Partial double taxation for Norwegian investors when selling a partnership interest
Terje Bogaard of Deloitte Norway explains a ruling by the Norwegian Tax Appeal Board on the taxable gain when selling a partnership interest and the options to resolve the double taxation issue created.
On May 11 2022, the Norwegian Tax Appeal Board reached a decision (case SKNS1-2022-30) regarding the determination of the entry value upon the realisation of an interest in a limited partnership that also entails exit taxation of the underlying partnership assets. The taxpayer’s complaint was not accepted.
A Norwegian company sold an interest in a partnership to a foreign investor. The partnership held shares in a company resident in a low-tax jurisdiction.
The realised gain on the sale of the partnership interest was taxable income not covered by the Norwegian participation exemption method. In addition, the shares held by the partnership were subject to exit taxation because they were no longer under Norwegian tax jurisdiction.
The disputed subject of the case was whether the taxable gain on the partnership interest should be reduced by the exit tax gain as such or only the exit tax amount. The Tax Appeal Board decided on the latter, resulting in a partial double taxation.
The Tax Appeal Board decision
A realised gain on the sale of a partnership interest is, as a starting point, covered by the Norwegian participation exemption method. However, if the value of at least 10% of the share investments held by the partnership does not qualify for an exemption, the realised gain on the partnership interest is taxable. It is sufficient that the ownership limit has been exceeded once during the previous two years.
In this case, the realised gain on the partnership interest was taxable because the main investment was shares in the low-tax jurisdiction company. The parties agreed on this.
The transfer of a partnership interest from a Norwegian to a foreign investor that is not taxable in Norway is covered by the Norwegian exit tax rules. An unrealised gain on the underlying asset is taxed when taken out of Norwegian tax jurisdiction, but there is no exit taxation of assets that qualify under the participation exemption. The exit tax does not apply when a partnership interest is sold to another Norwegian investor.
In the aforementioned case, the unrealised gain on the low-tax jurisdiction shares was primarily taxed. The parties agreed that the terms for exit taxation were met. However, the taxpayer claimed that it resulted in an illegal double taxation that had to be neutralised.
According to the Norwegian Tax Act, an exit tax gain is included as taxable income from a partnership. Regardless, it was only accepted that the exit tax amount was added to the tax input value of the partnership interest. Given that the tax input value was increased only by the exit tax amount, and not by the exit tax gain on the underlying assets, double taxation was only partly neutralised.
The Tax Appeal Board concluded that the Norwegian ban on double taxation did not apply because the gain was levied and taxed on two separate objects:
The interest held in the partnership; and
The underlying partnership assets.
If a Norwegian investor sells an interest in a foreign partnership to a foreigner, it may, in certain instances, be taxed for the realised gain on the partnership interest and be subject to exit taxation on the underlying assets if neither qualifies under the participation exemption method. This does not apply if a Norwegian investor sells an interest to another Norwegian investor.
Furthermore, there should not be exit taxation upon the sale of an interest in a Norwegian-based partnership to a foreigner. The foreign investor is taxable in Norway on the partnership income. Given that the income derived from the underlying assets is included in income taxation in Norway, it is not considered to have been taken out of Norwegian tax jurisdiction. It is only the realised gain on the sale of the partnership interest that may be taxed. The same applies if a foreign investor sells a Norwegian partnership interest to another foreigner.
Hence, there may partly be double taxation on the sale of an interest in a foreign-based partnership to a foreign investor – but not on a sale to a foreign investor – in a Norwegian-based partnership.
Need for change?
Given that the exit tax rules only apply to sales to foreigners, the rule has an uncertain side with regard to the European Economic Area (EEA) agreement in cases where the buyer is resident in the EU/EEA. To avoid that non-qualifying share investments were held by partnerships that qualified under the participation exemption method, the 10% threshold was introduced to capture gains from non-qualifying financial instruments.
Since the purpose of both rule sets is to capture the value increase on certain underlying assets, the taxation rules should have been better coordinated to avoid that the same underlying asset (the non-qualifying shares) is, in effect, taxed twice, albeit on two different levels.
One option is to remove the exception in the participation exemption method and let the exit tax rules cover all transfers of partnership shares, regardless of whether the buyer is tax resident in Norway or abroad. This would also remove the possible EEA conflict.
Another option is to let the whole taxable exit gain increase the tax input value of the partnership shares, which is a solution similar to that for the taxed income of a Norwegian controlled foreign corporation.