Finland. Tax Obstacles Concerning the Transfer of Non-Incorporated Businesses from One Generation to Another

Transcription

1 Tax Obstacles Concerning the Transfer of Non-Incorporated Businesses from One Generation to Another Finland Author: Mr. Kari Alhola Director, Business Administration and Economics Haaga Institute Polytechnic Suomen verokonsulttien yhdistys

2 TABLE OF CONTENTS Introduction Chapter 1: Transfer inter vivos Section 1: Transfer free of charge: gift I Income taxes II Indirect taxes Section 2: Sale I Income taxes II Indirect taxes Chapter 2: Transfer mortis causa 1 Income taxes 2 Indirect taxes Conclusion/finally Bibliography 1

3 INTRODUCTION Generally, an individual enterprise as opposed to incorporated enterprises is of small or medium size. In the Finnish law, there is no general definition of a small or medium size enterprise (SME), but a number of definitions are adapted to the domain concerned. For example, in the Accounting Act (just modified), the SME which is allowed to publish its yearly statement of account in an abridged form is meant to designate those enterprises which do not pass the following limits: turnover or comparable figure euros; balance sheet total euros; average number of employees In the article 2a of the act, concerning the advanced allowances for investments in developing regions, the limits of a small or medium-size enterprise are a turnover of 20 million euros and a balance sheet total of 10 million euros. There is no other definition of the SME in the Finnish law, but e.g. the Auditing Act includes a few rules. Namely, at least one authorised auditor has to be elected by the partners, by the shareholders meeting or equivalent body, where at least two of the following three conditions are met: The balance sheet total in the annual accounts for the preceding financial period was in excess of EUR Turnover or comparable net sales in the annual accounts for the preceding financial period were in excess of EUR The average number of employees during the preceding financial period exceeded 10. Only an authorised auditor may be elected by the partners, by the shareholders meeting or equivalent body, where at least two of the following three conditions are met: The balance sheet total in the annual accounts for the preceding financial period was in excess of EUR Turnover or comparable net sales in the annual accounts for the preceding financial period were in excess of EUR The average number of employees during the preceding financial period exceeded 50. In Finland, 94 % of the SME qualify as "a very small enterprise" with less than ten employees; "small enterprises" represent 5 % (between ten and 50 employees) and "medium-size enterprises" (between 50 and 250 employees) represent 1 % of SME. Income taxation of individuals The main law for the income taxation of individuals is the Income Tax Act. 2 The Income Tax Act is a general law covering all types of income. However, the net income from agriculture as well as business profits and income from professional activities are determined, for the purposes of income taxation, under the provisions of the Law on the Taxation of Farm Income 3 and the Law on the Taxation of Business Profits and Income from Professional Activities 4, respectively. 1 Chapter 3 article 9 clause 2 of the Accounting Act of December 30, 1997 (modified/ratified July 13, 2001/629). 2 Income Tax Act (ITA) Farm Income Tax Act Business Income Tax Act (BITA)

4 Income subject to tax is defined as the taxpayer s annual receipts in money or money s worth. In addition to this definition, the Income Tax law provides several examples of receipts regarded as chargeable income and of receipts not included in chargeable income. In applying tax legislation, the principle is that receipts are subject to tax unless there is explicit provision to the contrary. Thus the concept of chargeable income is very extensive. The income is taxable for the tax year in which it has been drawn by the taxpayer, in which it has been paid to the taxpayer s account, and in which the taxpayer has received the income or the income is at his/her disposal. Capital gains are taxable for the year in which the sale or exchange or any other disposal took place. The tax is levied on net income; the expenses incurred in acquiring and maintaining income are deductible for the year in which they are paid. In certain cases the allocation principles of business taxation are also followed in the taxation of individuals. Owners of commercial, industrial or agricultural enterprises which will especially hold our attention in the present report are taxed on their net profit estimated in practice from the statement of account, which is to be adjusted according to the tax regulations. Transfer from one generation to another Inheritance and gift Inheritances and gifts are not normally considered as income but they belong to the scope of inheritance and gift tax. When a whole enterprise or assets that belong to the enterprise are received as inheritance or gift, an inheritance or gift tax is levied on them. When the beneficiary is a taxpayer who is an entrepreneur or who continues with the business in question, an acquisition cost is imposed on the assets for his /her income taxation (BITA article 15) The transfer from one generation to another can be done when the transferor is alive as a sale, a gift-like sale or as a gift. The extreme option is transfer after the death as inheritance. There is no difference in taxation between the transfer of a farm or the transfer of an enterprise as inheritance. (Claiming tax relief reduces the amount of the imposed inheritance or gift tax considerably). We shall first consider the transfer inter vivos of an individual enterprise be it without charge (donation) or for valuable consideration (Chapter 1). Then we shall consider the rules that apply to the transfer because of death (Chapter 2). 3

