Ref. Ares(2014)75867-15/01/2014 CONTRACT SI2.ICNPROCE009493100 IMPLEMENTED BY FOR DEMOLIN, BRULARD, BARTHELEMY COMMISSION EUROPEENNE - HOCHE - - DG ENTREPRISE AND INDUSTRY - Study on Effects of Tax Systems on the Retention of Earnings and the Increase of Own Equity Jean ALBERT Team Leader - ANNEX 16 - - NORWAY - COUNTRY REPORT - Submitted by Rune JALVING Country Expert February 15, 2008 1
NORWAY Mazars Revisjon AS Rune Jalving Bogstadveien 27B 0355 Oslo Norway +47 23 19 63 00 INTRODUCTION The Norwegian Parliament passed a major tax reform in 2004-2006, and the different elements in the reform came into force from the taxation year of 2004-2006. This reform replaced the last major Norwegian tax reform from 1992. Until this tax reform, dividends were tax free for both private business owners and corporate business owners. After the tax reform private business owners have to pay 28% tax on almost the entire dividend, giving a marginal tax rate of 48,16% for distributed earnings. In reality the same rules applies to both limited companies and partnerships. The change in tax on dividends in 2006 was well known, and this encouraged extremely high dividends in 2005 which was the last year with tax free dividends. Most small and medium sized companies therefore reduced retained earnings to an absolute minimum during 2005. 2
The main effect of the tax reform has in our view been: 1. Partners and shareholders that own the part/shares individually, retain earnings in their Undertaking rather than distributing them. 2. An increased number of limited companies have been established by private investors for the purpose of buying and selling shares without taxation through their private limited company. 3. An increased number of tax free transformations from individual ownership of shares and businesses to limited companies. Conclusion The Norwegian tax system has changed from encouraging distribution of earnings prior to the tax reform to encouraging retention of earnings after the tax reform in 2006. 3
PART 1 GENERAL QUESTIONS 1. What are the main characteristics of the tax systems applicable on enterprises and business owners in your Country (corporate income tax, income tax, capital gains tax, other profit based taxes, capital based taxes, other taxes)? A flat tax rate of 28 per cent applies to corporate taxable profits (ordinary income). The tax base is the sum of operating profit/loss, financial revenues and net capital gains minus tax depreciation. As from 2005, the general rules for the timing of income and expenditure for tax purposes are no longer based on the accounting rules. Taxable income is recognized when it is earned and expenditure when it is incurred, according to the so-called realization principle. Main legislation regarding taxation: - Income Tax Act ( Tax Act ), dated 26 March 1999 no 14 with related regulations - Tax Assessments Act, dated 13 June 1980 no 24 - Petroleum Tax Act, dated 13 June 1975 no 35 - Inherance Tax Act, dated 19 June 1964 no 14 The Parliament (the Norwegian Storting) each year passes a resolution determining the level of tax rates and government dues. The Tax Authorities also publish a yearly guide describing practical tax issues. 1.1. Corporate Income 4
1.1.1. What are the general principles for the computation of taxable profits? The tax base is the sum of operating profit/loss, financial revenues and net capital gains minus tax depreciation. Capital Gains The main rules in connection with taxation of capital income are found in the Tax Act section 5-20 et seq. For corporations capital gains on the sale of assets is treated as ordinary taxable income. Capital gains deriving from shares are not taxable for limited companies. Taxation of capital gains from the sale of fixed assets can be deferred by purchasing other fixed assets that can be depreciated. Depreciation On the whole, declining balance depreciation is used for tax-related depreciation. The main rules are found in chapter 14 in the Tax Act. For tax depreciation purposes fixed assets are divided into 9 different categories according to the expected life of the assets, cf. section 14-43 in the Tax Act. These are as follows: Depreciation category Maximum tax depreciation rate a) Office equipment 30 % b) Acquired goodwill 20 % c) Goods vehicles 20 % d) Passenger vehicles, machinery, furniture and 20 % fixtures e) Ships, vessels, drilling rigs, etc. 14 % f) Aircraft 12 % g) Plants for transmitting electric power and technical 5% equipment in power plants h) Buildings, hotels, restaurants, etc. 4(8) % 5
i) Commercial buildings 2 % The higher rate in h) applies if the expected life is less than 20 years. The cost price of assets with an estimated life span of less than three years and of assets costing less than NOK 15,000 may be deducted immediately. Loss carry forwards Operating loss carry forwards may be carried forward for an unlimited amount of years, cf. section 14-6 in the Tax Act. Carry backs are not permitted, except in connection with end of the business, cf. the Tax Act section 14-7. Carry backs in connection with end of business is allowed for up to two years before the income year. 1.1.2. What are the main differences between the tax balance sheet and commercial balance sheet? The principles for depreciation as well as rules concerning timing are the main differences between the tax balance sheet and commercial balance sheet. In addition reserves for obsolete inventory, depreciation trade receivables, and reserves for restructuring, pension, warranty and other risks booked according to good accounting principles are not included in the tax balance sheet. As from 2005, the general rules for the timing of income and expenditure for tax purposes are no longer based on the accounting rules. Taxable income is recognized when it is earned and expenditure when it is incurred, according to the so-called realization principle, cf. the Tax Act section 14-2. The rule change have had little effect so far since the earlier rule was that reserves according to good accounting principles was not tax deductible. The change in legislation was made 6
