Note: “Road To Exit: Start-up’s First Year” is a practical blog series addressing the most common legal questions and problems that a start-up company and its management faces during their first year of operation. The series is sponsored by Attorneys at Law Borenius Ltd.
For a company with genuine international business that is not confined to a single country, it can be worthwhile to consider international options when it comes to taxation. Startups that do not require the actual work being done completely in Finland can consider settling in another country with a more favourable tax climate for the shareowners. For IT-related firms and services this is especially true. Companies that require the actual work to be done in Finland have more limited possibilities to optimise their taxation, though it is still possible.
1. Taxation of limited liability companies
The payable tax of a limited liability company is based on both bookkeeping rules and tax law. The tax percentage in Finland is 26 %. Dividends paid to natural persons are tax exempt up to 9 % of the net worth of the company (however, the maximum is EUR 90,000 per shareholder). 30 % of the dividend exceeding 9 % of the net worth is tax exempt and 70 % is taxed earned income with a personal progressive tax rate up to approximately 50 %.
2. Practical example
Let’s take an entirely hypothetical example of a company’s taxation in Finland:
|The company shows an income in the bookkeeping of||EUR 100,000|
|(As not all costs are deductible in taxation, the income in taxation is||EUR 120,000)|
|Taxes (26 %)||EUR –31,200|
|The profit after taxes is thus||EUR 68,800|
Assuming that aside from the profit, the company includes only the minimum share capital of EUR 2,500, the net worth of the company is EUR 71,300. 9 % of the net worth can be distributed tax exempt, i.e. EUR 6,417. The remaining EUR 62,383 of the distributable earnings is treated as earned income dividends, and if distributed, all 30 % is tax-free (i.e. EUR 18,715) and the rest is taxed based on the shareholder’s personal progressive tax rate.
3. Practical example of a structure abroad
Let’s look at the possibilities if the business was operated in a country with a lower level of taxation. For practical reasons, we are looking only at EU countries, though countries with tax treaties with Finland are also possible. Within the EU, there are several countries with lower corporate income tax rates than Finland. The lowest ones can be found in countries such as Bulgaria and Cyprus (10 %), Ireland (12.5 %), Latvia (15 %) and Poland (19 %) to name a few.
A quick comparison with Cyprus
|Income in bookkeeping||EUR 100,000|
|(Income in taxation might be the same||EUR 100,000)|
|Taxes (10 %)||EUR –10,000|
The dividends could then be distributed to a Finnish parent company, which receives these dividends as tax-free income. The Finnish parent company would then distribute the dividends to the shareowners.
|Share capital||EUR 2,500|
|Net worth||EUR 92,500|
Calculating 9 % of the net worth gives us EUR 8,325 of tax exempt dividends, which is EUR 1,908 or some 30 % more than if the business had been operated in Finland. If all the income is distributed, the tax-free part of earned income dividends is EUR 24,503 and the rest, EUR 57,172 is taxed based on progressive tax rate.
4. As easy as that?
Clearly the realities are not always as rosy as presented. There is a risk that despite the group structure, the business is considered to be done in Finland, which creates a permanent establishment (PE) in taxation in Finland. This means that the income of a foreign subsidiary is taxed in Finland as such. To avoid the risk of a PE, it is important that the business is in fact operated in the subsidiary country. There can also be requirements, legal or other kinds, which need to be fulfilled in the foreign countries. The cost associated with establishing a company abroad can also seem like a hurdle, but on the other hand, e.g. the wage costs can be lower than in Finland. In other words, there are many options with different trade-offs.
Successful tax planning always starts from the individual needs of the startup. Though Finland might seem like a natural choice at the beginning with relatively little extra work, foreign companies can be incorporated to bring some serious tax benefits if the company goes far. In case of compensation for IPR, it can be worthwhile to allocate these from the beginning to countries with lower or no taxation. Several countries also give incentives or benefits that speak for establishing a company in these countries, generous R&D deductions in France and royalty taxation in Ireland or Spain to name a few.
In general it could be said that the larger the operations are the more benefits can be achieved through careful tax planning. On the other hand, even if in the beginning it is merely a small-scale startup, from a tax point of view it is often drastically more advantageous to create the optimal group structure from the onset, rather than to change it later and move e.g. valuable IPRs abroad at a later stage when their transfer at the fair market value causes taxable income and thus tax cost to the Finnish transferor company.
About the Author
Sami advises on domestic and international tax matters in corporate and personal income taxation. Sami has wide experience in acting as a daily administrative tax advisor and a tax coordinator of domestic and international group’s Finnish companies and branches. He is specialised in tax planning, mergers and acquisitions, corporate restructuring and changes of generation.
Attorneys at law Borenius Ltd is one of the leading law firms in Finland offering a full spectrum of commercial law services. Attorneys at law Borenius’ mission is to be the most hands-on, client-centred business solution provider. The firm’s approach to business challenges is team-oriented, combining its strong and diverse expertise with a thorough business understanding.
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