By Ville Alahuhta, Head of Tax Finland, LL.Lic., M.Sc (Econ), Bird & Bird Attorneys Ltd, Finland
Late 2021, Finland implemented a regulation concerning taxation of reverse hybrid arrangements included in article 9a of ATAD2 directive (Council directive (EU) 2017/952 amending Directive 2016/1164). The new rules have been implemented in Section 8a of the Finnish act on taxation of cross-border hybrid arrangements (Hybrid Act) and have been applied for fiscal year 2022 onwards.
The Finnish tax administration (FTA) issued guidelines on the application of reverse hybrid legislation on May 27, 2022. Although the guidelines generally follow the preliminary works of the Hybrid Act, it contains some standpoints that are worth pointing out and that appear relevant from the point of view of application of the law in practice.
Briefly on Domestic Legislation
In short, the reverse hybrid legislation mostly focuses on taxation of general partnerships and limited partnerships. For Finnish tax purposes, partnerships are not treated as tax subjects. Instead, partnerships are tax calculation units, the taxation of income taking place at the level of the partners of the partnership. Limited partnerships are very commonly used in Finnish PE funds and other joint-venture investment structures.
Amendments to Hybrid Act enhance Finland’s taxation right in terms of the partners of Finnish partnerships that are not tax resident in Finland. The Finnish taxation office would have the right to tax if the partner were a corporate entity or other legal arrangement set out in the Hybrid Act, the partner together with dependent entities directly or indirectly hold at least 50% of the votes or capital of the partnership, or has the right to at least 50% of the profits of the partnership, and the tax domicile of the partner treats the partnership as non-transparent entity. Further, tax-transparent partners can be looked at in above evaluation.
As the key exemption, Finland has no taxing right if the partnership in question is an alternative investment fund that is qualified by Finnish Act on Managers of alternative investment funds, the partnership has a wide ownership-base,and the security portfolio of the partnership is diversified. The carve-outs to the definition of alternative investment fund in the Hybrid Act are crucial, as if the reverse hybrid regulation applies to a partner tax resident abroad, special rules otherwise attributing to foreign partners in Finnish alternative investment funds would in practice not become applicable.
Aggregation of Ownership
From a practical perspective, the question of aggregation of ownership thresholds has been of importance. Basically, this converges into whether de facto independent investors in, for instance, a joint venture structure can be treated as dependent entities under Hybrid Act and their ownership hereby aggregated.
The guidance issued by FTA discusses this briefly by stating that the intention of the provision is to prevent circumvention of thresholds when the ownership or voting power is diversified to several entities, which however act jointly based on, for instance, a partnership agreement. Notably, joint acting based on partnership agreement or other agreement requires that the partnership agreement or other arrangement has significant influence in respect of the relevant ownership or voting power.
Exemption Regarding Certain Alternative Investment Funds
Originally, it was not certain whether the Finnish reverse hybrid provisions would contain an exemption attributing to alternative investment funds, as article 9a of ATAD2 directive refers to collective investment vehicles. Eventually, the exemption concerning Finnish alternative investment funds was included in Hybrid Act, with the added specifications set out above.
According to FTA, the wide ownership base would refer to partnerships with more than one or a few investors. Guidelines do not discuss the concept of investor in this respect: Hence it may be unclear whether a Finnish AIF having one or two fund-of-fund investors is deemed to have a wide investor base.
Further, the diversification is stated to refer to the actual implementation of risk diversification–nvesting in securities of one single entity has not been deemed sufficient. According to the FTA, the evaluation is made on comprehensive evaluation based on the whole situation of the fiscal year. Further, it shall be noted that concept of security is widely defined in the guidelines.
Conclusive Remarks
New amendments to Hybrid Act may be of relevance to several foreign investors, as limited partnership is a very common legal form for investments in Finland. Although the eventual obligation to hand in a Finnish tax return is at the level of the partner, which would be affected if the provisions discussed herein become applicable, also Finnish partnerships need to be aware on whether and to which extent the Hybrid Act applies to its partners.
Guidance issued by FTA sheds some light on the risk of application of Hybrid Act to partners with tax residence abroad. However, certain practical key concepts such as the fulfilment of criteria required to investors being deemed to act together is still left open.
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