as a consequence of the Supreme Court s decision in the so-called Shell-case (Rt 2004 s 1921), in which the company was entitled to deduct estimated future costs for abbandonment of an offshoreinstallation over the production period. 1.1.3. What are the most important adjustments for the computation of taxable profits/taxable gains on the base of accounting profits? The main difference is timing difference as described above: The principles for depreciation as well as rules concerning timing are the main differences between the tax balance sheet and commercial balance sheet. In addition reserves for obsolete inventory, depreciation trade receivables, and reserves for restructuring, pension, warranty and other risks booked according to good accounting principles are not included in the tax balance sheet. As from 2005, the general rules for the timing of income and expenditure for tax purposes are no longer based on the accounting rules. Taxable income is recognized when it is earned and expenditure when it is incurred, according to the so-called realization principle, cf. section 14-2 in the Tax Act. The rule change have had little effect so far since the earlier rule was that reserves according to good accounting principles was not tax deductible. We also has permanent differences, mainly are all gifts and mostly all representation cost not deductible, cf. the Tax Act sections 6-21 and 6-22. In addition are dividends and other financial income or losses linked with shares not taxable/deductible for corporations after the tax reform, cf. the Tax Act section 2-38. 7
1.2. Income 1.2.1. What are the general principles of income taxation of business owners on business income, wages, distributed earnings, interest on loans and capital gain (sale of shares)? The Norwegian tax system is been based on a two-tier structure, income tax is levied on two different concepts of income: general income and personal income. The main rules regulation general income is placed in chapter 5 in the Tax Act, and rules relating to personal income in chapter 12. In this dual income tax system, capital income (including distributed earnings, interest and capital gains) earned by personal tax payers is taxed as general income at a flat tax rate of 28 percent, whilst income derived from labour and pensions are taxed progressively as personal income up to maximum 47,8% on salary. The flat 28 percent tax rate is also applied on the income of limited companies and other corporate tax payers. 1.2.2. Is there a different tax treatment for income from different income sources? No, except for wages/pensions which are taxed at a higher rate. 1.3. Capital A brief summary of relevant/applicable tax provisions is given hereunder. No 8
difference between partnerships and sole traders. (When it is no changes between 2002 and 2006 only 2006 are filed in) Norway RELEVANT TAX PROVISIONS AND SUBSEQUENT CHANGES For CORPORATIONS (distinguish specific tax rates for SMEs) 2002 2003 2004 2005 2006 Corporate tax 1. Tax rate 28 % Standard 28 % Reduced 28 % Minimum Tax 28 % Special Rates Non profit tax (local tax on corporations, energy tax ) 2. Tax accounting rules NA Property tax 0,1-0,7 % in some urban municipals. Real estate transactions 2,5 % stamp duty. Duty on energy Tax cost included deferred tax are booked as profit or loss and owes tax and deferred tax are booked in the balance 3. Booked depreciation not Depreciation allowable for tax purpose Basis Start with acquisition cost Methods Declining balance method Rates Office machinery 30% Goodwill 20 % Trucks, busses and taxis 20 % Cars, Agricultural tractors, machinery, tools, instruments 20% Ships and drilling platform 14% Planes 12 % Power stations, power lines 5 % Industrial buildings, hotels and restaurants 4 % Office buildings 2 % Accounting Intangibles Non depreciable assets Straight line depreciation Tax purpose 20 % declining balance method. Accounting 5-20 % straight line Site 9
Norway RELEVANT TAX PROVISIONS AND SUBSEQUENT CHANGES For CORPORATIONS (distinguish specific tax rates for SMEs) 2002 2003 2004 2005 2006 4. Provisions Risks and 0 % futures expenses Bad debts 0 % Pensions 0 % Repairs 0 % 5. Losses Carry forward Carry back Transfer of losses 5. Inventories Valuation rules Allocation methods Personal Income tax Interest Income 10 year 10 year 10 year 10 year No limit 2 year with end of business Use of group contribution For tax purpose gross value, no reductions NA 28 % Dividends 0% 0% 0% 0% 28 % Employment income Capital gains tax Sale of fixed assets Timing rules Accounting rules Inflation Rates Exemptions 13,5% (K289-793,2) (19,5 % above K793,2) 13,5% (K320-830) (19,5 % above K830) 13,5% (K340,7-872) (19,5% above K872) 13,5% (K354,3-906,9) 19,5% above K906,9) Tax: 28 % +9 %(394 100-750 000)+ 12 % (above 750 000) Social security: 7.8 % (uncapped) 28 %. House for private use tax free after one year residence Possible to take 20 % of profit yearly (declining balance method) Enter as income first year NA NA NA 10
Norway Sale shares of RELEVANT TAX PROVISIONS AND SUBSEQUENT CHANGES For CORPORATIONS (distinguish specific tax rates for SMEs) 2002 2003 2004 2005 2006 Tax free for corporations. For private owned shares 28 % tax on profit Capital loss Fixed assets 28 % Shares Wages Average cost to the Undertaking Average cost to the employee Overall tax on distributed earnings or Dividends Timing Tax credit structure Excluding non profit tax Including non profit tax Deduction of expenses General rule Nondeductibility of expenses Thin capitalization Overall corporate tax on Retained earnings Excluding non profit tax 14,1% +12,5% above K607,2 14,1% +12,5% above K895,4 14,1% +12,5% above K930 14,1% +12,5% above K960,9) No deduction for companies. Private 28 % of loss 14,1 % Ca 35-40 % Taxable year of payment Taxable dividend are reduced with ca 3 % of cost of shares NA NA Yes Entertainment expenses, bribes and gifts are non-deductible Only in oil business off shore 20 % 28 % 11
Norway Including non profit tax Debt financing Interest deductibility Limits on interest deductibility Interest deductibility on business owner loan to Undertaking RELEVANT TAX PROVISIONS AND SUBSEQUENT CHANGES For CORPORATIONS (distinguish specific tax rates for SMEs) 2002 2003 2004 2005 2006 28 % Yes No Yes but interest are limited to ca 3 % 12
