European Union Tax Alert - 13 November 2012
Finnish taxation of dividends paid to nonresident pension funds violates EU law
By Pia Aalto, Johanna Tamminen, Mikko Jantunen and Outi Ukkola
The Court of Justice of the European Union (CJEU) ruled on 8 November 2012 that Finland’s legislation on the taxation of dividends paid to non-Finnish pension funds is incompatible with the free movement of capital principles in the Treaty on the Functioning of the European Union (TFEU, article 63) and the Agreement on the European Economic Area (article 40). The decision is the culmination of infringement proceedings brought against Finland by the European Commission.
The case involves the different tax treatment of pension funds, depending on whether or not the fund is resident in Finland.
Under Finnish domestic rules, 75% of dividend income received by a Finnish pension fund is taxable at a rate of 24.5% (26% before 1 January 2012). Thus, in principle, dividend income received by a Finnish pension fund is subject to an effective tax rate of 18.38% (19.5% before 1 January 2012). However, Finnish pension funds are taxed on a net basis. The Business Income Tax Act allows a deduction for tax purposes for expenses and losses incurred to acquire or maintain income from an economic activity. Deductible expenses include statutory transfers and all other sums, which in accordance with the principles governing the insurance industry, are necessary to cover liabilities in relation to investments for pensions. As a result, dividends received by domestic pension funds are effectively exempt from income tax.
In contrast, Finnish dividends paid to a nonresident pension fund are subject to a withholding tax of 18.38% (19.5% before 1 January 2012), although the rate may be reduced under an applicable tax treaty between Finland and the country in which the pension fund is resident. Nonresident pension funds are taxed on a gross basis without the right to deduct any expenses.
The European Commission had concluded that the differential treatment of pension funds places nonresident funds at a disadvantage and, therefore, is in violation of the free movement of capital.
The CJEU agreed with the European Commission, concluding that the fact that Finnish resident pension funds are permitted to deduct statutory transfers in computing their taxable income, while nonresident pension funds cannot, is a restriction of the free movement of capital in the TFEU and the EEA Agreement, which cannot be justified.
The ECJ decision opens up refund opportunities for non-Finnish pension funds. Since the Finnish statute of limitations for filing a withholding tax reclaim application is five calendar years following the calendar year in which the tax was levied, nonresident pensions funds with 2007 Finnish-source dividend income should file their reclaims by 31 December 2012.