in low-tax jurisdictions.
In principle, the government proposal follows the main features of the draft proposal published earlier this year with the exception of few additional changes, as discussed below.
Finnish CFC regime and current legislation:
The current 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
- 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
- if the effective income tax rate in its domicile is less than 3/5 of the Finnish corporate income tax (i.e. 12%).
Exemptions: 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.
In brief, foreign entity’s income is subject to CFC taxation in Finland if a Finnish tax resident, together with its related parties, has sufficient control in the foreign entity, the foreign entity’s level of taxation is significantly lower than in Finland, and the genuine economic activities exemption is not applicable. If an entity qualifies as a CFC, the proportion of the income of the CFC controlled by Finnish tax residents is taxed as their income in Finland.
Proposed Changes :
The Finnish Government has proposed changes to controlled foreign company legislation that would widen the scope of the law and bring Finland in line with the European Union Anti-Tax Avoidance Directive (ATAD I).
1.Wide definition of CFC:
- Under the proposed measures, a foreign entity may be considered a CFC if 25 percent of its shares are owned, directly or indirectly, by Finnish residents as against the current holding threshold is 50 percent. 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.
This presented participation threshold is significantly stricter than the 50% threshold adopted by the Directive and the 50% threshold of the current CFC rules.
- A CFC will be considered low-taxed if its effective tax rate is less than three-fifths of the Finnish tax rate, or 12 percent. This is unchanged from the current law. According to the proposal, a CFC is an entity with an actual level of taxation of less than 60% of the actual level of taxation the entity would be subject to in Finland. Finland’s current corporate income tax rate is 20%, which leads to an effective tax rate threshold of 12%, when the foreign entity’s taxable income is calculated in accordance with the Finnish rules. The level of taxation is assessed separately for each year.
2. To whom it is applicable: 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. Thus compared to current legislation, the non-resident associated corporations will also be taken into account in assessing the control in the foreign CFC.
3.Totality of the income of the CFC to be considered: The current entity approach would be remained which means that the taxable CFC income is not divided into active and passive income or income arising from non-genuine arrangements. In other words, if an entity is deemed as a CFC, the total income of that entity is taxed as CFC income.
4.Non implementation of the Alternative models laid out in the Directive: According to the proposed new rules, the type of income received by the foreign entity or the artificial nature of the transactions would not be relevant in the assessment. Thus, Finland would not implement either of the alternative models laid out in the Directive as such but instead the new rules follow similar approach as the current rules.
5. Amended Exemption for Considering an Entity to be a CFC:
Requirement of Substantive economic activity: The main exemption in the proposed rules is the genuine economic activities exemption. The concept of genuine economic activities is assessed differently depending whether the foreign entity is a EEA resident company or not.
The proposal follows the Directive’s, as well as the current CFC rules’, framework of excluding EEA resident companies with genuine economic activities from CFC taxation. Under the proposed rules, a foreign CFC company is exempted from CFC rules if the entity carries on a substantive economic activity supported by staff, equipment, assets, and premises.
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.
Additional requirements for CFCs in non-EEA state: 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:
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- 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
- Outside EEA, only certain types of industries would be exempt. profits mainly arise from industrial production, other production or provision of services, shipping activities or sales or marketing activities related to the these activities
Abolishment of current exemption to tax treaty resident companies.
The current exemption applicable to tax treaty resident companies would be abolished. Consequently, the effective level of taxation of such non-EEA resident companies, which do not fall under the genuine economic activities exemption, would be monitored.
Industries with genuine economic activities: Outside the EEA, the concept of genuine economic activities also requires that the entity carries out certain type of business activity. The new rules exempt only companies the income of which mainly arises from industrial or other comparable production activities, shipping activities, as well as sales or marketing activities related to such exempt activities. The government proposal widens the current concept of activities comparable to production activities to include marketable services.
Service activities unrelated to production activities: However, the proposal lists service activities which are not comparable to production activities, such as certain investment management services, holding and transferring of intangibles, as well as intra-group financing, insurance and management services.