Norway RELEVANT TAX PROVISIONS AND SUBSEQUENT CHANGES For PARTNERSHIPS (distinguish specific rates for SMES) 2002 2003 2004 2005 2006 Tax applicable to partnerships 1. Tax rate 28 % Standard 28 % Reduced 28 % Minimum Tax 28 % Special Rates Non profit tax (local tax on corporations, energy tax ) 2. Tax accounting rules NA Property tax 0,1-0,7 % in some urban municipals. Real estate transactions 2,5 % stamp duty. Duty on energy Tax cost included deferred tax are booked as profit or loss and owes tax and deferred tax are booked in the balance 3. Booked depreciation not Depreciation allowable for tax purpose Basis Start with acquisition cost Methods Declining balance method Rates Office machinery 30% Acquired goodwill 20 % Trucks, busses and taxis 20 % Cars, Agricultural tractors, Accounting Intangibles machinery, tools, instruments 20% Ships and drilling platforms 14 % Planes 12 % Power stations, power lines 5 % Industrial buildings, hotels and restaurants 4 % Office buildings 2 % Straight line depreciation Tax purpose 20 % declining balance method. Accounting 5-20 % straight line 13
Norway Non depreciable assets 4. Provisions Risks and futures RELEVANT TAX PROVISIONS AND SUBSEQUENT CHANGES For PARTNERSHIPS (distinguish specific rates for SMES) 2002 2003 2004 2005 2006 Site 0 % expenses Bad debts 0 % Pensions 0 % Repairs 0 % 5. Losses Carry forward Carry back Transfer of losses 5. Inventories Valuation rules Allocation methods Personal Income tax Interest Income No limit 2 year with end of business Use of group contribution For tax purpose gross value, no reductions NA 28 % Dividends 28 % Employment income Capital gains tax Sale of fixed assets Timing rules 13,5% (K289-793,2) (19,5 % above K793,2) 13,5% (K320-830) (19,5 % above K830) 13,5% (K340,7-872) (19,5% above K872) 13,5% (K354,3-906,9) 19,5% above K906,9) Tax: 28 % + 9 %(394 100-750 000)+ 12 % above 750 000) Social security: 7.8 % (uncapped) 28 %. House for private use tax free after one year residence Possible to take 20 % of profit yearly (declining balance method) 14
Norway RELEVANT TAX PROVISIONS AND SUBSEQUENT CHANGES For PARTNERSHIPS (distinguish specific rates for SMES) 2002 2003 2004 2005 2006 Accounting Enter as income first year rules Inflation NA Rates NA Exemptions NA Sale of Tax free for companies. For shares private owned shares 28 %tax on profit Capital loss Fixed assets 28 % Shares No reduction for companies. Private 28 % of loss Wages Average cost to the Undertaking Average cost to the employee Dividends Timing Tax credit structure Deduction of expenses General rule Nondeductibility of expenses Thin capitalization Retained earnings Debt financing Interest deductibility Limits on interest deductibility 14,1% +12,5% above K607,2 14,1% +12,5% above K895,4 14,1% +12,5% above K930 14,1% +12,5% above K960,9) 14,1 % Ca 35-40 % Taxable year of payment Taxable dividend are reduced with ca 3 % of cost of shares NA Yes Entertainment expenses and gifts are non-deductible Only in oil business off shore 20 % 28 % 28 % 28 % No limit 15
Norway Interest deductibility on business Owner loan to Undertaking RELEVANT TAX PROVISIONS AND SUBSEQUENT CHANGES For PARTNERSHIPS (distinguish specific rates for SMES) 2002 2003 2004 2005 2006 Yes Yes but interest are limited to ca 3 % 1.3.1. Is there a different tax treatment between distributions of earnings and capital gains realised by the sale of the business or the shares in the undertaking? CAPITAL GAINS FROM SALE OF SHARES IN LIMITED COMPANIES Corporate Shareholders According to section 2-38 in the Tax Act, Norwegian Corporate Shareholders (i.e. limited liability companies and similar entities) are not subject to tax on capital gains derived from realisation of shares in companies which are resident within the EEA, while losses suffered from such realisation are not tax deductible. Costs incurred in connection with the purchase and sale of such shares are not tax deductible. Individual Shareholders Norwegian individual shareholders are taxable in Norway for capital gains on the realisation of shares, and have a corresponding right to deduct losses. This follows from section 10-30 et seq. in the Tax Act. This applies irrespective of how long the shares have been owned by the individual shareholder and irrespective of how may shares that are realized. Gains are taxable as general income in the year of realisation, and losses can be deducted from general income in the year of realisation. The current tax rate for general income is 28 %. Under current tax rules, gains or loss is calculated per share, as the difference 16
between the price of realisation and the individual shareholder s purchase price for the share. The tax base of the share is gains exceeding a risk-free return on the investment surplus tax free amount relating to the Shareholder Model (only applying to Norwegian Individual Shareholders), may be deducted from a capital gain on the same share, but may not lead to or increase a deductible loss, cf. section 10-31 in the Tax Act. The tax base of each share is based on the individual shareholder s purchase price for the share, adjusted for RISK-adjustments up to and including the 2005 income year. (The RISK-method was the Norwegian method for avoiding double taxation of a company s profits and a shareholder s gain on the shares, effective until and including the 2005 income year.) If an individual shareholder disposes of shares acquired at different times, the shares that were first acquired will be deemed as first sold (the FIFO -principle) upon calculating taxable gain or loss, cf. section 10-36 in the Tax Act. Costs incurred in connection with the purchase and sale of shares may be deducted in the year of sale. CAPITAL GAINS FROM SALE OF BUSINESS SHARES Corporate Partners Norwegian Corporate Partners (i.e. limited liability companies and similar entities) are not subject to tax on capital gains derived from realisation of shares in partnerships resident within the EEA, while losses suffered from such realisation are not tax deductible. Costs incurred in connection with the purchase and sale of such shares are not tax deductible. This follows from the main rule in section 2-38 in the Tax Act. 17