5 CHAPTER 1: TRANSFER INTER VIVOS SECTION 1: TRANSFER FREE OF CHARGE: GIFT Income taxes The donor Capital gain taxation is applied in Finland when property is being assigned. There is usually no capital gain taxation on gifts because no payment 5 is usually made to the donor. The starting point is then that the donor is not taxed. However, if the sale in question is below cost price, i.e. like a gift, liability to pay taxes may come into question (capital gain taxation). Taxation on capital gain is prescribed separately in the Income Tax Act. 6 Capital gain is income from capital (capital income). The tax on income from capital is 29 per cent (in the year 2001). If property is assigned free of charge by a sole proprietorship or in agriculture, no income tax is imposed on the donor. However, assignment against payment of a sole proprietorship is considered as a last transaction, which is taxed according to the BITA 7. Capital gain taxation cannot be applied to it. A gift-like sale can lead to taxation. As an exception to the main rule, transfers from one generation to another involving the assignment of private property to next of kin are not taxed according to the ITA 8. The exemption from taxation involves cases in which the taxpayer disposes of real property from his/her agricultural or forestry business the beneficiary is either alone or with his/her spouse a child of the donor, the donor's direct heir, sister, brother, stepsister or stepbrother the disposed property has been more than ten years altogether in the possession of the donor or in the possession of the donor and the person who has assigned the property free of charge. It is worth noticing that the provision is applicable to agriculture but not to a sole proprietorship. Next of kin The list in the paragraph of the law is exhaustive, which means that the exemption from taxation does not apply to assignments to the direct heirs of siblings. The child of a spouse, an adoptive child or a foster child is also considered as a child according to the ITA article 8 (clause 2). Also, a common-law spouse is a spouse according to the ITA article 7 (clause 3). Provisions which apply to spouses are thus also applied to persons who have lived continuously in marriage-like circumstances in the same household during the tax year without getting married, who have been married to each other before, or who have a child together. Further disposal/transfer The provision of the ITA article 48 (clause 5) aims at making sure that the exemption meant for a restricted group of people is not used as a roundabout method in order to get exemption from taxes in cases where the property finally goes to some other person than the next of kin defined in the ITA article 48 (clause 1, paragraph 3). This kind of tax avoidance could take place, for 5 Without financial consideration. 6 Income Tax Act articles Business Income Tax Act. 8 Article 48 Clause 1 Paragraph 3. 4

6 example, when a father sells his farm at a profit exempt from taxes to his son and after a while the son assigns it at the same price to an outsider. According to the ITA article 48 (clause 5), there is no exemption from taxation if the property is further transferred before five years have elapsed from the beneficiary's title. If the further assignment of next of kin is made five years after the original possession of the gift by the beneficiary, the profit exempted from taxation cannot be taken into account any more. In the further assignment the time of possession of the beneficiary is counted from the time when the sale was made; for example, the son cannot make use of the time when the father was the owner of the property. The donee The person who receives property as a gift is liable to pay taxes on it to the state as prescribed in the inheritance and gift tax act. 9 The income taxation is, thus, not directly applied to the donee. On the other hand, business received as a gift is taxed normally. With a gift-like sale/exchange, as well as with the disposal of a whole business the BITA article 15 is applied if the acquisition costs from the current assets and fixed assets calculated according to the selling price (financial consideration) are less than the book values of the donor. This being the case, the donor is not liable to income taxation. The donee may continue with the depreciation from the same book values but he/she has to pay gift tax on the difference between the current value and the payment made. Gift taxation will be considered at a later point. BITA article 15 A deductible acquisition cost of liquid, current, investment and fixed assets acquired free of charge as inheritance, gift, or the like, is the probable transfer price at the time of the transfer, or a probable lower transfer price at the time the assets are brought into use in the business. If the taxpayer has received the whole business or profession without charge, the acquisition cost of the assigned liquid, current, investment and fixed assets is deducted in the same way as it is deducted from the income of the doner/transferor. The income taxation of a sole proprietorship When the taxpayer has received the whole business or profession as inheritance, gift or as some other title free of charge, the acquisition cost of the acquired business assets is deducted in business income taxation in the same way that it would have been deducted from the income of the doner (BITA article 15). For this reason the receiver has to continue the business or profession from the book values of the donor. The application of the BITA article 15 does not require that the whole business or profession is transferred with its assets and liabilities from one taxpayer to another. It is sufficient that the target of the transfer is such an organizatorial and material entity that can be considered a business or a profession. However, in practise, the provision is generally applied to cases in which the donee continues the donor's business or profession. According to the BITA article 15, the deductible acquisition cost of property assigned free of charge is the probable assignment (sales) price at the time of the transfer or the lower probable assignment price at the time when the assets is brought into use in the business. 9 Inheritance and Gift Tax Act article 1. 5

