The Supreme Administrative Court clarifies the scope of foreign investment fund tax exemption
The Supreme Administrative Court (“SAC”) has recently issued four rulings in which it clarifies the applicability of Finnish Income Tax Act (“ITA”) § 20 (a) to foreign funds. PwC advised clients in two of the cases.
ITA § 20 (a) was introduced into Finnish tax legislation in 2020. The new provision stated that a foreign investment funds must be contractual in nature, “open” (open to the public and open-ended) and have at least 30 investors to qualify for the tax-exempt status. Foreign alternative investment funds are treated the same as long as they meet the same criteria. Further, AIFs may also be considered tax exempt even if the criteria are not met, provided they meet certain other criteria related to the amount of capital (min. 2 MEUR), quality of investors (professional or equivalent), and distribution of profits (3/4 annually, excluding unrealised gains). AIFs which invest in real estate (as defined in the law) are required to distribute at least three quarters of their annual profits to investors to qualify for the exemption.
Perhaps the main point to note is that while Finnish funds are considered tax-exempt under the same criteria, they would be expected to meet them automatically due to applicable private law rules. No other types of funds should exist, or at least that has been the idea behind the rules.
Last Spring, we wrote about a ruling of the Court of Justice of the European Union (“CJEU”) where the Finnish rules were under scrutiny. In particular, the CJEU considered whether it is permissible under EU law to require foreign funds to be of contractual form for the tax exemption to apply. The CJEU ruled that the requirement constituted a restriction to the free movement of capital and was not justifiable by overriding reasons in the public interest.
Seven months later, the SAC stated in its first ruling concerning the new ITA § 20 (a) that a Delaware Statutory Trust qualified for the tax exempt status under ITA § 20 (a) although it was not contractual in nature.
In December three further rulings concerning ITA § 20 (a) have been published by the SAC.
The case concerned a sub-fund of a Luxembourg AIF set up as an FCP (fonds commun de placement). The sub-fund invested in real estate in the manner defined in Finnish law on real estate funds. The question was whether such a fund should qualify for the tax exemption.
ITA § 20 (a) provides that a domestic real estate fund or a comparable foreign real estate fund must distribute ¾ of its profits annually. The legal question focused on what should be considered comparable. In particular, a Finnish real estate fund must have at least 10 direct investors, but the fund in question only had one direct investor.
Based on the wording of ITA § 20 (a) as well as the reasoning in the Government Bill concerning ITA § 20 (a) and the principle of legality, the SAC ruled that a foreign real estate fund was not required to meet the private law requirements imposed on Finnish real estate funds in order to qualify for the tax exemption under ITA 20 § (a). The SAC stated explicitly that both Finnish and foreign real estate funds must only satisfy the requirement of annual profit distribution to qualify for the tax exemption.
The case also concerned a sub-fund of a Luxembourg AIF set up as an FCP. Approximately 58 % of the sub-fund’s assets were invested (directly or indirectly) in Finnish real estate, half of which was tied in development projects. The question again was whether the fund would qualify for the exemption. The legal question again focused on whether the fund should be considered comparable to a Finnish fund although a Finnish real estate fund may only invest a maximum of one-fifth of its assets in construction/development projects.
Curiously, here the SAC did not consider it important that the requirement is not expressly outlined in the wording of the tax law.
The SAC stated that since more than one-fifth of the assets were invested in development projects, it did not qualify for the tax exemption under ITA § 20 (a). It further assessed if the requirement on target investments may constitute a restriction on the free movement of capital. However, the SAC concluded that as the fund was not objectively comparable to a Finnish real estate fund, the restriction was permissible from an EU law perspective. The SAC considered, in particular, that the purpose of extending the tax exemption to real estate funds has expressly excluded construction/development activity, which remains subject to tax. The line has been drawn at 20 %. Thus, a foreign real estate fund which fails to meet the criterion is not in an objectively comparable situation.
These two rulings seem to indicate that the requirement of comparability in the wording of ITA § 20 (a) should be interpreted in line with the requirement of objective comparability as used in CJEU doctrine. If (objectively) comparable to a Finnish real estate fund, foreign real estate funds need only satisfy the requirement of annual profit distribution to qualify for the tax exemption under ITA § 20 (a).
The case concerned a closed-end French AIF, set up as an FCPI (fonds Professionnel de Capital Investissement). The fund had 33 investors, 18 of which were banks of a regional banking group and one a group entity of one such a regional bank. The regional banks indirectly held a majority in a publicly listed B S.A. However, the regional banks were not considered as a group since the banks were under the ownership of distinct owners. The remaining investors comprised the management company of the fund and its employees.
Here the legal question also focused on the comparability of the fund to a Finnish AIF and in particular, whether the fund met the minimum requirement of 30 investors as outlined in ITA § 20 (a). As the fund was closed-ended, in order to qualify for the tax exemption, it also had to meet certain additional conditions, in particular that its investors must be regarded as professional investors.
The SAC ruled that the regional banks were to be regarded as separate investors instead of a one single investor and thus the fund was deemed to have met the minimum requirement of 30 investors. The fund was deemed comparable to a Finnish fund although it was not examined if the management company and its employees qualified as professional investors from the perspective of Finnish law.