Individual Partners Norwegian Individual Partners are taxable in Norway for capital gains on the realisation of partnerships shares, and have a corresponding right to deduct losses. Gains are taxable as general income in the year of realisation, and losses can be deducted from general income in the year of realisation, cf the Tax Act section 5-1 and chapter 9. Retained earnings. No further taxation will take place before the earnings are distributed to the personal business owner(s). 1.3.2. Are there different tax treatments for long-term capital gains and short-term capital gains? No 1.3.3. Are there different tax treatments for capital gain from SME business stock and capital gain from larger companies business stock? No 2. What are the main types of business entities and the main differences in (corporate) income taxation for sole traders, general partnerships, limited partnerships and corporation and other business entities if relevant? The three main business entities are: 18
- Private Limited Companies - Partnerships - Self-employed employees Limited partnerships do only exist to a very limited extent. The main difference between the different business entities is that private limited companies are treated as a separate tax paying entity, as opposed to the two other types of business entities which will be taxed together with its owners (tax transparency), cf. the Tax Act section 2-2 par. 2 and 3. 2.1. Are partnerships treated transparent for tax purposes? Yes 2.2. Can partnerships opt for corporate income tax? No 2.3. Once they have opted for a regime is it easy to switch back? Not applicable 2.4. Is there a difference in this respect between general and limited partnerships? Not applicable 2.5. Can corporations opt to be treated tax transparent? 19
No 2.6. Once they have opted for a regime is it easy to switch back? Not applicable 2.7. Are their differences in this respect between the different types of corporations? No Table 3 INCLUDE RELEVANT TAX PROVISIONS IN 2002 AND SUBSEQUENT CHANGES UP TO 2007 Norway General Limited Corporation Sole Trader Partnership Partnership Corporate 28% 28% 28% tax Income tax 28% *) 28 *) 28% *) 28-50,7% Capital gains 28% 28% 28% 28% tax (shares) Option for N.A N.A N.A N.A Transparent treatment *) with withdrawal and dividend to persons, totally 48,16% 3. Are there any special tax regimes for SMEs for (corporate) income tax purposes? 20
No 3.1. What are the conditions to be fulfilled in order to benefit from these special tax regimes? Not applicable 3.2. Are there limits on the length of time during which these special tax regimes are available, or other limits? Not applicable 4. Are there any special tax incentives, such as (re-)investment reserves or provisions, special depreciations/capital allowances deductible for (corporate) income tax purposes? There are few incentives as listed in the Norwegian tax system. One incentive that can be mentioned is a regulation giving Undertakings the right to deduct costs from research and development directly from the tax base of the Undertaking. The rules are found in section 16-40 in the Tax Act. An Undertaking involved in business activity is given the right to deduct up to 20 % of such costs from the tax base, but is however limited to NOK 4 million for in-house research projects and NOK 8 million for projects commissioned to research institutions. The Undertaking can deduct costs for both in-house research project and project commissioned to research institution. The project must be approved by the Research Council of Norway in order to qualify for deductions. 21
4.1. Do these elements of internal financing represent an important alternative to the financing by retained earnings? No 4.2. Are there any compulsory measures in relation to the retention of earnings (e.g. legal constraints for the distribution of profits and dividend policy)? Yes, ref below DISTRIBUTION OF DIVIDENDS FROM A LIMITED COMPANY The Norwegian Limited Companies Act contains regulations which work as legal constraints for the distribution of earnings, cf. section 8-1 in the law. A limited company s equity is divided in restricted equity and unrestricted equity. It is only the latter type that can be distributed freely as dividend to the shareholders. In order to protect the creditors the Norwegian Limited Companies Act also contains other restrictions when it comes to distributing dividends: a) Dividends can only be distributed after a decision by the annual general meeting, cf. section 8-2 in the Limited Companies Act. b) Dividends can only be distributed if the equity is at least 10 % of the values in the balance sheet, cf. section 8.2, 2 nd paragraph in Limited Companies Act. c) Distribution of dividends must be in accordance with prudent and good business practice, cf. section 8.2, 4th paragraph in Limited Companies 22
Act. DISTRIBUTION OF DIVIDENDS FROM A PARTNERSHIP In a partnership the partners have a personal and unlimited responsibility for the partnership s debts. The need for creditor protection is not the same as for limited companies. The Norwegian Companies Act therefore contains few constraints for distribution of earnings from partnerships. According to the Companies Act section 2-26, the partnership s assets may not be distributed in so far this would evidently harm the interests of the partnership or its creditors. 5. Are there any differences in the tax treatment of stock and cash dividends? No However, it is not a common procedure to distribute shares instead of dividends to the Norwegian shareholders. It is however a legally acceptable choice. According to a formal opinion given by the Norwegian Department of Finance, distribution of shares will not be taxed if the shares are given to the owners in accordance with the original allocation of shares. If the distribution of shares changes the ownership structure, the distribution will be considered to be dividends and taxed as dividends according to the Shareholder Model, see a closer description of the model in question 6. 6. Have there been any changes in the tax regulation in recent years since 2002 that have had an important effect on the retention of earnings, the distribution earnings or the reinvestment of profits for a particular purpose? 23