7 Indirect taxes/gift tax The donor The donor is not taxed for the gift The donee In Finland there is one law for both inheritance and gift tax 10. A person who receives property as a gift is liable to pay tax to the State as prescribed in the Inheritance and Gift Tax Act. 11 Inheritance and gift tax of a sole proprietorship The donee is liable to pay inheritance or gift tax on a sole proprietorship received as a gift, inheritance or by will. When imposing the tax the current value of the business is valued which in practice is usually confirmed in the following way: the value of the real property and security contained in the fixed assets of the business is the taxable value confirmed for property taxation or the higher reasonable current value the value of the movable fixed assets is usually the book value when there is no other evidence of current value. The principles of valuation applied in inheritance and gift taxation on one hand and in net wealth taxation (capital taxation) on the other hand, differ mostly in real estate and current assets. In inheritance and gift taxation real estates are in some cases valued to a higher value than the one used in net wealth taxation, and the undervaluation of the current assets is not usually accepted. The calculation of the tax free of charge, when real estate and current assets are considered, is thus usually based on the different values used in net wealth taxation on one hand, and in inheritance and gift taxation on the other (SAC /2272). In gift taxation, the starting point of the valuation of property is to the current value. In principle, the current value for taxation purposes is gained by deducting liabilities (debts) from the assets (net assets). In practise, this can cause problems in the transfer from one generation to another. The transfer of a business or a farm to the person continuing it may lead to such a heavy load of gift taxes that it prevents the whole transfer or at least hinders the possibilities to carry out the business or profession to a considerable extent. For these reasons, among other things, tax relief provisions concerning the transfer from one generation to another have been included in the Finnish inheritance and gift taxation. The reliefs have to do with the provisions for the valuation of the transferred property and the possibility to have an extended period of payment for the inheritance and gift tax. In order to make the transfer of a business or farm from one generation to another easier, provisions which are rather difficult to understand have been prescribed in the inheritance and gift tax act. 13 Although it is about reliefs in the transfer from one generation to another, the provisions do not require kinship. Once a person is entitled to the tax benefits made possible by the provisions, he/she is liable to pay a gift tax. 10 Inheritance and Gift Tax Act / Inheritance and Gift Tax Act article Supreme Administrative Court (SAC). 13 The same provisions are applied both in inheritance and gift taxation. 6

8 Taxation of the donee Tax on gifts is imposed on the individual share of each beneficiary. In gift taxation, gifts from the same donor within three years are accumulated to determine the amount of tax. A gift tax is levied on the following property (received as a gift) 14 : any property, if the donor or the beneficiary was resident in Finland at the time when the gift was made; real property situated in Finland and shares or other rights in a corporate body where more than 50 per cent of total gross assets of the corporate body consist of real property situated in Finland. The same tax rates apply to both inheritances and gifts. Recipients are divided into three categories, the tax being twice and correspondingly thrice the amount in the first category. 15 The first category includes the following relationships: spouse children and their direct heirs parents The second category is applied to siblings of the deceased person and their descendants. Other relationships fall under category three. Tax rates in the first category 16 Taxable (inheritance and) gift Tax at the lower limit Tax on the exceeding part (euro) (euro) (per cent) 3 363, ,79 84, , , , , ,48 16 In the government bill (HE 91/ ) the scale is suggested to be changed into the following form: Taxable (inheritance and) gift Tax at the lower limit Tax on the exceeding part (euro) (euro) (per cent) 3 400, ,00 85, , , , , ,00 16 The tax rate is double in tax class II and triple in tax class III. Provisions concerning the transfer of a farm or a business A taxpayer may demand that part of the (inheritance or) gift tax is not charged under the following conditions 17 : the chargeable (inheritance or) gift contains a farm or a business part of them; 14 Inheritance and Gift Tax Act article Inheritance and Gift Tax Act article Inheritance and Gift Tax Act article Inheritance and Gift Tax Act article 55. 7

