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Prerequisites for Tax Exempt Capital Gain Derived from Transfer of shares
A recent Supreme Administrative Court ruling held that the interruption of a business-related connection between a parent company and its subsidiaries may result in a characterisation of the transfer of the shares of the subsidiaries as a capital gain, and therefore taxable as non-business-related (personal) income. Taxand Finland describes the ruling and the significance for group and holding companies.
Under the Finnish Business Income Tax Act, certain capital gains derived from transfers of shares by corporate entities are in certain circumstances exempt from tax. Under the relevant provisions, for a transfer to be exempt from tax, the following prerequisites must be met: the target shares must be a fixed asset of the selling company; the selling company must own at least 10% of the target shares; the ownership of the target shares must have lasted without interruption for more than a year; the target company must not be a real estate company; the selling company must not be engaged in venture capital activities; and the target shares must be shares of a company as defined in Article 2 of the EU Parent-Subsidiary directive or a company residing in a country which has a tax treaty with Finland that is applied to dividends.
In the case before the Supreme Administrative Court, company A, a Finnish limited liability company, sold the shares it owned in two other limited liability companies, company B and company C, in 2005. The shares of company B and company C had been accounted for on the company A's balance sheet as fixed assets.
Initially, company A had rented equipment and machinery to company B and company C that was used in the business activities of those companies. Until the end of 1999, company A also assisted company B and company C financially due the inadequate financial resources of these companies. After 1999, however, the operations of company B and company C had developed to the extent that they did not need financial support or machinery from company A. The CEO of company B and company C was also a member of the board of directors of company A. The business income earned by company A since 2000 was mainly derived from securities, shares and renting.
The Supreme Administrative Court decided that the shares of company B and company C owned by company A were considered to be fixed assets until the end of 1999 only. There is no specific legislative provision that deals with changes in the use or purpose of assets. The Supreme Administrative Court stated that as the business-related connection had ceased by 2000, and taking into account both the time-period between the change in use or purpose and the disposition of the shares, together with the business being conducted currently by company A, the target shares could not be considered to be fixed assets of company A and, therefore, the transfer of the target shares could not be exempted from tax.
Company A also argued that the shares of company B and company C had been treated as fixed assets of the company since the acquisition of the shares and, thus, the interpretation by the tax authorities could not be changed. The Supreme Administrative Court ruled that since the tax authorities had not provided a specific written or oral statement related to the type of property of the shares, the passive acceptation was not sufficient in terms of protecting the trust of a taxpayer.
The Supreme Administrative Court seems to have strengthened the prerequisites for characterising assets as fixed assets. The ruling is of great importance to several group companies and holding companies as the business-related connection between entities must exist from before the execution of tax exempt transfer of shares accounted as fixed asset as provided in section 6b of the Business Income Tax Act.
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