CC BY
9The taxation of earned income and capital income in Finland*
Reijo Knuutinen
Doctor in Law, Master of Science (econom ics). The writer's dissertation in September 2009 was Form and substance in tax law — With special emphasis on financial instruments
In Finland there is a dual income tax system according to which an individual taxpayer has two categories of income, namely earned income or capital income. Earned income is taxed at progressive rates whilst in capital income there is only one nominal tax rate. However, it is not always simple to keep those two categories separate. On the other hand, one nominal tax rate in income taxation is not the whole truth: real effective tax rates vary a lot, one reason for which is inflation.
Keywords: income tax, earned income, capital income, inflation, "form and substance"
1. Introduction
Taxation can be based on different kinds of phenomenon or criteria. In many countries, the main tax bases are income and consumption. In addition to those two, taxation can be based for instance on wealth1, different kind of transactions, effects on nature, and so on. In this article, the focus is on income taxation of individual taxpayers in Finland.
In the so called Nordic model2 the income of individual taxpayers is divided into two main categories: earned income and capital income. The salaries and wages are earned income; also, different kinds of fringe benefits are classified as earned income. However, dividends, interest and rent are examples of capital income. In addition, capital gains (when realized by selling for instance of shares or real estate), are capital income. The main idea in the Nordic model is that taxation of earned income is progressive while capital income is taxed at a flat rate.
2. Finnish dual income tax system for individuals Since 1993, Finland has applied a dual income tax system according to which individual taxpayers can have two categories of income, namely earned income or capital income.3 Furthermore, both types of income can consist
* Статья публикуется в авторской редакции.
1 In Finland the wealth tax was abolished in 2005 (1141/2005).
2 Prior to the reform in Finland in 1993, the other Nordic countries (Denmark, Norway and Sweden) had previously adopted the dual income tax system. It was consequently considered that in Finland it was needed an internationally competitive model for taxation of individuals.
3 Earlier, prior to the reform in 1993, Finland had applied a global income tax, according to which the taxpayers were taxed at a single progressive tax schedule for their global income. The same nominal tax rate was applied regardless of the source of income. At that time, it was seen a risk that the global income tax would lead to flow of capital from Finland. The objective of the reform was to create a more effective, non-regulating,
I Ш
I ^
I CO
I <
I Cl
I d I >
УДК 336 X
x
of three different sources: personal income, business s income and agricultural income. Business income and ^ agriculture income is divided into capital income and 2 earned income, based on the certain rules in tax sta- ® tutes.4 Instead, personal income is either capital income ^ or earned income in its entirety — depending on the ^ type of income. Business income consists of income g from professions or income from business. Agricultural cl income consists only of income arising from agriculture; ш however, income from forestry is considered as personal 3 income. Personal income is then every form of income -a that is not categorized as income from business or ag- < riculture. That is, for instance pensions, interest, wages н and capital gains which are personal income. <
Typical forms of capital income, also known as investment income, are dividends received from stock exchange listed companies, interest, rental income, or capital gains from selling assets. That is, the capital income is one way or the other a return on capital. Capital income is taxed at a flat nominal rate, which is now 28 per cent.5
Earned income could be defined as every other form of income that does not qualify within the criteria of capital income. In practice, earned income usually consists of wages, salaries and pensions. Earned income is subject to a progressive state income tax and a proportional municipal income tax. Taking both state and municipal income tax into account, the highest marginal tax rate can be over 50 per cent of income.
The distinction of two categories of income and three sources of income is also applied to deductions and losses. Therefore, losses of the category earned income are only deductible from the same category of income. On the other hand, the capital losses are deductible only from the capital gains, either for the same year or during the following three years.
3. Taxation of earned income
Earned income consists mainly of salaries, wages, pensions, certain fringe benefits and similar remuneration for work.6 Income from business or income from agriculture is partly earned income. However, social benefits like maternity, child and unemployment benefits are exempt from tax.7 In addition, scholarships are tax free up to 18 400,65 euros (year 2009); the exceeding amount is
neutral and competitive tax system built on a broader tax base.