9 the (descendant or) donee continues to run a firm or a business on such a farm or in such a business unit using the assets which he has received as an (inheritance or) gift; that part of the tax corresponding to the above-mentioned property is more than 840,94 euros 18. If a financial consideration has been used in a transfer and the consideration is more than 50 per cent of the market value, no gift tax is charged. 19 That part of the tax not charged and an additional 20 per cent is imposed if the taxpayer disposes of the main part of the farm or enterprise before five years have elapsed from the date of the assessment. 20 The disposal of the main part means that over 50 per cent of the business assets is disposed of. Both a disposal against payment and a disposal free of charge are meant here, but not the closing down of the enterprise. A gift-like sale When the payment made on a business is clearly lower than its current value, a gift-like sale is in question. The Inheritance and Gift Tax Act 21 is then applied in the disposal. According to it, the difference between the current price and the payment is considered a gift if the agreed payment is not more than ¾ of the current price. An example The current value of a business is euros. The selling price, euros, is less than ¾ of the current value (3/4 x = euros). The difference between the current value and the selling price, euros, is considered a gift. If the selling price had been more than euros, no gift tax should have been paid. Advance ruling If the payment is meant to be less than the current price and the beneficiary is unwilling to pay a gift tax, it is possible to appeal to the tax office for an advance ruling on whether a gift tax has to be paid on the disposal (Inheritance and Gift Tax Act article 39a). The advance ruling is not, however, given on the lowest possible selling price, of which the gift tax is not yet liable. The relief provisions and their calculation rules in the Inheritance and Gift Tax Act article 55. Part of the taxpayer's inheritance or gift taxis not charged if the taxpayer puts in an application at the Tax Office before the tax is imposed if 1) the chargeable inheritance or gift contains a farm, a business or a part of them; 2) the taxpayer continues to run a farm or an agricultural or forestry business or other entrepreneurship on such a farm or in such a business unit using the assets which he has received as an inheritance or gift and 3) part of the inheritance or gift tax corresponding to the above-mentioned (1) property is more than 850 euros 22. (Clause 1) In order to calculate the part of the tax that is free of charge, a tax is deducted from the tax imposed according to this act, a tax which should be levied on an inheritance or a gift if the 18 Just under modifying: 850 euros (HE 91/ ) 19 Inheritance and Gift Tax Act article Inheritance and Gift Tax Act article Inheritance and Gift Tax Act article 18 clause HE 91/ : markka (FIM) -> 850 8

10 agricultural land, forest, buildings, constructions, machines, equipment and apparatuses of a farm, as well as the assets belonging to some other business which is not a farm were valuated on grounds of the criteria applied in net wealth taxation in the year before the liability to pay the tax started. The difference between these, or if it is more than the part of inheritance and gift tax that exceeds the 850 euros 23, the part that is mentioned last, will not be charged. (Clause 2) If the disposal of a farm, business or part of a business in the cases mentioned in clause 1 paragraph 2 is in part against payment and the consideration is more than 50 per cent of the current value, no gift tax is charged on the farm, business or part of the business. (Clause 3) If the taxpayer disposes of the main part of the farm, business or part of a business that has been granted a relief mentioned in clauses 2 or 3, before five years have elapsed from the date the inheritance or gift tax was charged, that part of the tax not charged and additional 20 per cent is imposed. (Clause 4) The taxpayer has to notify Tax Office of the disposal mentioned in clause 4 before three months have elapsed from the disposal. The charge is imposed, where applicable, according to article 40. (Clause 5) Calculating the tax According to the provisions in the Inheritance and Gift Tax Act article 55 clause 2, two differences are calculated, the smaller one of them being the one free of charge. In the first difference the tax gift calculated on grounds of the taxable values of the net wealth is deducted from the gift tax calculated on grounds of current values. 24 In the second one, 850 euros are deducted from the gift tax calculated on grounds of the current values. 25 It is noteworthy that there is no relief in the gift tax if the tax on the property in the transfer from one generation to another is less than 850 euros. An example A father donates his child a business/farm. The current value is euros. The value of the net wealth calculated on grounds of the criteria for net wealth taxation is euros. Difference I: The gift tax calculated on grounds of the criteria for net wealth taxation is deducted from the gift tax calculated on grounds of the current values: Gift tax on current value or of euros Gift tax on net wealth taxation value or of euros = Difference I Difference II: 850 euros are deducted from the gift tax calculated on grounds of the current values: Gift tax on current value of euros /. 850 euros 850 = Difference II HE 91/ : markka (FIM) -> The gift tax calculated on grounds of current values./. the gift tax calculated on grounds of the net wealth taxation value. 25 The gift tax calculated on grounds of current values./. 850 euros. 9

