Taxation of foreign mutual investment funds – Is the Finnish taxation practice finally in line with the principle of free movement of capital?

In spring 2022, the Court of Justice of the European Union (CJEU) ruled that Finnish legislation cannot require foreign mutual investment funds to be contractual formed in order to be eligible for tax exemption. The ruling had a significant impact on the Finnish taxation practice, and several foreign company-formed mutual investment funds have since received positive decisions to their withholding tax refund applications.

Section 20 a of the Income Tax Act (ITA), which entered into force in the beginning of 2020, requires mutual investment funds to be open-ended, contractual formed and have at least 30 unitholders in order to be exempt from income tax. The tax exemption also applies to special investment funds referred to in Chapter 2, Section 1(2) of the Act on Alternative Fund Managers. Furthermore, the same exemption applies to similar foreign contractual formed special investment funds if the fund is open-ended and has at least 30 unitholders. 

In principle, Finnish mutual investment funds and special investment funds are always contractual, since the Finnish regulation concerning investment funds only permits establishment of contractual investment funds. In most other countries, it is possible to set up for example company-formed mutual investment funds. The UCITS Directive (2009/65/EC) also recognizes that collective investment undertakings can be established under contract law provisions (investment funds managed by fund managers), trust law provisions (unit trusts) or articles of association (investment companies).

In practice, Section 20 a of ITA has led to an interpretation, where the tax exemption is categorically not available for company-formed foreign mutual investment funds or special investment funds (such as SICAV and SCPI) based on their legal form. The previous case law followed mainly the same interpretation, even though the legislation in force at that time did not include contractual form as a precondition for the tax exemption. 

It has been outlined in the EU case law that regulation setting conditions for certain tax treatment that are characteristic to the domestic market may constitute a prohibited restriction of the free movement of capital and discriminate foreign entities (C-156/17, Köln-Aktienfonds Deka).

Case C-342/20, A SCPI concerned a French company-formed variable-capital real estate investment fund. The Helsinki Administrative Court requested a preliminary ruling from the CJEU on whether the freedom of establishment or free movement of capital should be interpreted to prohibit national legislation, under which only contractual formed foreign open-ended mutual investment funds can be treated as comparable to Finnish mutual investment funds that are exempt from income tax. In that case, foreign mutual investment funds that are not contractual formed, would be subject to withholding tax in Finland, even if there were no other significant objective differences in comparison to Finnish mutual investment funds. The CJEU ruled that the contractual requirement under Section 20 a of ITA is a restriction to the free movement of capital, since such a requirement is likely to place domestic mutual investment funds in a more favorable position than foreign investment funds.

Case 2022:130 of the Supreme Administrative Court concerned a Delaware Statutory Trust investment company based in the United States. Sub-fund A of the fund was open-ended and had more than 30 shareholders. The Supreme Administrative Court stated in its judgment on 15 November 2022, in line with the above-mentioned CJEU case, that Section 20 a of ITA shall be considered to contradict EU law in respect to the requirement of contractual form. Therefore, the legal form of the fund in question is not a factor that would prevent the foreign fund from being treated as comparable to a domestic mutual investment fund. Consequently, the dividends received by the fund from Finnish listed companies were exempt from withholding tax.

In the light of the above case law, it seems clear that certain legal form cannot be a requirement for tax exemption of foreign mutual investment funds, but the decisive factor for the tax treatment is whether the foreign investment fund carries out similar activities as a Finnish mutual investment fund. In addition, the tax treatment of the foreign mutual investment fund in its country of residence is relevant for the comparability assessment.

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