Finland must exempt foreign investment funds from withholding tax based on free movement of capital, the European Court of Justice rules. 

Executive summary

“A SCPI”, a French société civile de placement immobilier à capital variable (variable-capital property investment company) invests in immovable property in Finland. It has its registered office in France and has no place of business in Finland. In France, A is a transparent investment fund for tax purposes that is not subject to income tax. In Finland, from 2020 investment funds formed under the law of contract are exempt from tax on investment income whereas investment funds formed under statute are subject to tax. As a result, A SCPI, being formed under statute, is taxed on its income from Finnish immovable property.

On 7 April 2022, the ECJ ruled that the Finnish law violates the free movement of capital by not extending the exemption from income tax to foreign investment funds for reason of having been formed under statute rather than under contract law, as the objectives pursued by the tax exemption may also be achieved where an investment fund has been constituted under statute but benefits from an exemption from income tax or tax transparency in its country of residence.

Read the full decision by following this link: https://curia.europa.eu/juris/document/document.jsf?text=&docid=257486&pageIndex=0&doclang=EN&mode=req&dir=&occ=first&part=1&cid=3940192

Summary of the facts

A SCPI (“A”) is a société civile de placement immobilier à capital variable (variable-capital property investment company) governed by French law which invests in immovable property. It has its registered office in France and has no place of business in Finland. In France, A is a transparent investment fund for tax purposes that is not subject to income tax. It is the investors who are liable for income tax in respect of the income gained from the return on A’s units and from the disposal or redemption of those units.

In order to ascertain whether the income and profits derived from its investments in Finland would be taxable in Finland, A applied to the tax authority for a ruling relating to the 2019 and 2020 tax years.

The Finnish tax authority took the view, as regards the 2019 tax year, that A is, because of its essential characteristics, in a situation comparable to that of a Finnish, tax exempt investment fund. The tax authority concluded that the income received by A in Finland was exempt from income tax.

By contrast, as regards the 2020 tax year, the tax authority took the view, on the basis of the amendments made to the Law on income tax that were applicable from 1 January 2020, that A, as a variable-capital company, was equivalent to a regularly taxable limited liability company governed by Finnish law rather than a tax exempt investment fund constituted under the law of contract, as referred to in paragraph 20a of that law. Consequently, the tax authority found that the income received by A in Finland during the 2020 tax year was taxable in Finland.

A brought an action before the Administrative Court of Helsinki, Finland, the referring court, against the decision of the Finnish tax authority. In the context of that action, A submits that Paragraph 20a of the Law on income tax is contrary to EU law and argues that, irrespective of its being constituted under statute rather than under contract, its functional characteristics are comparable to those of a Finnish investment fund that is exempt from income tax.

The Administrative Court of Helsinki decided to stay the proceedings and to refer the case to the European Court of Justice (“ECJ”) for a preliminary ruling on the question whether the Finnish tax legislation at hand results in a prohibited restriction of the freedom of establishment (article 49 of the EU Treaty) or the free movement of capital (article 63 of the EU Treaty).

The applicable freedom

As regards the “applicable freedom”, the ECJ recalls that legislation intended to apply only to those shareholdings which enable the holder to exert a definite influence on a company’s decisions and to determine its activities falls within the scope of the freedom of establishment. Legislation which applies to shareholdings acquired solely with the intention of making a financial investment without any intention to influence and control falls exclusively in the scope of the free movement of capital.

The Finnish legislation at issue does not exclude from its scope situations coming within the scope of the freedom of establishment. However, as it covers investments carried out with a view to making a financial investment, without any intention to influence the management and control of the undertaking it is likely to predominantly affect the free movement of capital. Therefore it should be examined exclusively within the scope of the free movement of capital.

Prohibited restriction of the free movement of capital

Based on established ECJ case law, less favorable treatment by a Member State of income paid to non-resident investors, compared with the treatment of income paid to resident investors, is liable to deter foreign investors from pursuing investments, and amounts to a restriction of the free movement of capital which is – in principle – prohibited.

Such restrictions may be admissible only if the relevant provisions distinguish between taxpayers who are not in a situation which is objectively comparable, or if they are justified by overriding reasons in the public interest.

Objectively comparable situation

Citing established case law, the first ECJ reminded that the comparability of a cross-border situation with an internal situation within a Member State must be examined having regard to the aim pursued by the national provisions at issue as well as to the purpose and content of those provisions. Only the relevant distinguishing criteria laid down by the legislation in question must be taken into account.

Within this framework, the Finnish government held that:

the purpose of the exemption is to avoid the double taxation of income from investments and to try to treat investments made through funds as direct investments for tax purposes, and that

a French investment fund constituted in accordance with statute and a Finnish investment fund constituted in accordance with contract law are not in a comparable situation, given the objective of protecting investors in the event of funds becoming insolvent.

On these two arguments of the Finnish government the ECJ ruled as follows:

As regards the objectives of avoiding the double taxation of investment income and of treating indirect investments, carried out through funds, in the same way as direct investments for tax purposes, the fact that an investment fund has been formed in accordance with statute does not necessarily place it in a different situation to that of investment fund formed in accordance with contract law. Such objectives may also be achieved where an investment fund has been constituted under statute but benefits from an exemption from income tax or tax transparency in its country of residence.

As regard the argument of there being greater protection for investors where an investment fund is formed in accordance with contract law, while such protection may have led the Finnish legislature to require resident investment funds to be constituted in that form, it does not make for an objective distinction between investment funds constituted under the law of contract and those constituted in a different legal form.

Decision of the ECJ

The ECJ thus concludes that investment funds constituted by statue are in a situation which is objective comparable with investment funds constituted under the law of contract.

The Finnish Government not having shown that overriding reasons in the public interest justify the restriction of the free movement of capital, the ECJ rules that the Finnish law violates the free movement of capital by not extending the exemption from income tax to foreign investment funds for reason of having been formed under statute rather than under contract law.