11 In the comparison, the smaller difference (here euros) is not charged and, thus, the amount of the charged gift tax would be euros. (= ). In this context it should be emphasized that the reliefs in the Inheritance and Gift Tax Act article 55 should always be demanded separately before the end of taxation. As mentioned above, a provision preventing the further disposal and tax avoidance is possible in the ITA article 48 clause 5. This provision secures that the tax relief provision meant for next of kin is not taken advantage of in order to avoid taxes. The exemption from taxes is lost if the property is further disposed of before five years have elapsed from the date the beneficiary (buyer) has taken possession of the property. It is noteworthy that the loss exemption does not apply to the donor but to the beneficiary/donee. If the reliefs in the Inheritance and Gift Tax Act article 55 clauses 2 or 3 have been applied to the donee, also the increases in taxation in article 55 clause 4 have to be applied to him/her if the further disposal happens before the five years have elapsed. In the Inheritance and Gift Tax Act 26 as well as in the Transfer Tax Act 27, there are provisions which try to prevent the double taxation; i.e. that both gift tax and transfer tax would be imposed in the same transfer. Withholding the right to profits/usufruct The amount of inheritance and gift tax can be reduced by withholding the right to the profits of the property received as an inheritance, gift or by will, to some other person than the new owner. The annual income of the withheld right is capitalized on grounds of the Capital Tax Act article 32 and it is deducted on grounds of the Inheritance and Gift Tax Act article 9 clause 3 from the value of the property received as an inheritance, a gift or by will. No inheritance or gift tax is imposed on the beneficiary on the right to the profits, but an income and net wealth tax is imposed instead. Extension of the period of payment A taxpayer who has been granted a tax relief can under certain circumstances apply for an extension of the period of payment for the charged inheritance and gift taxes. The application has to be put in at the Tax Office before the tax is charged. The taxpayer can be granted more time to pay when the chargeable amount of the taxes on a farm, a business or part of them is at least euros. 28 If there is other property than a farm or a business contained in the inheritance or gift, the part of the chargeable tax has to be at least euros 29 of the total amount of the tax. A tax, which has been granted extension of the period of payment is collected at the annual amounts of at least 850 euros 30 (the amount is the same every year). No interest is charged on the extended time. 31 Exemption or deferred payment According to the Inheritance and Gift Tax Act article 53, the National Board of Taxes can on application grant total or partial exemption from inheritance or gift tax. The Tax Office decides on 26 Inheritance and Gift Act article Transfer Tax Act article Inheritance and Gift Tax Act article 56 clause 1. HE 91/ : markka (FIM) -> HE 91/ : markka (FIM) -> HE 91/ : markka (FIM) -> Inheritance and Gift Tax Act article 56 clause 2. 10

12 the application if the applied amount is less than euros 32, but if the matter is important on grounds of principle, the National Board of Taxes can also make a decision. The Ministry of Finance can also decide on the matter if it is important on grounds of principle. The grounds for exemption are the essentially reduced tax-paying ability due to an illness of the taxpayer or his/her next of kin, or some other similar reason, or the apparent risk to the continuity of the business and to keeping jobs. According to the Inheritance and Gift Tax Act article 53 clause 3 the Tax Office can on the same grounds grant a deferment to the payment of the tax. The National Board of Taxes can for special reasons also make a decision on the deferment. The decisions made under the article 53 of the Inheritance and Gift Tax Act are not appealable. SECTION 2: SALE Income taxes The transferor The Income Tax Act (ITA) article 48 clause 1 paragraph 3, makes possible a transfer which is totally exempt from taxes to the transferor in the transfer from one generation to another, as mentioned above. According to the provision, the profit gained from the disposal of the property is not chargeable income, if the taxpayer disposes of real property used in agriculture or forestry if the recipient is either alone or with a spouse a child of the donor, the donor's direct heir or his/her sister, brother,stepsister or stepbrother, or if the real property has been for more than ten years by the taxpayer or the taxpayer and the person from whom the taxpayer received the property without a financial consideration. It is noteworthy, first, that all the preconditions have to be met and, second, that the relief is not applied to a sole proprietorship. The sale in the transfer from one generation to another is thus exempted from taxes to the transferor under the abovementioned circumstances. The sole proprietor When a sole proprietor sells his business in a transfer from one generation to another, it is a transaction to which the provisions of BITA 33 are applied. ITA article 46 clause 1 paragraph 3 is not applied to the transfer of the real estate contained in the business assets. A sole proprietor and an farmer (agricultural entrepreneur) are in a different position. In practice, the sale of a sole proprietorship is considered the last business transaction of the business. ITA article 128 includes one possibility for a tax relief - income spreading, which is adaptable in the sale of a sole proprietorship in certain cases. Income spreading 32 HE 91/ : markka (FIM) -> The relief on the transfer from one generation to another is not applied, thus, when a sole proprietor is transferred to next of kin. The sale is considered the last transaction of the business and there is a normal business tax. For this reason the entrepreneurs planning a transfer from one generation to another usually change their business into company form before the sale. 11

