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Top management’s incentive scheme considered as tax avoidance
The Finnish Supreme Administrative Court recently issued a ruling in which benefits received by top management through a holding company structure were considered as earned income under the general anti-avoidance rule. Taxand Finland highlights how this ruling overturned the preliminary ruling issued by the Finnish Central Tax Board.
In the case at hand, the top management of company A had set up a holding company B that acquired shares of company A. The acquisition of the shares was financed with equity capital contributed by the top management and a loan issued by company A to company B. Company A and the top management had concluded a shareholders’ agreement that included leaver provisions and restrictions on the right of pledge and disposal of both companies shares. Moreover it was agreed that after a certain date the shareholders of company B and company A’s board of directors will decide to dissolve the holding company structure and potential income arising as a result will be paid to company B’s shareholders in company A’s shares. Under the agreement, the primary way to dissolve the structure was to merge company B to company A and then sell company A’s shares followed by liquidation of company B.
Based on information provided by company B, the holding company structure was set up to enhance the top management’s collective and long-term commitment to company A and to create a joint financial interest to meet company A’s strategic objectives. In addition, the structure was considered to be transparent and clear in the light of insider rules and corporate governance regulation. Members of the top management have a real risk to lose their significant equity capital contribution to company B. Furthermore the loan agreement between company B and company A was concluded at arm’s length terms.
In its evaluation, the Finnish Supreme Administrative Court highlighted company A’s integral involvement in the arrangements and the fact that the arrangements concern only the top management of company A. Consequently it was decided that the arrangements constituted above all a management’s incentive scheme the material intention of which was that the top management will benefit from the potential increase in the share value. It was concluded that the arrangements should be evaluated as a whole also taking the Finnish anti-avoidance rules into account, resulting in the ruling that as a result of the arrangements the top management receives an employment-related benefit that will be treated as earned income in taxation.
Also published in Thomson Reuters' Taxnet Pro, 28 May 2014
Historically tax avoidance allegation has been dismissed if a taxpayer has been able to demonstrate business reasons for the transaction. In the case at hand the demonstration of the business reasons by the taxpayer was not sufficient, but instead the Finnish Supreme Administrative Court evaluated the applicability of the anti-avoidance rule by comparing validity and materiality of the business reasons presented with the tax avoidance motive. The approach taken in the decision can be seen to impair foreseeability and legal security in taxation.