Since this reform, a broad tax base has been the foundation of
the Finnish tax system.
4 Agricultural and business income is apportioned into earned income and capital income according to the same principles. An amount equal to 20 per cent of the net capital used in the business or agriculture at the end of the previous tax year is taxed as capital income (Income Tax Act 1535/1992, ITA 38 §). The remaining 80 per cent is earned income. Due to the progressive taxation of earned income it can be in some cases more beneficial for low-income earners to receive earned income instead of capital income. In such case the taxpayer has an option to demand that only 10 per cent of the net capital shall be considered capital income.
5 The capital income tax has in 2005 decreased from 29 to 28 per cent (716/2004).
6 ITA 61 §.
7 ITA 92 §.
earned income.1 Pensions are usually considered earned income, no matter whether it is a mandatory or a voluntary pension, or whether the pension fees have been paid by the taxpayer himself or by his employer. In addition, options based on employment are always earned income2, despite the fact that these are financial instruments and the value is dependent on the market value of the share of the company.
Wages, salaries and all other forms of earned income are subject to state income tax, municipal income tax, church tax and some social security contributions. The state income tax is levied at a progressive rate. Instead, municipal income tax and church tax are levied at proportional rates. The state income tax rate schedule is annually issued by Parliament. The following rates apply as of 1 January 20103:
< >
Taxable income, EUR Tax on lower amount, EUR Rate on excess, %
15 200-22 600 8 6,5
22 600-36 800 489 17,5
36 800-66 400 2 974 21,5
> 66 400 9 338 30,0
Each municipality levies upon its residents a proportional municipal tax. The municipal income tax is annually set by the municipal council based on the municipal budget. In 2010, the tax rate ranges from 16,25 to 21 per cent, depending on the municipality.4 In addition, members of either the Evangelical Lutheran Church or the Orthodox Church have to pay church tax. This is levied on the income as assessed for the municipal income tax. The church tax is imposed at flat rate varying between 1 and 2 per cent and depending on the municipality.5 Furthermore, individuals covered by the national health insurance pay a health insurance contribution to the Social Insurance Institution. Finally, also the unemployment insurance contribution and the employment pension contribution are deducted from the salary.
Altogether, in many case the marginal tax rate is about 55 per cent for high-income level persons (taxable income over 66 400 euros). The marginal tax rate is dependent on which municipality the taxpayer lives in and if he/she is a member of the church. There are also many kinds of deductions for calculating the taxable income of the taxpayer.6
4. Taxation of capital income
Capital income is income from capital; economically it is a return on capital. In capital income taxation there is a flat rate of 28 per cent. However, every kind of return on capital is not taxable capital income.
The present dividend taxation model distinguishes for tax purposes between dividends distributed by stock exchange listed companies and dividends distributed by non-listed companies. In respect of individuals, 70 per cent of dividends distributed by listed companies are taxed as capital income of the shareholder. The remaining
1 ITA 82 §.
2 ITA 66.3 §.
3 1250/2009.
4 989/2009.
5 989/2009.
6 There are different kinds of deductions: deductions for
expenses incurred in acquiring or maintaining the income (so
called "natural deductions"), deductions allowed in both national
and municipal income taxation, or deductions which may only
be claimed in state income taxation or only in municipal income
taxation. Furthermore there are certain deductions claimed di-
rectly on the payable tax.
30 per cent is tax exempt.7 The tax burden of taxpayers receiving dividends distributed by listed companies is hence 19.6 per cent. However, since the corporate income tax is 26 per cent, the total tax burden of dividends distributed by listed companies to individuals will be about 40.5 per cent.