13 If an individual person has had an earned income of at least euros 34 during the tax year and the income has accumulated before or after during two or more years and it is at least one fourth of the total amount of the chargeable earned income he has received during the tax year an income spreading has to be carried out by demand of the taxpayer if the demand is done before the end of the taxation. For example, the income gained from the disposal of a business is considered this kind of income. The transfer of a sole proprietorship (sale) is considered a transaction of the business itself where the sole proprietorship sells its factors of production to the buyer. The targets of the sale of the sole proprietorship are its assets. The transfer of a sole proprietorship can be carried out in two different ways. On the one hand, the whole business can be transferred, or, on the other hand, parts of the property can be transferred. The transfers are taxed according to the BITA (normal income taxation). The tax consequences of the sale of a sole proprietorship can be demanded a relief in certain cases. The ITA articles makes an income spreading possible e.g. when income is gained in the transfer. It is applied only in state taxation. The income spreading has to be demanded and it is also assumed that, for example, the amount of the income is at least euros (earned income) the income in question can be considered to have accumulated before or after during at least two years the income in question is at least one fourth of the total chargeable earned income gained by the taxpayer in the tax year. The act includes a list of the types of earned income that can be considered to have accumulated during two or more years and thus the income spreading can be applied to them (ITA article 128 clauses 2 3). The income gained, for example, in the transfer of a business is included in these types of income (ITA article 128 clause 2 paragraph 2). According to the ITA article129, the income on which the income spreading is carried out is divided by the amount of the years during which the income has accumulated, however, not more than five years. The tax on this income is calculated in the following way. One part of the income is added to the rest of the chargeable earned income of the taxpayer in the tax year, these are summed up, and the tax on the rest of the chargeable earned income is deducted from the sum. The tax on the income 35 (in question) is calculated by multiplying the tax charged on the part of the income by the amount of the years in which the income is considered to have accumulated. The tax on this income must be at least 15 per cent of the income, however. The tax is charged as income in the year in question. The income spreading demand has to be put in before the taxation ends! The next example illustrates income spreading. An example A sole proprietorship whose owner has an earned income of euros, has a net assets of 0. The income gained in the transfer is euros and it has accumulated during five years. An income spreading is demanded. Because it can only be carried out in state taxation (and only on earned income), other taxes are not calculated in the following. 34 HE 91/ : markka (FIM) -> euros 35 The income that has been spread. 12

14 The transferee /5 = other earned income in all of which state tax on euros state tax The difference of euros is multiplied by the amount of the years in which the income 37 has accumulated (not more than five years). Here five years, or 5 x = euros. State tax in all or euros. Without the income spreading, the state tax would have been on the chargeable income of euros a total of euros. The tax saving would be in a case like this about euros. In the sale the transferee (the buyer) is not as a rule charged an income tax. Indirect taxes/gift tax The transferor In the sale the transferor (the seller) is not as a rule charged a gift tax. VAT is not charged in the sale of goods and services included in the transfer of a business or part of a business, or in other transfer to the person who continues with the business, who starts using the transferred goods and services to any purpose that can have a deduction. 38 This provision of the VAT is applied, for example, when a sole proprietorship sells his business to a new businessman. The transferee The price of the sale matters because gift tax provisions can be applied to the transferee in spite of the abovementioned relief provisions. If the price (consideration) is less than 75 per cent of the current value, the sale can be considered as a gift-like sale in which case it could have gift tax consequences. However, if the sale has included at least 10 per cent 39 of the business and if the transferee is continuing with the business, a relief provision is applied. According to it, The gift tax consequences are not charged at all if the consideration is more than 50 per cent of the current value. Because of these provisions, also, it is important to know the current value. In practice, assessing the current value may prove difficult. Also, even if the transferor and the transferee were able to 36 The normal progressive tax scale is applied (to this total). 37 Income spreading 38 Value added Tax Act article In 2000 it was 20 %. The Inheritance and Gift Tax Act (article 57) was changed with an act that was ratified (1084/2000; HE 104/ ) in the way that the demand of the part of the own which is the condition for the relief was lowered to 10 per cent. 13

15 assess the current value in connection with the sale, the tax authorities might not agree on the current value. In order to avoid disagreements like this on the current value, an advance ruling can be granted. According to the Inheritance and Gift Tax Act article 39a, the Tax Office of the transferor can grant a advance ruling on written application. Either the transferor or the transferee can apply for the advance ruling. If the price is less than 50 per cent of the current price, neither relief provision can be applied as such, but the transferee is charged a gift tax according to the scale in the article 14 of the Inheritance and Gift Tax Act. The scale has been given above. The other reliefs made possible in the article 55 of the Inheritance and Gift Tax Act have been mentioned above as well. If the (sale) price was more than 50 per cent of the current price there is then no gift tax consequence. An example A father sells a farm, which he has owned for more than ten years to his child who is continuing with the farm. The difference between the assets and liabilities in the balance sheet of the business is euros. The net wealth taxation value is euros. The current value of the farm on which there is an advance ruling from the Tax Office, is euros. The (sale) price has been agreed on a) euros b) euros The transferor s (father) tax a) The father has owned the farm for more than ten years. The ITA article 48 clause 1 paragraph 3 can now be applied and the capital gain is free of charge. b) As in a) (i.e. the capital gain is free of charge on the same grounds). The transferee s (child) tax a) Because the (sale) price ( euros) is less than 50 per cent 40 of the current price the difference between the current price and the consideration is considered a chargeable gift. The amount of the gift is in this case euros ( ). The relief provision in the Inheritance and Gift Tax Act article 55 can, however, be applied. It is done in the following way: Current value Sale price (consideration) The part considered a gift The part of the gift of the current value 57 % Tax value of net wealth taxation The part (57 %) of the net wealth taxation value calculated above Tax on the gift 41 (on euros) Tax on the gift (on the net wealth taxation value; euros) 40 The application of the relief provision provided that the consideration is "more than 50 per cent". 41 According to the scale in the Inheritance and Gift Tax Act article

