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30 May 2014
The taxation of a bankruptcy estate may affect the liquidation results and expenses arising from the bankruptcy proceedings (the administrative expenses). Taking tax planning into account may significantly increase a creditor's disbursements in bankruptcy.
The Bankruptcy Act (120/2004) includes no special provisions regarding taxation. The relevant provisions in respect of bankruptcy estate taxation are set out in tax legislation – including the Income Tax Act (1535/1992), the Business Income Tax Act (360/1968), the Act on Taxation Procedure (1558/1995) and the Value Added Tax Act (1501/1993). However, these acts include definitions which are open to various interpretations relative to bankruptcy law. Moreover, the number of bankruptcy-related administrative court decisions and advance rulings of tax authorities are limited.
Tax issues differ depending on whether a bankruptcy estate continues the debtor's previous business. Pursuant to the Income Tax Act, a bankruptcy estate is not a separate legal entity. However, the bankruptcy estate may be liable to pay income tax from the income accrued from a business that the bankruptcy estate is independently conducting.
According to the Value Added Tax Act, a bankruptcy estate is liable to pay value added tax (VAT) for the business which it continues independently following the commencement of bankruptcy proceedings. Therefore, a bankruptcy estate may also be liable to pay VAT on the sales of assets or services.
According to the Income Tax Act, a bankruptcy estate is not a separate legal entity which is obliged to pay income tax as a taxpayer. Neither does the opening of bankruptcy proceedings cause any changes to the debtor's fiscal position. The bankruptcy estate operates on behalf of the debtor and has control over the debtor's assets. The bankruptcy proceeding itself does not change the ownership of the assets, which belong to the bankruptcy estate. Thus, the bankruptcy estate is not obliged to pay income tax, for example, on income from rent and stock dividends owned by a debtor or on capital gains accrued as a result of liquidation. Bankruptcy itself does not change the debtor's position from a tax law viewpoint. Consequently, the bankruptcy estate may also offset the debtor's previous verified losses over a 10-year period.
The estate administrator drafts and files both the bankruptcy estate's and the debtor's tax return notifications to the tax authorities. The notifications must be filed no later than four months from the end of the debtor's accounting period.
A bankruptcy estate which does not continue the debtor's business has a limited obligation to keep accounting records required by the estate. Accounting records must contain sufficient information concerning:
Provided that a bankruptcy estate continues the debtor's business, accounting obligations will continue as they were before the bankruptcy (ie, the accounting must be organised in compliance with the Accounting Act (1336/1997)).
Pursuant to the Bankruptcy Act, the debtor's outstanding taxes are not automatically taken into account as claims in bankruptcy proceedings. Neither do such claims have a better ranking than other receivables. In order to be entitled to a disbursement, the tax authorities must lodge a claim in a same way as other creditors.
Notwithstanding this, in a situation where a bankruptcy estate independently conducts the debtor's business, it is liable to pay income tax for the net business income. Applying this rule may cause difficulties in practice, as the business income source of a bankruptcy estate must be adequately defined. Taxable income and deductible expenses incurred in acquiring or maintaining income are determined in accordance with income tax legislation. Earned income is not directly comparable to the accounting records of the bankruptcy estate.
Immediately after the commencement of bankruptcy proceedings (and when the current financial status and estimated future fund flows have been properly investigated), the bankruptcy administration may decide to continue the debtor's business. Whether the activities of a bankruptcy estate can be deemed as continuing the business will be determined according to the individual circumstances. It is generally considered that a bankruptcy estate does not continue the business, for example, if it merely:
For this purpose, the bankruptcy estate may also:
Contrary to this, a bankruptcy estate is likely to conduct business independently where its operation consists of:
The decision to continue the business rests with the creditors, although the background work requires cooperation with the estate administrator and the debtor's representative. Particularly for extensive bankruptcy estates, the estate administrator should negotiate without delay with the majority creditors in terms of the bankruptcy estate's alternative course of action regarding tax and, where it is necessary, on any potentially related financial liabilities.
In situations where uncertainty prevails over the application of tax legislation, it is recommended that the bankruptcy estate request an advance ruling. The advance ruling is a preliminary statement issued by a regional tax office on the decision it intends to make concerning tax under the relevant conditions and circumstances.
For example, for VAT, an advance ruling may be given on a written application in terms of the taxation of possible business transactions, provided that the matter is considered to be important to the applicant. The advance ruling application must contain a specified description of the question for which the advance ruling is applied. The ruling of a regional tax office is a binding resolution relative to the tax authorities. The ruling will remain in force for a fixed term only, and for no longer than until the end of the year in which the ruling was given.
A debtor's obligation to pay VAT ends on bankruptcy. A bankruptcy estate is not liable to pay VAT regarding the liquidation of assets, provided that it does not continue the debtor's previous business. Therefore, the liquidation deeds (eg, a memorandum of understanding or a sale and purchase agreement) may not include any clauses according to which VAT would be included in the purchase price.
On the other hand, a bankruptcy estate is liable to pay VAT should it decide to continue the debtor's previous business and it is expected that the future annual turnover will be more than €8,500. The figure includes, among other things, the total amount of taxable sales and supplies of immovable property or related transfers of rights.
When a bankruptcy estate conducts a business for which VAT is payable, the estate administrator must request VAT registration. The registration application must include a description of the conducted business. A copy of the minutes of a creditors' meeting – including a decision according to which the bankruptcy estate is continuing the debtor's previous business – should also be enclosed with the application.
When registration has been carried out, a bankruptcy estate's obligation to pay VAT, as well as its right to deduct the payable tax, is determined under the VAT Act (as for other entrepreneurs operating businesses in Finland). Outstanding VAT is classed as an expense arising from the bankruptcy proceedings. Thus, a bankruptcy estate is liable for making payments to the tax authorities when each taxable period is considered to be concluded. The alternative reporting periods are monthly, quarterly and yearly.
For further information on this topic please contact Matias Leskinen at Hammarström Puhakka Partners, Attorneys Ltd by telephone (+358 9 474 21), fax (+358 9 474 2222) or email (firstname.lastname@example.org). The Hammarström Puhakka Partners, Attorneys Ltd website can be accessed at www.hpplaw.fi.
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