The Norwegian Parliament passed a major tax reform in 2004-2006, and the different elements in the reform came into force from the taxation year of 2004-2006. This reform replaced the last major Norwegian tax reform from 1992. The most important elements in the Tax reform of 2004-2006 will briefly be described in the following. The different regulations will be explained in greater detailed in part 2-4 below. Private (individual) business owners The tax reform of 2004-2006 introduced tax on distributed earnings that was earlier not subject to tax. The so-called Shareholder Model (also called the Shielding Method for Personal Shareholders) came into force from 2006. The main rules are found in chapter 10 in the Tax Act (section 10-10 et seq.). Double-taxation was introduced for distributed earnings from both limited companies and partnership. The shielding method implies that the dividends exceeding a risk-free return on the investment are taxed as general income with a flat tax rate of 28 % on the hand of the business owner, cf the Tax Act sections 10-11 and 10-12. Before distribution the company has paid the ordinary 28 % corporate tax on the operating profits. The total maximum marginal tax rate is therefore 48.16 % (28 % + (72 x 28 %)) for distributed earnings from both limited companies and partnerships. Corporate business owners In order to avoid chain taxation where shares, derivatives from shares and some other financial instruments are owned by companies, the taxation of the companies income from such instruments were abolished from 2004 the Tax Exemption Method, cf. section 2-38 in the Tax Act. This tax exemption applies to both dividends and to capital gains. Correspondingly, capital losses on such 24
instruments are no longer deductible. The method applies to private and public limited companies and other companies of the same standing as limited companies for tax purposes. The Tax Exemption Method will apply to both domestic and cross border income on shares. To prevent tax avoidance arrangements, the Tax Exemption Method will not be applicable to investments in foreign countries outside the EEA, unless the company has owned the shares for at least 2 years and the ownership stake exceeds at least 10 % of the company, cf. section 2-38, 3 rd paragraph in the Tax Act. The impact of the Tax Reform of 2004-2006 Many investors/business owners have adjusted to the new regulation introduced in the tax reform. The main effect of the tax reform has in our view been: Partners and shareholders that own the part/shares individually, retain earnings in their Undertaking rather than distributing them. An increased number of limited companies have been established by private investors for the purpose of buying and selling shares without taxation through their private limited company. An increased number of tax free transformations from individual ownership of shares and businesses to limited companies. More detailed explanation in question 25. 7. Are there any current plans for tax reforms that have as their object to have an impact of the retention of earnings? No 25
PART 2 TAX ASPECTS OF RETAINED EARNINGS VERSUS DISTRIBUTED PROFITS AND WAGES 8. What is the tax treatment of retained earnings compared to distribution of earnings on the level of the Undertaking and at a combined level of Undertaking (corporate) and business owner (individual)? LIMITED COMPANIES Taxation of earnings: The Undertakings earnings are taxed as ordinary income with a flat tax rate of 28 %, cf. section 5-30 in the Tax Act. The tax base is the sum of operating profit/loss, financial revenues and net capital gains minus tax depreciation. Retained earnings are not taxed before distributed to the shareholders. A limited company is not subject to net wealth tax. Distribution of earnings: Corporate Shareholders According to the Tax Act s main rule in section 2-38, Norwegian Corporate Shareholders (i.e. limited liability companies and similar entities) are not subject to tax on distributed earnings from companies which are resident within the EEA. Individual Shareholders Dividends distributed to Norwegian Individual Shareholders are taxable under the so-called Shareholder Model. The main rules are found in chapter 10 in the Tax Act (section 10-10 et seq.). The Shareholder Model implies that 26
dividends exceeding a risk-free return on the investment (the cost base of the shares) are taxed as general income (28 % flat tax rate) when distributed to individual shareholders, cf the Tax Act sections 10-11 and 10-12. The shielded risk-free return is computed as the cost base of each share multiplied by an annually fixed interest rate. For 2006 the risk-free interest rate was 2.1 %. If the dividend for one year is less than the calculated risk-free interest, the surplus tax free amount can be carried forward to be offset against dividends distributed a later year, or against any capital gain (set off against losses are not allowed) from the alienation of the same share. The maximum marginal rate tax rate of distributed earnings to an individual shareholder will be 48.16 %. PARTNERSHIPS Taxation of earnings: Partnerships are not separate tax entities, cf The Tax Act section 2-2 par. 2. The partnership s profit are nevertheless calculated on a net assessment basis on partnership level as if the partnership was a separate tax entity. The result is then divided between the partners according to the owner s share in the partnership, and then taxed as net taxable earnings or deductible loss, cf the Tax Act section 10-41. The earnings are taxed as general income at a flat tax rate of 28 %. If the earnings are retained in the partnership (and not distributed to the owners) no additional tax will apply before the earnings are eventually distributed to the partners. The partnerships net wealth will however be divided between the partners according to the owner s share in the partnership and taxed according to the rules applying for wealth tax, cf the Tax Act section 4-40. Distribution of earnings: 27