Taxation regarding the dividends distributed by non-listed companies is more complicated. Dividends distributed by non-listed companies are tax exempt to the extent that the dividend represents an annual yield of no more than 9 per cent of the mathematical value, i. e. the net asset value (somewhat adjusted book value), of the shares owned by the taxpayer.8 Dividends are tax exempt up to 90 000 euros per shareholder per year, if that 9 per cent limit is not exceeded. (So in this case the economic income of 90 000 euros is only subject to the corporate income tax rate of 26 per cent.) However, 70 per cent of dividends exceeding a yield of 9 per cent of the net asset value are taxed as earned income, while the remaining 30 per cent are tax exempt. On the other hand, 70 per cent of dividends exceeding 90 000 euros is taxed as capital income, provide that the dividend represents a yield of less that 9 per cent of the net asset value. In that case the remaining 30 per cent is tax exempt.9
Interest and rental income are considered capital income. Interest on deposits, bonds and debentures is subject to a withholding tax of 28 per cent. Other forms of interest are considered and taxed as normal capital income.
Capital gains, which also are included in capital income, are calculated by subtracting the acquisition price as well as transaction costs from the sales price. If the original acquisition price is unknown or if the taxpayer otherwise so elects, a minimum deduction of 20 per cent of the sales price is to be applied. Furthermore, if the asset sold has been owned for at least ten years, the minimum deduction is 40 per cent.10 Instead, capital gain from the disposal of home is tax exempt, if the taxpayer, during his period of ownership, has used the dwelling as his permanent residence continuously for at least 2 years. There are also some other types of capital gains which are tax exempt.11
For the sake of neutral and fair treatment, capital losses are deductible. However, there are some important limitations. Capital losses are deductible only from capital gains — that is, not from other type of capital income. The losses are deductible only at the same year or during three following calendar years.12 In addition, some other deductions are made from capital income generally as well.13
7 ITA 33 a §.
8 Basically, the mathematical value of a share is the net asset val ue of the company divided with the total number of shares. The net asset value is calculated by subtracting debts from the company's assets in the balance sheet. This is calculated on basis of the book value in the year previous to the year in which the dividend is distributed.
9 ITA 33 b §.
10 ITA 46 §.
11 ITA 48 §. For instance, capital gains from the disposal of household effects are tax exempt if the annual gain does not exceed 5 000 euros. Also, capital gains on assets like shares are tax exempt if the aggregated proceeds during the tax year do not exceed 1000 euros.
12 Instead, losses from business or agriculture are generally set off against the income from the same source during the following 10 years.
13 For instance, taxpayers are entitled to deduct all expenses incurred in acquiring and maintaining capital income (ITA 54 §). Interest expenses are also generally deducted from capital income (ITA 58 §).
Income from capital is taxed at a proportional state income tax rate of 28 per cent. The municipal tax is not levied upon income from capital. Consequently, taxation of capital income is often more beneficial than taxation of earned income — at least with nominal terms.
5. Problems with the distinction between earned and capital income
Since the marginal tax rate of earned income can reach about 55 per cent, it is obvious that high-income taxpayers prefer receiving capital income, which is taxed at a modest nominal rate of 28 per cent. Instead, for low-income taxpayers it can, on the contrary, be even more beneficial to receive earned income than capital income.
Due to the current tax system, which is built on a broad tax base, transforming earned income into capital income (or tax exempt income) is possible only under certain circumstances. The best transformation possibilities are probably available to the taxpayers who run and own a non-listed company. The problems arises, when the same person is both in the role of a worker and in the role of the owner. In this kind of situation it may be hard to say — in substance — which part of the compensation is a wage and which is return on capital. The formal labels of the receipts do not always reflect the economic reality. Business owners often try to minimize their tax burden by limiting wage payments. Instead, they can receive compensation for entrepreneurship for example through dividend payments.1
6. Is earned income and nominal capital income comparable?
The other problem is the different nature that capital income has compared to earned income. A monthly paid salary tells us immediately its present real value. (If there are delays for example of a few weeks between working and getting the salary it is not taken into consideration.) However, capital income always accrues during some period of time — and during that period the value of the money normally changes because of inflation.2 As a matter of fact, capital income is usually poorly measured because of inflation. Both from an economic and tax theoretical standpoint it should be clear, that the inflation is not (real) income, and so it should not be taxed. Only income that increases real wealth and consumer opportunities should be taxed. Nevertheless, in tax systems inflation is seldom taken into account directly.