Wider scope for Regional activities: Contrary to the currently applicable CFC rules, which have required that the sales and marketing activities could only be performed in the company’s state of residence in order for the exemption to apply, the new CFC rules would also exempt regional sales and marketing hubs from the applicability of the rules, provided that the operations relate to industrial production or comparable activities. This change will provide more flexibility for companies with regional activities.
By proposing the new exemption rules, consequently, the Finnish Ministry of Finance abolished the use of a CFC blacklist and the current exemptions for certain industries and EEA and tax treaty countries.
Challenges:
The different approaches compared to the Directive, as well as compared to the current rules, will likely cause following challenges for both taxpayers and tax authorities, which are as follows:
1.Difficulty on obtaining requisite information : In practice, the low CFC threshold significantly expands the scope of the rules. It may also prove to be challenging to obtain necessary information to assess potential CFC taxation when the participation in the CFC is e.g. only 25%.
2.Possibility of timing differences : The proposed new rules do not take into account the timing differences, e.g.different depreciation rules. More accelerated depreciation rules than the Finnish depreciation rules may trigger CFC taxation for the years when larger depreciations are deducted even though the level of taxation over the years would not be lower than the above mentioned threshold.
3. Widening of the existing CFC requirements: As discussed above, the scope of the application of the CFC rules is significantly widened due to the newly proposed amendments. The proposed CFC rules are, in many ways, stricter compared to both the requirements of the Directive and to the current domestic CFC rules.
Compared to the current CFC rules, the proposed rules have a lower threshold (lowered from 50% to 25%) and have a more rigorous requirement to satisfy the exemption provision for the non-EEA state. As a result, genuine business operations subject to low taxation in non-EEA countries may get classified as CFCs. In particular, intra-group and other service activities as well as holding company structures may trigger CFC taxation in situations that have so far not been subject to the current CFC rules.
Also the abolition of the current exemption applicable to tax treaty resident companies outside EEA could bring several new foreign entities under the scope of the CFC regulation. This again hinges upon the issue of catching genuine business activities in non-EEA countries within the net of CFC qualification.
4. Room for ambiguous interpretation: The natural follow-up to the wider CFC rules is the sufficient room for interpretation. For instance the amended industry exemption outside EEA introduces questions of interpretation as to which service activities would be exempt. An advance ruling on the interpretation in specific cases may be recommendable in order to achieve certainty on the treatment.
5. Possibility of double taxation? : The Directive has led many EU countries to implement CFC rules which may lead to the taxation of the same company’s income as CFC income in several jurisdictions. The proposed Finnish CFC rules do not take this type of double taxation into account at all. Thus there is a need to analyse the effect of the rules on the Group structures with multiple layers of companies, operating in different jurisdictions.
6. Positive effect of exemptions on regional activities: On the other hand, the new rules introduce new options to enhance the group structure for many operators with regional activities due to the extension of the scope of sales and marketing exemption.
7. Directly targeting holding company structures: 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.
Conclusion:
The proposed new CFC rules based on the Directive will be implemented across all EU Member States by 1 January 2019. The legislation is a bold step which is yet to witness its long-term effect in the coming years.The proposed rules are stricter than the currently applicable CFC rules in particular for Finnish companies with subsidiaries outside of the European Economic Area (“EEA”).Thus a careful review of the CFC legislation must be made in tandem with the other kinds of CFC legislation that other member states would be proposing. This will help in analysing the ultimate effect of the proposed CFC and overcome the challenges identified. For instance it could help in assessing the possible double taxation on the same income. Furthermore, for Finnish tax purposes it should be found out whether there are adequate exchange of information procedures in place with Finland and the state of residence of the possible CFC. At the same time the multinationals must assess their group structures which will be impacted through the legislation. Thus the work is underway from both sides of the aisle, i.e., the taxpayers and the tax authorities to tackle the issue related with CFCs.
References:
1https://www.tax-news.com/news/Finland_To_Strengthen_CFC_Legislation____96945.html
2https://www.dittmar.fi/insight/new-cfc-rules-require-review-of-corporate-structures/
4https://www2.deloitte.com/fi/fi/pages/tax/articles/tax-alert-cfc-rules.html#
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