The tax treaty between Finland and France is undergoing significant revisions
Finance Minister Saarikko signed a new tax treaty on April 4, 2023, which still requires a legislative proposal and approval by the parliament for its enactment. The currently effective treaty, established in the 1970s, will soon be replaced. The main changes in the new treaty involve methods to eliminate double taxation, the taxation of dividends at source, the taxation of pension income, and the definition of a permanent establishment.
In the previous treaty, double taxation was eliminated by allowing each treaty state to exempt income earned from the other state. This generally resulted in income being taxed in only one country, without crediting taxes paid abroad. For instance, capital gains from a holiday home in France owned by a resident of Finland were taxed solely according to French tax law. Conversely, capital losses from the sale of a French holiday home could not be transferred to Finland. However, for earned income, even though the income wasn’t added to the taxable amount, it was considered in determining the tax progression on Finnish earned income, so earnings from France increased the tax rate on Finnish income.
Elimination of Double Taxation
The updated treaty now primarily uses the credit method, where Finland taxes foreign income but credits the amount of tax paid abroad against the Finnish tax on the same income. A limitation of this method is the varying bases of tax deductions in different countries before taxation. For instance, France might tax a touring musician on gross income, whereas Finland considers net income when calculating the maximum credit. This can result in a higher overall tax rate than if the income were taxed only in Finland or France.
Under tax treaty law, the country of residence credits tax paid to the source country. However, the updated treaty introduces a special procedure for certain pension payments. If a person residing in France receives a pension from Finland, the Finnish tax on this pension is reduced by the tax paid in France, meaning the source country carries out the credit. For pensions already in payment as of April 4, 2023, a transitional rule applies to those residing in one treaty country and receiving a pension from the other, continuing the 1970 treaty’s practice of taxing the pension only in the resident’s country.
Taxation of Dividends
In the new treaty, the taxation of portfolio dividends changes, allowing a 15% withholding tax for source country. Portfolio dividends refer to dividends where there is no significant direct ownership, like those from funds. The withholding tax may be lower if national law (such as the Finnish law on taxation of limited tax liability income, 627/1978) dictates. Also, no withholding tax applies if the dividend recipient directly owns at least 5% of the company’s capital during a 365-day period including the dividend payment date.
Furthermore, provisions in the previous treaty related to France’s then-existing dividend tax refund system (“Avoir Fiscal”) have been removed in the updated version. Special conditions in Article 6 of the dividend article also apply to dividends from certain real estate investment funds.
Permanent Establishment
The definition of a permanent establishment (Article 5 of the treaty) in the updated treaty adopts the latest formulation proposed by the OECD. This affects the so-called negative list (Article 5.4), which previously permitted avoid the creation of a permanent establishment despite meeting the general criteria of geographical and temporal permanence. The negative list refers to certain preparatory or auxiliary activities, like maintaining a storage facility. The updated provision assesses all preparatory and auxiliary activities as a whole, in conjunction with related companies. Practically, even if a company’s activities are auxiliary, like advertising, if a sister company within the same group already has a permanent establishment, or if the activities of both companies combined create one, the negative list does not apply.
In conclusion
In conclusion, these are some of the most notable changes, but they are not the only ones. Additionally, even if a provision seems unchanged, interpretations of the updated treaty can legitimately use all legal source material published up to the date of its signing, whereas for the older treaty, material published after 1972 requires clarification of its applicability.