A new taxation method was introduced for partnerships from 2006. The rules are placed in chapter 10 in the Tax Act (section 10-40 et seq). The method is called the Shielding Method for Partnerships, and means that only distributed earnings exceeding a risk-free interest on the capital invested in the partnership should be taxable. The partners will be subject to 28 % taxation on distribution of earnings. In order to compensate for the initial 28 % taxation, only 72 % of the distributed earnings will be taxable, cf the Tax Act section 10-42 par. 3. The shielding method for partnerships will ensure the same level of taxation for partnerships as for limited companies. The maximum marginal rate tax rate of distributed earnings will be 48.16 % (0.28 + 0.72*0.28) SELF-EMPLOYED INDIVIDUALS Taxation of earnings: A new taxation method was introduced from 2006 to self-employed individuals. The method is called the shielding method for self-employed individuals and according to chapter 12 in the Tax Act, the method aims to tax as personal income all business earnings exceeding a risk-free interest on the capital invested. See a closer description of taxation of personal income in question 23 point ii). The shielding method for self-employed individuals will apply to all individual persons who exercise some kind of business activity. The business activity must be suitable for creating a profit and must be carried out for the owner s account and risk. It is further requirements concerning the activity s extent and duration, cf the Tax Act section 12-10. 8.1. Is there an economic double taxation of distribution of earnings (taxation of Undertaking income and then taxation on the 28
distribution of earnings at the Undertaking level or at the business owner level)? Yes There is a double taxation of distribution of earnings. The Undertaking will first be taxed for its income at a flat tax rate of 28 %. Distributed earnings exceeding a risk-free interest on the capital invested will be taxed with 28 % when distributed to individual shareholders or owners. Distributions corresponding to a risk-free rate of interest are except from double taxation under both the Shareholder Model and the Shielding Method for Partnerships. The maximum marginal rate tax of distributed earnings is 48.16 % for both limited companies and partnerships. A very important exemption from the main rules described above, is tax exemption for earnings distributed to private limited companies. Since these rules were implemented in 2004 the number of private limited investment companies has increased due to the favourable tax rules compared to the rules for individual shareholders. A private limited company can receive dividends and realise capital gains from the alienation of shares or ownership in partnerships without taxation. INCLUDE RELEVANT TAX PROVISIONS IN 2002 AND SUBSEQUENT CHANGES UP TO 2007 Norway Undertaking Individual Business owner Corporate 28% tax Income tax 28% *) 50,7% Dividend tax 0% *) 28% *) Dividend credit 0% 0 % 29
Capital gains tax from shares or partnerships Capital gains tax from sale of assets If option for Transparent treatment chosen 0% 28% 28 % 28 % N.A N.A *)Until/including 2005 dividend had a 0% tax rate. Total tax on distributed earnings is 48,16% 30
9. Please describe the differences in the tax treatment of distribution of earnings realised as a capital gain in the context of a sale of the shares or of the business compared to that (i) of retained earnings, (ii) of wages salaries paid to the business owner and (iii) of a loan granted by the Undertaking to the business owner? CAPITAL GAINS FROM SALE OF SHARES IN LIMITED COMPANIES Corporate Shareholders According to the Tax Act s main rule in section 2-38, Norwegian Corporate Shareholders (i.e. limited liability companies and similar entities and partnerships) are not subject to tax on capital gains derived from realisation of shares in companies which are resident within the EEA, while losses suffered from such realisation are not tax deductible. Costs incurred in connection with the purchase and sale of such shares are not tax deductible. Individual Shareholders Norwegian individual shareholders are taxable in Norway for capital gains on the realisation of shares, and have a corresponding right to deduct losses. This follows from section 10-30 et seq. in the Tax Act. This applies irrespective of how long the shares have been owned by the individual shareholder and irrespective of how may shares that are realized. Gains are taxable as general income in the year of realisation, and losses can be deducted from general income in the year of realisation. The current tax rate for general income is 28 %. Under current tax rules, gains or loss is calculated per share, as the difference between the price of realisation and the individual shareholder s purchase price for the share. According to the law s section 10-31, the tax base of the share is gains exceeding a risk-free return on the investment. Surplus tax free amount relating to the Shareholder Model (only applying to Norwegian Individual Shareholders), may be deducted from a capital gain on the same share, but 31
may not lead to or increase a deductible loss. The tax base of each share is based on the individual shareholder s purchase price for the share, adjusted for RISK-adjustments up to and including the 2005 income year. (The RISK-method was the Norwegian method for avoiding double taxation of a company s profits and a shareholder s gain on the shares, effective until and including the 2005 income year.) If an individual shareholder disposes of shares acquired at different times, the shares that were first acquired will be deemed at first sold (the FIFO - principle) upon calculating taxable gain or loss, cf. section 10-36 in the Tax Act. Costs incurred in connection with the purchase and sale of shares may be deducted in the year of sale. CAPITAL GAINS FROM SALE OF BUSINESS SHARES Corporate Partners Norwegian Corporate Partners (i.e. limited liability companies and similar entities) are not subject to tax on capital gains derived from realisation of shares in partnerships resident within the EEA, while losses suffered from such realisation are not tax deductible. Costs incurred in connection with the purchase and sale of such shares are not tax deductible. Individual Partners Norwegian Individual Partners are taxable in Norway for capital gains on the realisation of partnerships shares, and have a corresponding right to deduct losses. Gains are taxable as general income in the year of realisation, and losses can be deducted from general income in the year of realisation. i) Retained earnings. No further taxation will take place before the earnings are distributed to the 32