16 In the following, two differences are calculated, according to the Inheritance and Gift Tax Act article 55. The smaller one of them is not charged. Difference I: = Difference II: = In the comparison, the smaller difference (here euros) is not charged and thus the chargeable amount of the gift tax is euros (= ). In practice this means that the tax was charged according to the net wealth taxable value. b) When the (sale) price ( euros) is more than 50 per cent of the current price, the relief provision of the Inheritance and Gift Tax Act article 55 can be applied and the transferee's gift is not chargeable at all. 15

17 CHAPTER 2: TRANSFER MORTIS CAUSA Income taxes The estate of a deceased person who has died during the tax year is taxed both on the income and assets of the deceased and the estate. In income taxation the estate is considered as an independent taxpayer until the estate has been distributed. 42 The income and expenses of the estate are entered on a tax return and the estate pays the taxes. The estate can also continue in the business of the deceased. This business is taxed as an independent taxpayer during the three years following the death. 43 Indirect taxes/inheritance tax There is no difference in taxation when a farm or a business if transferred as an inheritance or gift. In the case of death inheritance taxation comes into question where the starting point of the valuation is the valuation to the current value. In practise this can cause problems in the case of a transfer from one generation to another. The transfer of a business or a farm to a continuator may lead to such a heavy inheritance (or gift) tax load that it prevents the whole transfer or at least hinders the possibilities to continue the business to a considerable extent. For these reasons, relief provisions concerning the transfer from one generation to another are included in the Finnish Inheritance (and Gift) Tax Act. The reliefs are applied to the valuation provisions of the transferred property and to the possibility of getting an extension on the period of payment of the inheritance and gift tax. The prerequisites for the relief In the transfer from one generation to another, a relief can be granted both for the inheritance and the gift tax. The prerequisites are 1. a farm or a business or at least ten per cent 44 of them is included in the gift or inheritance 2. the taxpayer continues in the business or in the agricultural (business) on the farm he has received as inheritance or gift 3. the tax imposed on the farm or business is at least 850 euros 45. If a farm is received as an inheritance or gift the relief is applied to the forest as well. If only forest is received as inheritance or gift, no relief is granted. A business means here a business or a profession whose return is confirmed according to the BITA. A relief can be granted if the property of a sole proprietorship or a profession is included in the inheritance or gift. There has to be business activity in the business in order to the relief to be applied to the inheritance or gift tax due to the transfer of the ownership. A prerequisite of the relief is a personal work contribution in the business. The continuator has to have a share in the profit/loss of the business. Calculating the tax relief The rules for calculating the tax relief are quite complicated in the act. The idea of the provision is that the tax on the transferred business assets is imposed on grounds of its net wealth taxable value, instead of its inheritance tax value. The tightening up of the basis of net wealth taxation has lessened the advantages of the relief provision. 42 ITA article ITA article In the year 2000 it was still 20 %. 45 HE 91/ : markka (FIM) ->

18 As mentioned above, two differences have to be calculated, in accordance with the provisions in the Inheritance and Gift Tax Act article 55 clause 2 in order to calculate the tax relief. The smaller one of these differences is not charged. Difference I: tax based on calculations with the current values tax based on calculations with net wealth taxable value. Difference II: tax based on calculations with the current values 850 euros. An example of this has been given above. Usufruct No inheritance tax is levied on the value of a right to annual income or on the value of a usufruct. Instead, the annual value of such rights is included when computing the beneficiary s income for income tax purposes during all the tax years in which he/she is entitled to such income. Extension of the period of payment The taxpayer who has been granted tax relief can under certain preconditions apply for extension of the period of payment for the inheritance and gift taxes he has been charged. The application has to be put in at the Tax Office before the tax is levied. The taxpayer can have an extension when the chargeable amount of taxes on a farm, a business or part of them is at least euros. 46 If there are properties other than the farm or the business, the part of the chargeable tax on these has to be at least euros 47 of the total sum of the tax. A tax, which has been granted an extension of the period of payment, is collected in annual amounts of at least 850 euros 48. The annual amounts are of the same size and the maximum time is five years. No interest is charged during the extension of the period of payment. 49 The deferment of inheritance taxation The Tax Office can grant a deferment of not more than one year for the charging of the inheritance tax if a party to an estate puts in an application before the inheritance tax is imposed. This is in the Inheritance and Gift Tax Act article 25 clause 3. The deferment can be granted if good reasons are given to support the application. For example, if in the distribution of an estate the estate includes an enterprise that is continued by the estate or parties to the estate, if the assets to be inherited is not insignificant considering the total assets of the estate. Exemption or deferred of payment According to the Inheritance and Gift Tax Act article 53, the National board of Taxes can an application grant total or partial exemption from the inheritance or gift tax. The Tax Office decides on the application if the applied amount is not more than euros 50 but if the matter is important on grounds of principle, the National Board of Taxes can also make a decision. The Ministry of Finance can also decide on the matter if it is important on grounds of principle. 46 Inheritance and Gift Tax Act article 56 clause 1. HE 91/ : markka (FIM) -> HE 91/ : markka (FIM) -> HE 91/ : markka (FIM) -> Inheritance and Gift Tax Act article 56 clause HE 91/ : markka (FIM) ->

