Holding company based management incentive schemes have become a common feature for Finnish listed companies, but to some extent also for privately held companies, especially in private equity investments. In a customary structure, managements’ participation in their employer company (target) is structured through a management holding company with an intended lifecycle of three to five years. The holding company acquires shares in the employer company and the acquisition is financed with a mixture of equity invested by management (some 20%) and loans (some 80%) granted by the employer company.
Dividends received from the employer company are primarily used to pay interest on the loan, but the interest can also be capitalized to the balance of the loan, for example, in circumstances where the employer company is not in a dividend payment position. Under the shareholders agreement between the holding company and the employer company, the repayment of the loan capital may likewise be postponed if the intended initial lifecycle of the structure is extended. In addition, the shareholders agreement includes customary provisions on pledge of shares as collateral for the loan, good and bad leaver scenarios and transfer restrictions on the shares.
As set out above, the structure is usually limited to a period of three to five years after which the holding company is either merged into the employer company or dissolved or the structure is terminated by other appropriate means. The idea behind the structure is to enable the holding company to receive tax-exempt dividends (or at a lower effective corporate income tax rate) from the employer company and for the management to take advantage of capital income taxation (as opposed to progressive salary taxation) upon distributions from the holding company or when the structure is terminated and profits are realized.
The Finnish Supreme Administrative Court has, however, on 2 May 2014 ruled that holding company based management incentive schemes – similar to the one described above – fulfill the criteria of tax avoidance. The Supreme Administrative Court considered that the purpose of use of the holding company was merely to facilitate the conversion of managements’ employment related earnings or profits into more lightly-taxed capital income. Therefore, any earnings or profits arising out of the structure should primarily be taxed as managements’ salary at progressive tax rates similarly to traditional stock options and other incentive schemes based on employment. In its ruling, the Supreme Administrative Court paid particular attention to the involvement of the employer company in the set-up and in the management and administration of the structure. The ruling of the Supreme Administrative Court is obviously likely to set the current holding company based management incentive schemes under review by the tax authorities.
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