personal business owner. ii) Wages salaries paid to the business owner. LIMITED COMPANIES Wages paid to the business owner would be taxed both as general income (flat tax rate of 28 %) and as personal income (which is according to the rules in the Tax Act s chapter 12, the basis for calculation for social insurance contribution and surtax). The tax rates for personal income is progressive and varies from 0 12.0 % for surtax. This follows from the yearly Tax Resolution stating tax rates for the income year 2007. The rate for social insurance contribution is 7.8 % (uncapped)for employment income, cf the National Insurance Act section 23-3 and Resolution for assessment of levies etc. for the National Insurance section 2. The total marginal tax for personal wages is therefore 47.8 %. For most wages (between NOK 400,000 and NOK 650,000 at the rates for 2007) the total marginal tax rate is 44.8 % (surtax equals 9 %). The employer will also have to pay employer s contribution to the National Insurance, cf the National Insurance Act section 23-2. The general rate for employer s contributions is 14.1 %, but reduced rates apply to businesses located in Northern and rural areas. PARTNERSHIPS The company s earnings can either be distributed to partners (see description in question 8), or paid to the partner as income from employment. According to the Norwegian Companies Act, a partner which has worked for the Partnership has a right to be paid for this. This income will be taxed as personal income. The tax rate for personal income is progressive. The tax rate for surtax varies from 0 12.0 %. The social insurance contribution will be charged at a higher rate than for ordinary employees (normally 7.8 %) with 33
10.7 % (11 % as of 2008), but on the other hand, no employer s contribution will be charged, cf the National Insurance Act section 23-2 par 2. SELF-EMPLOYED INDIVIDUALS A self-employed individual is not separated from his/her business activity. The shielding method for self-employed individual will apply to all individuals who exercise some kind of business activity. The main rules are found in the Tax Act chapter 12. This method aims to tax as personal income all business earnings exceeding a risk-free interest on the capital invested. The tax rates for personal income are progressive and the basis for calculation of surtax and social insurance contribution. As for partnerships the social insurance contribution will be charged at a higher rate than for ordinary employees (normally 7.8 %) with 10.7 % (11 % as of 2008), but on the other hand, no employer s contribution will be charged, cf the National Insurance Act section 23-2 par 2. iii) Loan granted by the Undertaking to the business owner The Tax Act contains rules concerning rights to deduct costs in chapter 6. The general tax treatment of loans is that the lender is taxable for received interests with a flat tax rate of 28 %, and the paid interests are deductible in general income with the same amount for the borrower, cf. the Tax Act section 6-40. INCLUDE RELEVANT TAX PROVISIONS IN 2002 AND SUBSEQUENT CHANGES UP TO 2007 Norway Distributed Retained Profit Wages/Sala Loan to business owner profits ries to business owner Sale of 28% 0% 47,8% 0% 34
shares Sale business of 48,16 % 28% 47,8% 0% SUMMARY: The Norwegian tax system gives an incentive for individual shareholders in private limited companies or partnerships to retain earnings rather than distribute them. Such business owner will obtain a tax credit when keeping the earnings in the company, and a higher annual amount could be reinvested. Wages are normally taxed at a higher level, especially for higher income, and are therefore no favourable solution from a tax perspective. 10. Is the combination of wages (paid to the business owner by the Undertaking), profit distributions and retained earnings a tax planning issue that is anticipated and addressed by the business owners in view of minimising the overall tax burden of the business owner and the Undertaking? Yes These issues are the key elements to consider when it comes to tax planning. The choice of business structure is in many cases driven by tax incentives, and the main issues to take into consideration will be described in the following. LIMITED COMPANIES The previous Norwegian tax system with no tax on distributed earnings opened for a more extensive tax planning. 35
The current maximum marginal rate tax rate of 48.16 % for distributed earnings (when distributed to the individual business owner) for both limited companies and partnerships are quite similar to the marginal tax rate for personal income. This means that there are not the same incentives as earlier to pay out a low salary and then distribute the earnings as dividend. The current Norwegian tax system has elements which function as incentives to retain earnings in the company, rather than to distribute them. By retaining earnings, the individual business owner will obtain a tax credit which means that a higher annual amount could be reinvested. This means that the business owner has the same incentive as earlier to pay out as low salary as possible, but now to retain the earnings in the company rather than distributing them. That is, naturally if the business owner can afford to keep earnings in the Undertaking rather then distributing them to meet his need for private consumption. There at two very important questions under evaluation by Norwegian Tax Authorities in connection with salaries to the individual business owner contra retained earnings: 1. Must a business owner pay out any salary (or can he/she keep all earnings in the Undertaking)? 2. If the answer to the first question is yes, what will then be the right level of salaries paid to the business owner? The answer to the first question has been ruled over in the Norwegian Supreme Court in the Dillerud-case on 7 December 2006 (case no: HR-2006-02054-A). According to this ruling, an individual business owner is obliged to take out a salary from the Undertaking. The legal foundation for this standpoint is a non-statutory substance over form rule in the Norwegian tax jurisdiction, under which a transaction may be disregarded for tax purposes if 36
