New Tax Law Welcomes Foreign Investments in Finnish Private Equity and Venture Capital Funds
Private equity plays an important role in driving economic growth in Finland by creating jobs, generating returns for investors, and developing the businesses of Finnish companies. During the past five years, private equity investors have invested EUR 4,9 billion into Finnish companies. Despite the significance of private equity investments, Finnish private equity funds have traditionally attracted less foreign capital compared to their foreign peers – potentially due to the Finnish tax environment. In my master’s thesis, I examined the tax treatment of Finnish private equity funds and their foreign fund investors in Finland.
In 2017, only 30% of the investments in Finnish private equity funds were made by foreign fund investors, whereas the corresponding figure in Europe averaged 50% and in Sweden 80%. The low number of foreign investments made into Finnish private equity funds resulted at least partially from the national tax legislation in force at the time. Prior to a legislative amendment in 2019, foreign investors were not able to invest in Finnish private equity funds through funds of funds without facing a risk of double taxation.
A similar problem occurred in the early 2000s when the tax environment for fund structures was unfavourable in Finland. Foreign investors were prevented from making tax-efficient investments in Finnish private equity funds as they were liable to tax in Finland on all income received through such funds in addition to being subject to their home country tax laws. As a comparison, in the case of direct investments in portfolio companies or investments made through foreign private equity funds, only part of the income would have been subject to tax in Finland.
For the purposes of neutralising taxation and improving the competitiveness of the Finnish private equity and venture capital industry, Finland introduced special tax rules for foreign investors in Finnish private equity funds. The new regime enabled a flow-through tax treatment of income received by foreign investors in the case of direct investments in Finnish private equity funds.
In practice, the flow-through tax treatment means that capital gains received from exits are generally not subject to tax in Finland. Without the flow-through tax treatment, foreign investors would be liable to tax in Finland on all income, including all capital gains, derived through Finnish private equity funds in addition to being subject to their home country tax laws. Thus, the application of the special tax regime is crucial to foreign investors from the perspective of tax efficiency.
As suggested by the FVCA, the special tax regime was also extended to cover foreign investors investing through funds of funds in 2019. Therefore, foreign investors are now able to invest both directly and indirectly in Finnish private equity funds without a risk of double taxation. However, the special tax regime requires certain conditions to be met at each level of the fund structure in order for foreign investors to benefit from the favourable tax treatment. Particularly in more complicated fund structures, the application of the special tax regime should always be analysed on a case-by-case basis.
To summarise, an unnecessary barrier for foreign fund of funds investments in Finnish private equity funds has finally been removed. Taking into account the various actions and initiatives facilitating and promoting private equity and venture capital industry in Finland taken by both the government and non-governmental organisations, such as Slush, the amendment of the special tax regime was a logical and coherent move by the government.
As a result of the tax law amendment, the difference in the percentage of foreign investments in Finnish (30%) and Swedish (80%) private equity funds should decrease in the future at least to the extent that the gap resulted from differences in taxation.
About the author:
Winner of the FVCA Master’s Thesis Competition
Isabella works as an associate lawyer in Hannes Snellman’s tax team. Her special interest lies in tax aspects related to private equity funds and M&A transactions. The blog post is based on her award-winning master’s thesis focusing on the tax treatment of Finnish private equity funds and their foreign investors in Finland.