Generally

According to the Finnish Business Income Tax Act (BITA), a Finnish limited company (Osakeyhtiö; Oy) and certain other entities can transfer shares tax exempt if specified conditions are met. This tax exemption is called the participation regime and it is applicable in many forms in many countries. In a nutshell, the legal requirements for a participation exemption in Finland are:

1. The seller does not mainly practice private equity investments (i.e. is not regarded as a private equity investor);
2. The seller has owned at least 10 % of the share capital of the target company uninterruptedly for at least one year;
3. The ownership of at least 10 % has ended at most one year before the transfer;
4. The target shares are among the shares which have been owned this way;
5. The target company is not a housing company, a real estate company or another company of which activities mainly consist of real estate holding or managing; and
6. The target company is domestic company, a company listed in the appendix 1 of EU directive 2009/133/EC or a company resident in a country with which Finland has in force a tax treaty, which is applied to dividends distributed by that company.

Even if the legal requirements are quite clear, the Finnish participation exemption can be regarded as one of the most complex tax regimes in Finland. The complexity does not occur from the law but from the legal praxis and government proposals. According to BITA, the participation exemption regime applies only to shares which are regarded as fixed business assets of the seller company. However, BITA does not give a clear guideline when shares should be regarded as fixed assets.

According to tax praxis, target shares are seen as fixed assets of the seller company, if the seller company have a business connection with the target company (i.e. whether the target company enhances, enables or otherwise is linked to the business activities of the seller company). If the seller company does not have any business activities (i.e. is a holding company), the participation regime very unlikely applies.

Business connection

Tax acts do not include paragraphs in respect of the term “business connection”, but there are a few Finnish Supreme Administrative Court decisions that give guidelines to when two companies should be seen as connected business wise. According to the Supreme Administrative Court and legal literature regarding such legal praxis, the evaluation of existing business connection is made based on three steps: 1) What are the reasons for the ownership connection of the companies, 2) does the two companies have administrative connection and, most importantly, 3) what is the actual business connection during the ownership. If these parameters indicate that the two companies are connected business wise, they should have a business connection in respect of the participation exemption. The Finnish Tax Administration has often given the most impact to the interpretation of the third step: If two companies have mutual invoicing or other clear business activities, the two companies should have a business connection. If there are no clear invoicing or other business relations between the two companies, the Tax Administration have been very strict with not determining the shares as fixed assets.

Business connection in groups

According to legal literature and guidelines from the Finnish Tax Authority, a business connection between two companies can also be determined taking into consideration the business connection of the group as a whole. Thus, a business connection can be determined also through business relations of subsidiary companies, even if the parent company (seller) has not have clear business connection with the target company. However, the tax practice of such evaluation has not been clear and interpretative problems have arisen especially in situations where the parent company has sold one of its subsidiary companies but the mother company itself has no business activities (i.e. it has acted as a group holding company).

New Prejudicate from the Supreme Administration Court (KHO 2019:61)

In Prejudiate KHO 2019:61, the Finnish Supreme Administrative Court evaluated business connection in a situation where a group parent company had sold shares of its subsidiary company. The parent company and the target company did not have any mutual invoicing or other mutual business actions. The target company had arranged events, in which other group companies had marketed their services and products. According to the Supreme Administrative Court, it was clear, that the target company had a business connection with these other subsidiary companies. The Supreme Administrative Court ruled, that participation exemption is applied to the share sale. The seller company did not carry out business activities of its own and was regarded as a group holding company.

The important and interesting part about this prejudicate is the phrasing of the Court’s decision. According to the Supreme Administrative Court, the target shares were regarded as fixed assets of the parent company because the ownership indirectly enhanced the business activities of the parent company, as the ownership directly enhanced the business activities of its subsidiaries. As clarification, according to BITA, assets should be seen as business assets, if the ownership directly or indirectly enhances the business activities of the owner. Yet, this is the first time, that the Supreme Administrative Court has given published guidelines in respect of when ownership is seen to enhance a company’s business indirectly. The Supreme Administrative Court did not comment on the given fact, that the seller company itself did not carry out business activities.

The Future of the Interpretation

The prejudicate should be very impactful especially in terms of share sales in larger groups. It is common, that the highest parent company of a group is mainly a holding parent company and the group’s actual business activities are centered in the level of subsidiaries. According to the new prejudicate, holding parent companies should be able to sell the shares of their subsidiaries tax exempt, even if the seller has no actual business activities, if the subsidiaries have mutual invoicing or other business relations.

As clarification, interpretation, whether owned shares are seen as fixed assets is always made based on the distinctive features of the situation at hand. It would be impossible to give a straight specific guideline of when shares would be seen as fixed assets in any circumstances. However, the new prejudicate gives us much more certainty in share sales in bigger groups.

Especially for companies or groups that are aiming for an exit, participation exemption gives a very useful tool for tax planning. It is very important, that the group structure is established efficiently tax wise from the very beginning of the business.