According to a recent Etla study, the Finnish tax system for unlisted companies needs to be changed in some minor respects. The current system distorts companies’ decisions, resulting in welfare losses. However, the study shows that there is no need for a major overhaul of the system, which can be remedied by changing key parameters. The researchers suggest considering both the shares of normal income (8%) and the shares taxable at the owner level (25% and 85%).
Etla Economic Research study The Structure of Finland’s Tax System for Unlisted Companies is Sound – The Details Deserve Further Consideration, Etla Brief 139) is based on a recent article published in a scientific journal (Seppo Kari and Olli Ropponen, 2024). The study shows that the current Finnish system distorts business decisions, resulting in welfare losses. The study also shows that the problem can be fixed by changing key tax parameters.
– The problem is therefore not in the design of the system. The system can be made nondistortionary by appropriate choices of its key parameters. These parameters should also follow changes elsewhere in taxation,” says Olli Ropponen, Research Manager at Etla
According to Dr. Ropponen purpose of the Etla Brief is, on the one hand, to shed light on the key features of the tax system for unlisted companies in Finland, and on the other hand, to provide insight into the need for development within the system. The starting point is the dual income tax system, which justifiably aims to tax capital income differently from earned income. The need for development, in turn, is focused on the system’s parameters, not its structure.
The scientific article revisits the income-splitting regulations within the Nordic dual income tax framework. These regulations were introduced to counteract the inclination to transfer income between labor and capital income tax bases. They involve imputing a return on equity, considered as capital income, and taxing the residual portion at rates similar to those imposed on labor income.
There are primarily two methods for computing imputed capital income. One method involves imputing a return based on the shares’ acquisition price (implemented in Sweden and Norway), while the other calculates a return using the net book assets of the company (utilized in Finland).
The study (Seppo Kari and Olli Ropponen, 2024) examines the economic implications of the net asset-based splitting approach, an area not extensively explored in earlier literature. The findings suggest that with appropriate selection of tax-parameter values, the net asset-based splitting system embodies the fundamental characteristics of a neutral corporate tax system akin to the ACE corporation tax.
Consequently, the analysis indicates that the issues regarding incentive concerns in the Finnish taxation of closely held companies, highlighted in previous studies, stem more from erroneous parameter values rather than flawed underlying principles.
