The grey economy relating to corporate income tax of small and medium sized companies amounts to up to €120 million a yea

Small companies engaged in grey economy activities typically hide their profits, whereas medium sized companies exaggerate their expenses. Digitalization of financial administration would provide the Tax Administration with more information for the basis of tax audits, which would help to uncover grey economy activities.

According to the recent report, the grey economy relating to corporate income tax of small and medium sized companies amounts to an average of €120 million. This is around five per cent of the corporate income tax payable by those companies.

The corporate income tax is paid by limited liability companies on their business profits. The grey economy relating to corporate income tax refers to activities where companies evade paying the corporate tax on purpose and against the law.

However, some losses of tax revenue can be tackled through authorities’ prevention measures, such as tax control.

“Although most Finnish companies act according to law, a notable amount of tax revenue attributable to corporate income tax is lost every year due to the grey economy. It corresponds to the amount by which the funding for vocational training is reduced this year,” says Janne Marttinen, Director of the Tax Administration’s Grey Economy Information Unit.

The information is based on the Grey Economy Information Unit’s recent report. The report looked into limited liability companies whose annual turnover was less than €10 million.

Small companies hide sales profits, medium sized companies exaggerate expenses

The report discovered that evasion of corporate income tax takes different forms depending on the company’s size. Companies with the smallest turnover typically fail to report their business profits either partly or in full.

“In other words, some or all of the company’s income remains undeclared, and so the company does not generate a profit, on the basis of which corporate income tax is determined,” Marttinen explains.

An estimated 70 per cent of the grey economy relating to the corporate income tax of small and medium sized limited liability companies is attributable to companies whose turnover is less than €300,000 or is not known to the Tax Administration.

According to Marttinen, an explanation for this is that it may be easier to bend the rules in small companies whose activities are not as well organised as those of larger companies. Smaller companies do not necessarily have external accountants, either.

The report says that in medium sized limited liability companies, profits are typically reduced by exaggerating expenses.

“The company’s profits may be artificially reduced by recording entrepreneurs’ personal expenses in the company’s bookkeeping, for example, so as to reduce the amount of taxable profits,” says Marttinen.

According to the report, grey economy activities are found especially in construction, food and beverage service activities and services to buildings and landscape activities.

The grey economy regarding large companies was not investigated

The recently published report did not look into large companies. According to Marttinen, large companies typically seek to evade taxes by rearranging their income and expenses between different countries to minimise their tax liabilities.

“The grey economy manifests itself differently in large companies and in small and medium sized companies, so to estimate the volume of the grey economy in large companies, a separate investigation using different methods is needed,” says Marttinen.

Digital financial administration would enhance the prevention of the grey economy

The Tax Administration combats the grey economy through taxpayer guidance and tax control. Collaboration between various authorities plays a key role in the investigation of fraud.

Tax audits, for example, help to expose grey economy actors, and taxes will then be imposed. Tax audits in limited liability companies reveal sales not entered in the books, and unfounded expenses and other arrangements that have been made to evade taxes. The Tax Administration also reports economic crime to the police.

In tax audits, the Tax Administration makes use of reference data received from third parties, such as banks and payment service providers.

“If even more comprehensive data were received from third parties, fraudulent companies would be increasingly likely to be exposed. We think the constantly increasing digitalization could also help combat the grey economy if information on companies’ purchases and sales were transferred to authorities in real time,” says Marttinen.

The Tax Administration, in collaboration with other authorities, is currently preparing a digital financial administration service for companies. The idea of the service is that any data a company has reported once could be used for reporting to different authorities.

To tackle the grey economy, the Action Plan for Tackling the Grey Economy and Economic Crime was approved in December. The action plan covers no less than 19 projects coordinated by different authorities.

Further information on the topic:

The grey economy of corporate tax for small and medium-sized limited companies is up to 120 million euros per year

Action plans – Grey economy & economic crime

Key figures in the prevention and investigation of tax fraud in 2023