Furthermore, the effect of inflation on different kinds of income types varies. So the effective tax rates vary with different kinds of income types or instruments as well. Let us take an example: A person has a money deposited for one year with an interest of 3,0 per cent. If the inflation would be 2,0 per cent at the same time, the real return of the deposit is 1,0 per cent. However, the tax of 28 per cent is not based on the real but on the nominal interest. The tax is: 0.28 • 3,0 = 0.84, which compared to real return of 1,0 tells us that effective tax rate is 84 per cent.3
1 The tax free amount of dividends can be maximized to 90 000 euros per shareholder. The total tax burden will hence consist of the corporate income tax of 26 per cent, which is paid by the corporation.
2 In Finland the inflation rate is now about 1 per cent which is low from a historical perspective. The inflation has been low in many other EU countries as well. It remains to be seen, what kind of effect the present financial and public debt crisis (2008-) will have in inflation rates in the longer run.
3 In some countries the inflation is often partly observed in determining the tax rate of capital gains. In practise this usually means equity instruments. Yet adjustment for inflation is basi-
Some forms of capital income — like interest payments, ^ dividends or rent — are taxed at the same time or with
only limited delay compared to their economic accrual. ^
Instead of that, some forms of capital income — espe- <
cially capital gains — is taxed only when it is realised, m
which means selling the asset or the instrument. So ^
there can be a long deferral in taxation compared to the x
economic accrual of the income. In fact, the increase ^
in value is economic income; but in taxation only the s
o
realised income is normally taken into account. Also this m
fact has an effect on the effective tax rates of different 2 kinds of income types or instruments.
Despite the fact, that we have one nominal flat tax ^
rate in capital income taxation, the real effective tax ^
rates vary a lot with different kinds of income forms, g
instruments and situations. From this point of view it cl
makes the comparison of taxation of earned and capital UJ
income difficult. 3
7. General problems of "form and substance" ^
in tax law ^
In international tax literature the phrase 'form and sub- < stance' is often used in the context of tax avoidance. There the question often arises of whether the legal form of the transaction or the economic substance of the transaction is relevant in determining the tax treatment. However, the relationship of form and substance can be understood in a much broader way. The writer argues that there is a tension between form and substance throughout the entire system of income taxation. The main justification for this view is that taxable income is understood, defined and measured in a way that deviates from the economic concept of income. In fact, most or even all the issues of form and substance have some background at the law-making level.
Secondly, the relationship of form and substance can be observed at the level of interpretation. Basically, there cannot be any tension between the form of the rule and the content of that same rule. The content needs the form in order to exist, while form without content would be an empty shell. However, there can be tension in the interpretation of the rule. Law is connected to language. Tax statutes are in written form, and language is not as exact as mathematical numbers. The same content can often be expressed in different ways, and different contents can usually be expressed in a similar fashion. Interpretation is needed to give the words meaning.
Sometimes the tension between form and substance can be observed in the actions of a given taxpayer. He or she can choose a certain form of transaction partly or mainly to gain a tax benefit. We may describe this kind of transaction a formal one to some extent. Furthermore, a person can make a transaction without having any real business reason at all. Such a transaction can be described as overly formal or formalistic. Tax avoidance is typically based on formalistic transactions.
Obviously, there are many relationships of form versus substance, and only some of them have been earlier mentioned within this paper. However, I argue that the most relevant form and substance relationships can be placed on a law-making level. The natural starting point in income taxation is the idea that taxable income reflects a person's economic income. Yet deviations from that principle are made for different reasons. First, people have different
cally as important as employing debt instruments. In fact, it is even more important, because the realization requirement and tax deferral do not affect debt instruments the way they affect equity instruments.
