Controlled Foreign Corporation (CFC) legislation aims to prevent tax avoidance by using tax havens. In principle CFC refers to a foreign company or an entity which is located in a low-tax jurisdiction and directly or indirectly controlled by one or more associated Finnish residents or non-residents having permanent establishment in Finland. According to the Finnish CFC legislation the foreign entity’s actual tax burden in its tax jurisdiction must be less than 3/5 of the Finnish tax burden, thus less than 12 %.
Substantial changes to CFC provisions from 1 January 2019 onwards
As of 1 January 2019 the Finnish CFC legislation was significantly reformed as a part of the EU’s anti tax avoidance directive (Council Directive (EU) 2016/1164 of 12 July 2016, ATAD). The most essential changes relate to calculation of the control / ownership level and so called escape-rules. Furthermore, in future also non-residents can be taxed on their share of CFC’s income if their share is connected with a permanent establishment (PE) located in Finland. The old CFC legislation was applicable only to Finnish residents.
Changes regarding the control level
Before the preconditions of control level was analyzed in two-tier system. First there needed to be clarified whether the company or entity located in a low-tax jurisdiction was directly or indirectly controlled by Finnish tax residents. If the Finnish tax residents held at least 50 % of the capital or votes of a CFC or had the right to at least 50 % of the profit of the CFC then the first requirement was met. However, if the CFC had only one Finnish tax resident who for example held only 49 % of the capital, votes and right to profit of the CFC then the first requirement was not met and there was no need to check the second requirement.
In the old system when the first requiremet was met then the control level had to be analyzed at individual shareholder level separately. In principle, the individual Finnish tax resident shareholder together with his/her/its related parties had to hold at least 25 % of the capital or votes of a CFC or have the right to at least 25 % of the profit of the CFC in order for her/his/its share to the CFC’s income to be taxable in Finland. If this individual shareholder level was below 25 % then the CFC’s income was not taxable in Finland.
The reformed CFC legislation removed the two-tier system. From 1 January 2019 onwards the control level is analyzed directly for each individual shareholder separately. According to the new provisions the control level is met if Finnish residents together with related parties have at least 25 % of the capital or votes of a CFC or have the right to at least 25 % of the profit of the CFC. According to the new rules, the control threshold is lowered from 50% to 25% and both resident and non-resident related parties’ direct or indirect holdings are taken into account and also a non-resident can be taxed in Finland if his/her/its share is connected with a permanent establishment (PE) located in Finland.
Changes regarding the escape-rules
Escape-rules are so called exemptions and if they apply then the foreign company or entity is not regarded as a CFC even if the pre-conditions (i.e. requirement of tax burden and control level) are met. These escape-rules were updated under the reform.
In the new legislation there is one escape-rule for companies and entities resident in the European Economic Area (EEA) and one escape rule for companies and entities resident outside the EEA. According to the new legislation a foreign company or entity resident within the EEA is not considered a CFC if it is genuinely established in the jurisdiction of its tax residence and if it carries out genuine economic activities in that jurisdiction.
A foreign company or entity resident outside the EEA has to met the conditions related to the genuine establishment like a company or entity resident in the EEA but furthermore in order for it not to be qualified as a CFC it has to meet three additional requirements: 1) the jurisdiction of residence is not included in the list on non-cooperative jurisdictions published by the Council of the EU, 2) there is sufficient exchange of information between Finland and the jurisdiction of residence and the exchange of information is in fact fulfilled, 3) the company’s or entity’s income mostly arises from industrial or other comparable production activities, shipping activities or sales and marketing activities related to such activities.
There are some examples in the government bill but these are quite ambiguous and will be outlined in more detail in court cases.
Conclusions
If the CFC-requirements are met Finland can tax the shareholder’s share to the CFC’s income in Finland. Individual shareholders will be liable to pay earned income tax or capital income tax depending on the type of CFC income. Corporate shareholders will be liable to pay 20 % corporate income tax. Finland will credit against the Finnish taxes the foreign taxes which the CFC has paid in its residence country on the same income.
According to our understanding Finnish residents should declare CFC-income on their tax returns if the CFC requirements are met. Denying this might lead to tax increases or criminal liability. We recommend to check the new escape rules carefully case by base. Many matters are still open to interpretation and we assume these will be outlined in court later on.
