Tax Treatment of Final Tax Losses in breach of EU Law

On 14 May 2020, the European Commission called on Finland to bring its rules on the tax deductibility of cross-border group contributions in line with EU law. Furthermore, on 15 May 2020, the Finnish Supreme Administrative Court (“SAC”) issued a precedent (KHO 2020:51) concerning the utilisation of a foreign subsidiary’s tax losses after a cross-border merger and especially the definition of final tax losses.

Although the two cases relate to different tax-related questions, namely cross-border group contributions and cross-border mergers, the underlying phenomenon is the same – Finnish tax legislation concerning the cross-border balancing of profits may be in breach of the freedom of establishment.

The European Commission initiated an infringement procedure against Finland with regard to the deductibility of group contributions on 7 May 2019. As Finland has not amended its rules regarding the tax deductibility of group contributions despite the Commission’s infringement package, the Commission sent a letter of formal notice to the Finnish Government on 14 May 2020, stating that Finnish legislation on group contributions infringes EU law.

Finnish group contribution rules do not currently allow for the tax deductibility of group contributions that are made to affiliated companies resident in other EU/EEA member states even if the group contributions are paid to cover definitive tax losses incurred by these affiliated companies.

Pursuant to the Commission’s notice, the different treatment of domestic companies and companies resident in other EU/EEA member states is in breach with the principle of the freedom of establishment set out in Article 49 of the Treaty on the Functioning of the European Union and Article 31 of the EEA Agreement.

In the event that Finland fails to make necessary amendments to its legislation within the next four months, the Commission may refer the case to the Court of Justice of the European Union (“CJEU”).

The issue affecting the utilisation of final tax losses has surfaced in relation to the taxation of cross-border mergers as well. The SAC’s recent precedent KHO 2020:51 concerned the right of a Finnish company (A Oy) to utilise the tax losses of its Latvian subsidiary (A AS) after a cross-border up-stream merger of A AS into A Oy.

The SAC assessed as to whether the conditions for the finality of A AS’s tax losses had been met in accordance with the case law of the CJEU in order to decide whether the tax losses in question could be utilised by A Oy against its profits after the completion of the cross-border merger.

Firstly, the SAC ruled that A Oy as the surviving company had to demonstrate that, in the cross-border merger, the foreign merging company A AS had exhausted all the existing possibilities for utilising the tax losses in its home country. Pursuant to the CJEU’s case law, if the subsidiary has received income, no matter how little, the possibility exists for the generated tax losses to be utilised in the subsidiary’s home country against profits generated in future. The SAC ruled that it had not been demonstrated that A AS would not receive any income in the upcoming years.

Further, the SAC held that the finality of a foreign company’s tax losses cannot be affected by the fact that the company’s home country does not allow for tax losses to be transferred. Therefore, the SAC held that the restrictions imposed by Latvian tax law on the utilisation of tax losses do not, as such, imply that it would be impossible for a third party to take the tax losses of A AS into consideration in Latvia in future tax years in the event that A AS is sold to a third party.

Consequently, the SAC ruled that A Oy had not demonstrated that the conditions for the finality of A AS’s tax losses had been met and, therefore, A Oy was not entitled to deduct the tax losses of A AS after the merger.

Both of the above matters relate to the tax treatment of final tax losses in the context of EU law. The infringement procedure against Finland may lead to amendments to Finnish tax legislation regarding the cross-border balancing of profits. The SAC’s decision demonstrates the current high standard of proof for the finality of tax losses and, consequently, for the deductibility of cross-border tax losses. As regards the future, potential amendments to the group contributions scheme may have an impact also on the tax treatment of tax losses in cross-border mergers.

Borenius’ lawyers are available to assist in addressing any questions you may have regarding the amendment.