(i) the transaction has no, or only minor, consequences other than the reduction of tax and (ii) the result of respecting the transaction would be contrary to the basic policy of the tax provision in question. The ruling concludes that an individual business owner must be paid a market based salary for work done on behalf on the Undertaking. This will apply for both limited companies and partnerships. It is to be said, that the ruling has been criticised by several legal experts. These issues will continue to be debated and the rules connected to these issues are expected to be further developed in the time to come. PARTNERSHIPS The earnings will be taxed as general income at a flat tax rate of 28 %. According to the Norwegian Companies Act section 2-26, a partner which has done work for the Partnership has a right to be paid for this. This means that a partner could have the option to choose between distributed earnings and income from self-employment. The current tax system gives an incentive to pay out the company s earnings as income from self-employment rather than distributed earnings, as distribution does not qualify for earning pension points for accruing rights to additional pension, cf the Tax Act section 12-2 litra f and the National Insurance Act section 3-13 and 3-15. Only income up to 12 G ( as of May 2007: NOK 1,048,080) are included in the basis for pension points. Distribution of earnings will be taxed at a flat rate of 28 % when distributed (i.e a combined marginal tax rate of 48.16%), while income from selfemployment will be taxed with up to 51 % for amounts above NOK 682,500 at the rates for 2008 (28 % ordinary tax + 12 % surtax + 11 % social security levy) (For lower amounts not charged with surtax the difference will be even larger. 37
The question is if the partners freely can use the partnership s earnings as they want. The answer to this question is no. The main rule must be that each partner is paid a market based salary for the work that is carried out on behalf of the partnership. 11. In respect to the previous question, is the business owner more interested in minimising his/her tax burden and then the Undertaking s or both equally? If the business owner has a 100 % majority in the Undertaking, the tax burden of respectively the company and the business owner is two sides of the same issue. Business owners will most likely try to adjust to the tax system is such a manner that the total tax burden is minimised. In Undertakings with more than one owner, the outcome of tax consideration could vary from the ones in Undertakings with a sole business owner. The owners could have different point of views on how the Undertakings earnings should be disposed, both from a tax perspective as well as from a general business perspective. It is therefore impossible to give any definite answer to this question. Both partnerships and self employed individuals have the possibility to transform their Undertaking into a limited company without tax consequences tax-free transformation. The rules are regulated in section 11-20 et seq., in the Tax Act. Many business owners have adjusted to the new tax regime, and transformed their Undertakings into limited companies. This would have important tax consequences since the business owner then can decide to retain parts of the Undertaking s earnings instead of being taxed with a high tax rate as personal income. 38
12. Are there instances in which minimising the tax burden of the business owner would mean dramatically increasing the tax burden of the Undertaking? No 13. For corporate income tax or capital gains tax purpose, are there any incentives/disincentives to retain earnings rather than distribute them or pay wages? Yes The Norwegian tax system has clearly incentives to retain earnings in the Undertaking rather than distributing them. This is especially noticeable for Undertakings buying and selling securities. Since limited companies are not taxable for neither received earnings or for capital gains the tax system has built in an important incentive when it comes to the type of business entity to choose. A limited company would be the preferred company structure in most such cases. The Norwegian tax reform of 2004-2006 has stimulated many individual investors to establish investment companies. 13.1. Are there any limitations or ceilings for these incentives? A business owner can not keep an unlimited amount of earnings in the company. Especially the relationship between salaries and retained earnings are important. Must a business owner pay out any salary (or can he/she keep all earnings in the Undertaking)? If the answer to the first question is yes, what will then be 39
the right level of salaries paid to the business owner? The answer to the first question has been ruled over in the Norwegian Supreme Court in the Dillerud-case on 7 December 2006 (case no: HR- 2006-02054-A). According to this ruling, an individual business owner is obliged to take out a market salary from the Undertaking in accordance with the arms-length principle. The legal foundation for this standpoint is a non-statutory substance over form rule in the Norwegian tax jurisdiction, under which a transaction may be disregarded for tax purposes if (i) the transaction has no, or only minor, consequences other than the reduction of tax and (ii) the result of respecting the transaction would be contrary to the basic policy of the tax provision in question.. The ruling concludes that an individual business owner must be paid a market based salary for work done on behalf on the Undertaking. This will apply for both limited companies and partnerships. It is to be said, that the ruling has been criticised by several legal experts. These issues will continue to be debated and the rules connected to these issues are expected to be further developed in the time to come. 13.2. Is there a risk that these incentives can be used more than one time by the business owners by splitting up the business into different legal entities? No 14. What is the tax treatment of declared loans granted by the Undertaking to the business owner? According to section 6-40 in the Tax Act, the general tax treatment of loans is that the lender is taxable for received interests with a flat tax rate of 28 %, 40