Upcoming new tax legislation will allow Finland to tax non-residents' capital gains from the disposal of shares in a holding entity owning real estate in Finland indirectly through another entity or entities. The holding entities can also be non-Finnish entities. An applicable tax treaty may still prevent Finland from taxing such disposals.
We strongly recommend that foreign real estate investors review the structures of their Finnish investments. Proposed changes Currently, Finland does not tax indirect disposals of Finnish real estate by a non-resident investor. The pending amendments to Finnish Income Tax Act Section 10 would change this.
According to the government proposal, profits realised on the disposal of shares or similar rights in a holding entity will be subject to tax in Finland if more than 50 per cent of the total assets of the entity consist, directly or indirectly, of Finnish real estate. When evaluating the asset ratio, the last 365 days before the disposal are considered. If at any time during this period more than half of the assets consist of Finnish real estate, the indirect disposal is subject to tax in Finland under domestic law.
The concept of real estate covers also for example transferable land lease agreements, buildings and possession rights. Shares or other similar securities traded on a recognised stock exchange are excluded from the scope of the new rules. "According to the government proposal, profits realised on the disposal of shares or similar rights in a holding entity will be subject to tax in Finland if more than 50 per cent of the total assets of the entity consist, directly or indirectly, of Finnish real estate." Approximately half of Finland's double tax treaties ("DTT") limit Finland's right to tax indirect disposals of real estate.
Such DTTs include the treaties concluded with e.g. Luxembourg, the Netherlands, Austria and Belgium. On the other hand, many more recently concluded DTTs, such as the Nordic Tax Treaty and the treaties with Ireland, Malta and United Kingdom, allow the taxation of indirect disposals of real estate even though specific criteria may be applicable.
The government proposal lists also the DTTs with Cyprus, Germany and Switzerland as treaties allowing taxation of indirect disposals although the wordings of these treaties seems to suggest otherwise. To extend its taxing rights, Finland is contemplating withdrawing its current reservation to Article 9 of the Multilateral Convention ("MLI") concerning taxation of capital gains from transfers of shares or interests in entities deriving value mainly from immovable property. Further, going forward Finland would apply Article 9.4 of the MLI, which has a very similar wording as the proposed new Finnish rule.
The withdrawal of the reservation amends the division of taxing rights in relation to countries that are parties to the MLI and apply its Article 9.4. For example, Estonia, France and Russia fall into this category. Funds and other similar entities may be exempt under EU law, if they are considered exempt from tax in Finland.
It is currently expected that the changes in domestic rules would take effect during the spring of 2023. The amendments to the MLI will likely be applicable from the beginning of July 2023 or July 2024, depending on whether Finland makes the official declaration in 2022 or 2023. Our insights Following these changes to Finnish tax laws, the extent of Finland's taxing rights will depend on any applicable tax treaty.
The qualification for tax treaty benefits will thus become a decisive factor. For example, sufficient substance in holding companies and qualification under the principal purpose test will be of increased significance also in real estate investment structures. In addition, the exact wordings of the relevant treaty provisions vary from treaty to treaty, highlighting the importance of thorough treaty interpretation in each case.
We strongly recommend reviewing the effects of the new legislation on future exits, as well as on any restructurings relating to Finnish real estate investments. "It is currently expected that the changes in domestic rules would take effect during the spring of 2023." The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.