The personnel fund system has started to be used for large-scale tax avoidance. It is short-sighted and stupid, writes HS financial editor Anni Lassila.
The taxman came to the pages on March 26 new tax guidelines, which dealt with the taxation of personnel funds. The instruction, which appeared as a surprise, has caused great confusion in the industry, as it would seem to radically change the decades-old taxation practice of personnel fund shares in certain cases.
The details are complex and controversial – we’ll get to that a bit later. Even the experts seem to have been unclear as to what the taxman meant by his instructions. HS figured it out, but more on that a little later.
Tens of thousands with the help of the system, ordinary employees have received a small tax incentive to invest and save for a bad day or old age.
The most important thing in the whole mess is to ask why the taxman is suddenly interested in a decades-old system.
The answer is greed.
Some personnel fund service providers and companies that use the services discovered a few years ago that it is possible to use the personnel fund more widely to avoid taxes.
Funds have been established, for example, in medical companies and law firms, where the entrepreneurial partners have been able to channel a large part of their income into the funds tax-free.
Before, it was customary to convert the earned income of employee shareholders into lightly taxed labor investment dividends. When the legislature blocked the way, it was found that the personnel fund could be used for the same purpose.
Broadly interpreting the law, it is possible, but of course not the purpose of the personnel fund system.
When well-intentioned systems start to be used for large-scale tax avoidance of high-income earners, the existence of the entire system is endangered.
Such greed is therefore short-sighted and foolish.
Personnel fund is a method invented 35 years ago to encourage ordinary employees to invest long-term. The company paid the employees a small part of the profit, which was transferred to a fund managed by the personnel themselves. The fund usually invested the funds in the company’s stock.
In this way, people’s capitalism and the employees’ interest in the value development of the company were promoted. At that time, investing was not as popular as it is today. The state wanted to give long-term investment a small tax carrot.
The profit share could be put into the fund tax-free. In this way, the share of the tax was also able to increase the return if the value of the company’s stock increased.
Tax is only paid when funds are withdrawn from the fund. Withdrawals are limited, which means investing is inevitably long-term.
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When well-intentioned systems start to be exploited, the existence of the entire system is endangered.
Personnel Fund Act has since been changed many times. Today, performance bonuses, bonuses or personal items can be invested in the fund, and the fund can choose investment targets freely.
In the standard reward systems of ordinary companies, the maximum amount of the performance reward is often about one month’s salary.
But in some companies, even almost all earnings may now be defined as a fundable performance bonus.
Personnel funds is already in almost 400 companies. They already include more than 150,000 employees.
The tax incentive is an essential reason for the funds’ popularity. It is a big advantage that you can also invest the portion of the tax. The taxman gets his money back when the funds are withdrawn.
That’s why the taxman’s new tax instructions were startled. Experts in the personnel fund industry have been debating and wondering behind the scenes about the policy for a few weeks now.
It’s about however, is at least partly due to a misunderstanding. According to the taxman, this is not a new interpretation, but the purpose was only to remind that the funds operate according to the law.
However, communication about this was lame once again.
Now comes a slightly complicated matter.
There are two types of systems in personnel funds, some even mixed up in the same fund.
The assumption of the system in some old funds is that the members’ entire performance bonus is financed. However, the employee can decide to take part or all of the bonus in cash even after the bonus determination period.
Taxes and side costs of the salary are paid for the portion taken in cash as normal.
In the largest however, in some funds, the default is, on the contrary, that the fee is paid in cash. The employee decides for himself whether he wants to fund it.
Regarding the taxman’s new instructions from example number three gets the idea that in such a case the reward should be always collect income tax even before financing. This has not been done so far. So tax lawyers and personnel fund experts were confused about the topic.
The example was interpreted to mean that the default value of all funds should practically be changed to fund the rewards. That would be quite a stretch. According to experts, such an interpretation of the Personnel Fund Act cannot be applied.
Help prepared by a leading tax expert Tero Määtt now explain to HS that it is a misunderstanding. If the system assumes that the reward is paid in cash, the funded reward will only be taxed if the employee decides to fund it after the premium determination period.
If the employee makes a decision before the premium determination period has endedthere is still no tax on the part to be funded.
“That’s what it says in the Personnel Fund Act, and there’s nothing new here,” Määttä says.
Alan the misunderstanding is very understandable, because this essential condition was not noticed to be written in the example of the taxman’s instructions.
Määtta is surprised by the uproar, because he thinks it should be self-evident. He says that the example will be specified in this regard.
So no worries for those funds where the decision to fund the premiums is always made before the premium determination period ends.
If for some reason it would have been done differently, it will be solved by changing the schedule.
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The misunderstanding in the field is very understandable: an essential condition was not noticed to be written in the example of the taxman’s instructions.
Actual the reason for raising the issue is presumably abuse of the system. It can be seen from example number four of the taxman’s instructions.
It refers to a situation where the employee-owner of the company can decide for himself how much of his own earnings he defines as performance bonus at any given time and puts into the fund.
In such a case, tax must always be paid on the part that goes to the fund, according to the taxman. Of course, that makes funding unprofitable.
“The situation according to the example is not an arrangement according to the Personnel Fund Act. Some of these have now come to light,” Määttä says.
Eventually it would seem to be a perfectly reasonable line drawing. However, when it comes to tax laws and their interpretation, common sense does not necessarily have a place.
Once a loophole is discovered, it is defended to the last. There may be years of wrangling over the application of laws. The courts’ time will not be spared.
The questionable exploitation of the system is still not limited to companies operating perhaps against the law.
Even in some of the companies that operate completely according to the letter of the Personnel Fund Act, the systems are very generous.
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Once a loophole is discovered, it is defended to the last.
Let’s start to be on the verge of difficult questions, if you can get income equal to several months’ salary as a performance bonus and all of this can be invested tax-free in a fund.
The purpose of the personnel fund was to encourage ordinary employees to invest with a reasonable tax advantage. It is not intended to minimize the taxes of chartered doctors, fund managers, consultants, top executives or lawyers.
That’s why greed is now threatening the whole system.
If if I were the minister responsible for state tax revenues, I could say that the whole thing is over. It’s no trick to change the law or repeal it entirely.
There would be a simple solution: Let’s enact a reasonable maximum amount in euros that can be put into the fund. Let it be, for example, 4,000 or even 8,000 euros per year, regardless of what the reward system of each company can produce at most.
That would stop tax lawyers arguing, and the system could return to its original purpose.
The author is HS’s financial reporter and chairman of the board of Finland’s oldest operating fund, Sanoma’s personnel fund.