19 The grounds for exemption are the essentially reduced tax-paying ability due to an illness of the taxpayer or his/her next of kin or some other similar reason, or the apparent risk to the continuity of the business and to the keeping of jobs. According to the Inheritance and Gift Tax Act article 53 clause 3 the Tax Office can on the same grounds grant a deferment to the payment of the tax. The National Board of Taxes can for some special reasons make a decision on the deferment. The decisions made under the article 53 of the Inheritance and Gift Tax Act are not appealable. CONCLUSION/FINALLY The transfer of an enterprise (i.e. sole proprietorship) can be carried out during the entrepreneur's lifetime for example as a sale, as a gift or as a gift-like sale (Transfer inter vivos). After the death of the entrepreneur the transfer is carried out as inheritance or by will (Mortis causa). Possibilities of transfer that are free of charge are gift, will and inheritance. In these cases the continuity principle is usually adapted in the income taxation of the beneficiary who is continuing the entrepreneurship. The same grounds of taxation are used in inheritance and gift taxation (e.g. assessing the value of the gift, tax classes and scales). If the property has been received without financial consideration, the acquisition cost is the value, which has been used in determining inheritance and gift tax. In general, the taxable capital gain is calculated by deducting the acquisition cost and sales costs from the sales price. However, capital gains are tax-exempt i.e. in the following case: a taxpayer disposes of real property used in agriculture or forestry; the real property have been owned for more then ten years by the taxpayer or the person whom taxpayer received the property without a financial consideration; the recipients are certain close relatives. This relief is not applied to a sole proprietor/a sole proprietorship. A sole proprietor and an farmer are in the a different position. A taxpayer (i.e. the donee) may demand that part of the inheritance or gift tax is not charged under the following conditions: the chargeable inheritance or gift contains a farm or a business or a part of them: the descendant or donee continues to run a farm or a business on such a farm or in such a business unit using the assets which he/she has received as an inheritance or gift; that part of the tax corresponding to above-mentioned property is more than 850 euros. Part of a business is at least one tenth of the capital of the enterprise (Inheritance and Gift Tax Act article 57) (before, 1/5). The alteration in the act was implemented on January 1st, 2001 and it is applied to cases in which tax liability has begun after the implementation of the act. In these cases it is possible not to charge a tax on an heir who has in fact received at least one tenth (before1/5) of an enterprise in the distribution of an estate and continues the entrepreneurship with the inherited assets. No gift tax is charged according to the Inheritance and Gift Tax Act in a gift-like transfer of an enterprise or part of an enterprise if the price is more than 50 per cent of the market value. 18

20 It is prescribed in the Inheritance and Gift Tax Act how the part of the tax that is not charged is calculated. When the provision is applied two differences are calculated. The smaller one of these will not be charged. The principles of valuation used in inheritance and gift taxation on one hand and in net wealth taxation on the other hand differ mostly in real estate and current assets. In inheritance and gift taxation real estates are in some cases valued to the higher value than the one used in net wealth taxation and the undervaluaton of the current assets has not usually been accepted. The calculation of the tax that is not charged is actually generally based on the different valuations used in net wealth taxation on the one hand and in inheritance and gift taxation on the other hand, when it is applied to real estates and current assets (SAC 1990/2272). 19

21 APPLICATION FACTS FOR THE STUDY OF THE TAX COST OF THE BUSINESS TRANSFER EXAMPLE 1 The taxpayer has two adult children. His/her spouse died several years before him. His/her estate consisted of two main assets: a business organized as a sole proprietorship, and a house. The fair market value (FMV) of those two main assets is EURO 1 million each. The assets and liabilities of the business are the following: assets - machinery - business building - inventory - cash - original goodwill Total liabilities - bank liabilities - provision for local taxes Total Net assets FMV EURO / / book value for income tax purpose EURO During the last years, the annual earnings before tax (EBIT) from the business has been EURO The annual turnover amounts EURO The business employs 5 persons. All personal and business taxes have been paid except for local taxes, for which provisions were made. The taxpayer's will is to transfer the business to Child A, and the house to Child B. Please calculate the direct and indirect taxes for each different way of transferring the estate. If of interest, do not hesitate to envisage other hypothesis (for example, transfer to a third party). 20