The Tax Exemption Method is an important set of rules in Norwegian tax law that primarily exempts companies from tax liability on dividend income and capital gains on shares. This arrangement was introduced to prevent chain taxation within the corporate sector, but has several important exceptions and special rules. Here we review the central elements of the Tax Exemption Method, both in terms of which subjects and income are covered.
Fundamentals of the Tax Exemption Method
The Tax Exemption Method means that dividends and capital gains on shares within the corporate sector are exempt from tax liability, with certain exceptions. This prevents chain taxation where the same income is taxed multiple times in an ownership chain. As a natural consequence of the tax exemption, realized losses are also not tax deductible.
To correctly apply the Tax Exemption Method, two main questions must be answered:
Is the taxpayer covered by the Tax Exemption Method (subject side)?
Is the relevant income or loss covered (object side)?
Which Companies Are Covered by the Tax Exemption Method (Subject Side)
Norwegian Companies and Entities
The following Norwegian legal entities are generally covered by the Tax Exemption Method:
Limited liability companies and public limited companies
Savings banks and mutual insurance companies
Cooperative societies
Companies listed in the Tax Act § 2-2, first paragraph a to d
Securities funds
Associations and foundations
Bankruptcy and administration estates where the debtor is among the enumerated legal entities
A guideline is that distributions from exempt subjects should not be transferable to natural persons without tax liability arising for income beyond the shield deduction. Independent tax subjects that can own shares are typically covered, and the liability for the subject's obligations is usually limited to its capital.
Foreign Companies
The Tax Exemption Method also applies to foreign companies as shareholders. A "foreign" company in this context is a company that is not resident in Norway according to the Tax Act § 2-2, first paragraph, regardless of where the company is registered. This includes companies both within and outside the EEA.
To be covered by the Tax Exemption Method, the foreign company must "correspond to" a Norwegian subject. In the Supreme Court decision in Rt. 2012 p. 1380 (Statoil Holding), it was established that foreign companies should be assessed based on how the company form would have been treated for tax purposes in Norway, not how it is classified in the relevant other state.
Companies with Participant Assessment
Companies with participant assessment (formerly participant-taxed companies) are not separate tax subjects and are not listed as subjects under the Tax Exemption Method. Nevertheless, when determining the participants' income, income and losses under the Tax Exemption Method shall not be included in the income that is taxed continuously on the participant's hand (except for three percent of dividends).
What Income Is Covered by the Tax Exemption Method (Object Side)
Types of Income Covered
The Tax Exemption Method applies primarily to:
Legally distributed dividends from limited liability companies
Gains and losses on the sale of shares in limited liability companies
Distributions from savings banks, mutual insurance companies, cooperative societies, and securities funds
Gains and losses on the realization of shares in companies with participant assessment
Gains and losses on the realization of financial instruments where the underlying object is an ownership interest in a limited liability company
Withdrawals are equated with realization within the Tax Exemption Method, which means that if a limited liability company transfers a shareholding free of charge to a shareholder, the company shall not be taxed for gains on withdrawal.
Requirement for Legally Distributed Dividends
For the Tax Exemption Method to apply to dividends, the dividend must be "legally distributed." This refers primarily to the company law rules for dividend distribution, both material rules and procedural rules. Distributions in violation of the dividend rules of the Companies Act fall outside the Tax Exemption Method.
Important Exceptions to the Tax Exemption Method
Income from Companies in Low-Tax Countries Outside the EEA
Income and realization losses on shares in companies in low-tax countries outside the EEA are completely excluded as objects for the Tax Exemption Method. The criteria for which states are to be considered low-tax countries follow the NOKUS rules in the Tax Act.
Requirements for Companies in Low-Tax Countries Within the EEA
For income on ownership interests in companies resident in low-tax countries within the EEA to be covered by the Tax Exemption Method, it is required that the company is "genuinely established and conducts genuine economic activity in an EEA country."
The purpose of this requirement is to prevent adjustments and tax avoidance. When assessing whether a company is genuinely established, one must consider whether "the company, through its ordinary activities, participates in a fixed and permanent manner in the business community of the state of establishment."
Portfolio Shares in Companies Outside the EEA
The Tax Exemption Method does not apply to dividends from and gains/losses on the sale of shares in companies resident outside the EEA, where the taxpayer's share is less than ten percent (portfolio shares).
For dividends, the taxpayer must have owned "at least 10 percent of the capital" and had "at least 10 percent of the votes" for a continuous "period of two years that includes the time of accrual" for the Tax Exemption Method to apply.
For gains, the same requirement for ownership and voting share applies, but the condition of two years' ownership must be fulfilled "continuously for the last two years up to the time of accrual."
Income Recognition of Three Percent of Dividends and Distributions
Even though the income is covered by the Tax Exemption Method, three percent of the dividend shall nevertheless be included in ordinary income. This results in an effective tax rate of 0.66 percent for the covered income.
The three percent rule does not apply to dividends where the receiving limited liability company owns more than 90 percent of the shares in the subsidiary and has more than 90 percent of the votes that can be cast at the general meeting ("tax group").
For distributions from companies with participant assessment to corporate participants, three percent of the distribution shall also be considered taxable income. For such distributions, there is no exception based on the participant's ownership share.
In international relations, dividends and distributions to foreign companies are subject to the three percent rule if the company is liable to tax in Norway for income from a branch here.