^ philosophical ideas about what is or should be classified
1 as income. Furthermore, deviations and distinctions are ^ usually made for policy or political reasons, either for tax < policy or for other political purposes. Tax planning and d tax avoidance are themselves based on the deviations ^ between economic and taxable income.
x The writer argues that there is a tension between form
^ and substance throughout the entire system of income
s taxation. The main justification for this view is that tax-
□z able income is understood, defined and measured in a
2 way that deviates from the economic concept of income. ® This article suggests that two important exceptions are 2 made because of the realization requirement in defining ^ and measuring income, and the inattention to inflation g in the tax base. The deviations and problems are clearly cl more obvious in defining and measuring of capital income m compared to earned income.
2 The tensions become stronger with the use of new
~o financial instruments, like derivative financial instruments.
Р. Кнуутинен
доктор юриспруденции, магистр экономики университета Лауреа (Финляндия)
В статье представлена действующая в Финляндии система налогообложения дохода физических лиц, а также подход к идентификации различных видов дохода.
Ключевые слова: налог на доход, заработанный доход, доход с капитала, инфляция, форма и содержание
Современные налоговые системы предусматривают различные объекты налогообложения. Во многих странах основную роль в пополнении доходной части государственного бюджета играют налоги на доход и на потребление. Помимо этого, широко распространены налоги, взимаемые в связи со сделками и операциями различного характера, а также экологические налоги. В данной статье мы рассмотрим основные принципы налогообложения дохода физических лиц в Финляндии.
С 1993 г. Финляндия в рамках так называемой Северной модели налогообложения применяет систему, в соответствии с которой налогом облагаются
* Статья публикуется в переводе с английского языка в редакторском исполнении.
The derivative instruments do not fit neatly into the traditional cubbyholes of tax systems. The derivatives do not generate traditional or easily observed income such as dividends or interest. Instead, income from the derivatives comes from price changes according to the underlying instrument. However, observing the price or value change of one derivative does not tell us anything about the total effect on the taxpayer's financial position.
Equity in taxation should be measured in economic terms: according to the principle of horizontal equity, every euro, dollar or rubble should be taxed equally, independent of the source, only once and in real terms. But the restrictions and requirements of efficiency must also be taken into account in tax policy decisions. The law and its formalities are needed to give certainty to that process. But legal forms have no absolute value; they have no such specific aim. Rather, the legal forms should be seen as a way to implement equity and efficiency in taxation.
две категории доходов: заработанный доход и доход с капитала. К первому относят заработную плату и различные выплаты работодателя в пользу работника. Примерами дохода с капитала являются дивиденды, проценты и арендная плата, а также положительная разница между ценой покупки и продажи акций или недвижимости. В рамках Северной модели налогообложение заработанного дохода осуществляется по прогрессивной шкале, а налогообложение доходов с капитала — по фиксированной ставке.
Налогообложения дохода физических лиц
Два вида дохода могут поступать из трех различных источников. Имеются в виду доходы от ведения бизнеса, от ведения сельского хозяйства и личные доходы. К первому источнику относят доходы от профессиональной деятельности юристов и врачей, имеющих частную практику, и иные подобные виды доходов. Следующий источник включает доходы от ведения сельского хозяйства. Под личными доходами подразумеваются доходы в любой форме, которые не вошли в категории дохода от ведения бизнеса или сельского хозяйства. В частности, это могут быть доходы от лесоводства, пенсия, проценты, заработная плата и доход от прироста капитала.
Типичные формы дохода с капитала, называемого также инвестиционным доходом, — это дивиденды, полученные от компаний, акции которых котируются на фондовой бирже, проценты, арендный доход и доход от прироста капитала при продаже активов. Иными словами, под доходом с капитала понимается прирост капитала, полученный тем или иным способом. Доход с капитала облагается налогом по фиксированной ставке, которая в настоящее время составляет 28%.
Подоходное налогообложение в Финляндии*
УДК 336
