In 2023 capital gains tax exemption will be applied only on limited basis to Finnish real estate investments. Foreign real estate investors are urged to take the change into account in deal structuring as the impact the change in law is dependent on the applicable tax treaty.
Foreign real estate investors, having place of business outside of Finland, are subject to tax in Finland only on Finnish sourced income. As regards capital gain, Finland is able to levy 20% capital gains tax (for corporate investors) on Finnish real estates and shares in Finnish limited liability companies, which assets consist mainly of Finnish real estates. As Finnish real estates are mainly traded as share transactions, the key interest in tax planning has been to evaluate, what kind of real estate holding structures are subject to tax at exit. The above-mentioned wording of Income Tax Act (ITA) section 10 subsection 10 only refers to trading of shares in a Finnish company with direct Finnish real estate holdings. As a result, all indirect Finnish share transactions by the foreign real estate investors are tax exempted. Thus, Finnish real estate holdings are typically structured by incorporating a Finnish holding company to hold the shares in the target real estate company. When the shares in the holding company are sold at exit, the holding company typically does not have any direct real estate holdings and thus such an exit would be capital gains exempted in Finland. This interpretation was confirmed to be applicable in Supreme Administrative Court case law KHO 2013:101.
The use of a holding company structure adds another corporate layer, which may be seen as an issue by future purchaser. However, this issue is typically solved by decreasing the number of corporate layers by way of tax neutral mergers. The survival of tax losses is a key issue to ascertain in connection to a post-closing merger. Administration of a holding company is typically relatively simple in Finland.
In the Finnish real estate market, the target real estate companies are commonly so-called mutual real estate companies. In such a company, the shareholder has the right, pursuant to articles of association, to possess the premises of the respective real estate. From a tax perspective, this means that the shareholders will be taxed for the lease income. The holding company can thus facilitate a debt push down to the structure in addition to making exit tax exempt.
Finnish Government has announced a proposal for consultation to add subsection 10a to the section 10 where Finland is granted the right to tax capital gains from all real estate investments including indirect holding structures. The proposal is part of Government’s plan to close loopholes in the Finnish tax system. As a result of the new wording, the use of a holding company structure would not in all cases be available to enjoy the capital gains exemption. The new law will presumably be passed by the end of 2022 and be in force from 1 January 2023. It is expected that there will be no material changes to the proposal or its timetable.
Tax treaties and fund taxation
Finland applies the golden rule of taxation according to which tax treaties will be applied if they are more favorable to Finnish internal tax legislation. Finland has tax treaties with over 70 countries. The older tax treaties do not allow Finland to tax capital gains resulting from sale of shares in holding companies with no direct real estate holdings. These include tax treaty with Luxembourg, which is a very popular holding jurisdiction for foreign real estate investors. This then means that the change in Finnish law would not change the Finnish exit tax position of real estate investors using Luxembourg holding structure. The wording of the Luxembourg tax treaty is similar to the current wording of section 10 subsection 10 of ITA allowing tax exempt exit. On the contrary, the newer tax treaties allow Finland to tax capital gains resulting from indirect real estate exits. This includes tax treaties with Germany and Sweden, which both are a material source of foreign real estate investments in the Finnish market.
Finland exempts lease income and capital gain for domestic real estate funds. As regards foreign real estate funds, the tax exemption is, under specified criteria, limited to contractual based funds only. European Court of Justice ruled in April 2022 (C-342/20) that Finnish tax legislation is in infringement with EU’s free movement of capital and thus also other forms of eligible foreign funds than contractual are able to enjoy Finnish tax exemption. The discussed new subsection 10a of section 10 of ITA does not impact the tax exemption concerning real estate funds.
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