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Finnish Securities Market Act 2002

There is no specific legislation for Finnish venture capital funds and their management companies. Yet a recent amendment to the Finnish Securities Market Act of 2002 means that such management companies should take note of some of its provisions. Jari Vikio and Paulus Hiden of Borenius & Kemppinen discuss the impact of the amendment on Finland's venture capital community.

In Finland there is no specific legislation on venture capital funds or their management companies. Generally speaking management companies or venture capital funds are not considered to be investment firms or other entities subject to the supervision of the Finnish Financial Supervision Authority. However, after an amendment to the Finnish Securities Markets Act in 2002, any management company offering an investment in one of its funds should take into consideration the provisions of the Act.

Due to fiscal reasons (tax transparency) and contractual flexibility most Finnish venture capital funds have been structured as limited partnerships (kommandiittiyhtiö). There are also examples of structures with several parallel funds and some structures with feeder funds. The Finnish Act on Limited Partnerships allows considerable freedom in drafting documentation for a limited partnership. The fund structures are familiar to any participant in the market and in most cases are quite simple: investors participate as limited partners with a limited liability and the management company takes the position of the general partner (usually the only general partner) in the fund. The most common agreements are a partnership agreement in Finnish and a separate more detailed agreement between the parties, often titled a shareholders' agreement, an agreement among partners or a management agreement. The reason for this is that the partnership agreements need to be registered with the public trade register, and the most of the contractual arrangements are usually kept confidential - and are nowadays often drafted in English. Purely domestic structures with separate management companies or advisory companies are not common.

Terms of fund agreements

In substance the terms of a Finnish venture capital fund are quite similar to those of most foreign funds, although often the fund agreements are not drafted in as much detail. In any case, nowadays the fund documentation tends to be more extensive than it used to be.

The drawdown and profit distribution mechanisms are similar to most European funds. However, the profit distribution formula does not often contain a catch-up clause and may instead contain a provision according to which, after reaching a certain threshold, the carried interest payable to the management company increases for example from 20 per cent to 25 per cent.

Finnish fund agreements usually contain all customary clauses such as key-man clauses and so on. Nowadays also Finnish fund agreements tend to include provisions on such issues as distributions in specie, parallel funds, re-investments, borrowings and the like, all more or less as a result of the influence of foreign fund documentation. Some management companies have also agreed to non-default termination clauses, which had not been common in the past. One matter that distinguishes Finnish funds from others is that several Finnish funds have an investment committee consisting of representatives of the investors that may have an influence (an actual decision-making right or a veto right) on the making of investments or divestments. In comparison to an advisory board typical in foreign funds, the role of such a committee is clearly more significant.

Tax issues

Until recently, the tax status of foreign investors in Finnish limited partnerships has been unclear. Some Finnish management teams, hoping to attract foreign investors, have been compelled to set up vehicles in tax havens. Structures such as these force a management company to assess its corporate governance issues more carefully than before: in order to avoid causing tax problems to foreign investors of a fund, fund managers need to consider the way advisory agreements and decision-making issues are structured. Structures crossing borders have also made fund managers increasingly aware of regulatory requirements relating to client identification and the prevention of money laundering.

A Finnish partnership is considered to be transparent for tax purposes and only an accounting unit. Taxable profit is taxed as income of the partners. The tax status of foreign investors participating in a Finnish fund as limited partners has been unclear until a recent decision by the Supreme Administrative Court. The court case addresses the question whether Finland can tax non-resident foreign investors since the fund itself is transparent and therefore, not subject to taxation in Finland. In general, the issue is fairly complex.

A foreign person or entity that has not been resident in Finland during the tax year is liable to tax in Finland only for Finnish source income (a non-resident; limited tax liability). But, tax treaties may limit the application of domestic tax law to persons subject to limited tax liability. According to OECD Model Tax Convention article 7, the profits of an enterprise of a contracting state shall be taxable only in that state unless the enterprise carries on business in another contracting state through a permanent establishment situated in the other state. So, according to the model convention, if a foreign investor carries on business in Finland, the profits received by the investor shall be taxed in Finland but only to the extent that they are attributable to a permanent establishment in Finland.

The question is whether the investment of a foreign person or entity to a Finnish limited partnership constitutes a permanent establishment in Finland for the investor. If a permanent establishment is at hand, then the foreign investor is liable to tax in Finland. This may cause double taxation if double taxation is not entirely eliminated in the investor's state.

In 2002 the Finnish Supreme Administrative Court stated that an investment fund is considered to carry on a business in Finland and therefore the partners of the limited partnership also carry on a business in Finland. According to the ruling, an investment in a Finnish venture capital fund and acting as its a limited partner in such a fund (meaning, a limited partnership) results in the foreign investor having a permanent set establishment in Finland. Therefore the investor is liable to tax in Finland for the Finnish source income. Foreign entities treated as corporate bodies in Finland are subject to 29 per cent corporate income tax.

In the future, foreign investors will be able to estimate their Finnish tax cost related to a Finnish fund investment. On the other hand, the Finnish tax treatment will also without question lead to the creation of new investment vehicles for foreign investors.

Finnish offering rules

Until recently the scope of the Finnish Securities Markets Act was relatively narrow. Since an amendment effective as of the beginning of year 2002, however, the act has been applied to a broader variety of securities. Although the act does not take partnership shares of a limited partnership into account, it is evident that the marketing provisions apply also to private equity funds structured as limited partnerships.

This amendment creates a few problems for fund-raisers. The first question is whether or not a prospectus needs to be drafted. In most cases the answer would be no, since a private equity fund is not usually marketed to the public (the common interpretation of the term being at least 100 people). In any case it would be relatively difficult to directly apply regulations on the contents of prospectuses to private equity funds, such regulations being based on EU directives and having been drafted with a view to existing limited companies. Another question is whether, in order for the Securities Markets Act to be applicable to securities at all, the securities should be freely tradable. When it comes to venture capital or private equity funds, this is rarely the case. Besides, since the partners of a Finnish limited partnership (unlike shareholders of a limited company) and the partnership agreement should always be registered with the Finnish trade register, the formal execution of a transfer is not simple and will always take time and cause expense. Nevertheless, bearing in mind that, in principle, the Finnish Consumer Protection Act is applied to marketing of securities, fund managers should pay attention to their marketing especially when the target group includes more than a limited number of professional institutional investors.

Copyright © 2003 IFLR

Jari Vikio is a partner and Paulus Hiden a lawyer at Borenius & Kemppinen in Finland.

Borenius & Kemppinen is one of the largest and most experienced law firms in Finland. The firm provides a full range of high quality legal advice and services in all fields of corporate and business law. For more information please visit www.borenius.fi

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