Employment contracts that define pay in terms of net salary

1 Introduction

Foreign companies may enter into various types of employment contracts with employees posted in Finland. Salaries can be defined in terms of net salary . The objective is to avoid unexpected tax consequences. These contracts are intended to guarantee a planned net income level in the expatriate employee’s hands, and it is agreed that the employer, instead of the employee, will pay the taxes. 

Another popular arrangement is a tax equalization policy that entails agreement between employer and expatriate worker on gross income, including equalization of taxes, or tax protection.

Tax equalization schemes aim to safeguard the net income that the expatriate employee would theoretically have if he stayed in his home country to perform the same labour or personal services. During the posting/assignment/ secondment to a foreign country, employee and employer agree upon a grossed-up amount, from which a hypothetical tax amount, similar to home-country taxes, is subtracted. In reality, the expatriate employee’s actual income tax may be different. However, under the tax equalization employment contract, the employer will pay the final assessed taxes both in home country and assignment country. This payment is made on behalf of the expatriate. If the total of home-country and assignment-country taxes actually stays below of what was agreed to be the hypothetical tax, the employer is not expected to restore the difference to the expatriate employee.

Tax protection clause in employment contracts means that the employer agrees to pay the expatriate employee the excess amounts of income tax that are over and above the income tax payable if he were to remain in his home country to perform the same labour or personal services. Under the tax protection clause, there may be a tax benefit to the expatriate employee. This means that if the tax coverage payments from the employer are greater than necessary to pay the actual taxes, the expatriate employee will keep the difference. Similarly as in tax equalization, an amount of hypo tax is first computed and then withheld from gross pay.

It should be noted that employer companies might apply hybrid schemes that combine some characteristics of all the above variants. 

2 Ruling KHO:2008:31

Ruling KHO 2008:31 of Supreme Administrative Court
Finland’s Supreme Administrative Court has examined and judged (KHO 2008:31) a case where a foreign employer paid income tax on behalf of an employee who was liable to tax in Finland.

The case involved an employment contract for a fixed net salary. The U.S. employer and the expatriate employee, assigned to work in Finland, had agreed that the same net amount as would be payable in home country would be payable during the Finnish assignment. The U.S. employer had withheld taxes and tax-like charges from salary. However, the withheld amounts had not been paid forward to the Finnish tax authority. Also, while working in Finland, the expatriate employee did not make any prepayments of Finnish income tax on his own initiative. Instead, the U.S. employer company paid the Finnish tax authority the outstanding amounts, which had been invoiced by the Finnish tax authority afterwards, based on the incomes declared by the employee.

Under the ruling, payment by employer of these taxes on behalf of employee was taxable earned income for the employee, because a greater amount of money had been used for such payment than what had been withheld from employee’s pay. The benefit to employee was attributed to the tax year during which it was earned. Pursuant to § 10.1, subsection 4, Income Tax Act, the income was taxable in Finland, and under Article 15 of USA—Finland Tax Treaty, employment being exercised in Finland, the salary could be taxed in Finland. 

The Supreme Administrative Court has also made another judgment (KHO 1969-II-589, volume 10.3.1969/1487) regarding a similar situation. The case involved a housemaid who, in addition to cash wages, also received some in-kind benefits, and whose employment contract set out a fixed net pay in cash. Under the ruling, monthly wages subject to tax should equal the grossed-up amount from which, after monthly withholding, there remain only the monthly net cash amount and the monthly tax value of in-kind benefits.

3 Computations of gross and net taxable income

3.1 Gross salary subject to tax in Finland

Pursuant to Income Tax Act, a taxpayer’s taxable income includes his income received in cash, or received in the form of assets or benefits representing a taxable cash value (§ 29, Income Tax Act). The arrangements described above in the previous section mean that an agreement exists, between employer and employee, on paying a total gross pay amount, the consistent parts of which are (1) a fixed net cash amount and (2) an amount reflecting taxes both in home country and in Finland, payable by the employer on actual taxpayer’s — the employee’s — behalf.

Pursuant to the Supreme Administrative Court ruling, taxpayer’s gross salary for the income year had to be readjusted. The taxes computed during reassessment should be added to gross salary. This ruling will thus govern cases where an employment contract sets out a fixed net salary. It means that the outstanding Finnish income tax should already be declared during the income year, and it should be included in taxpayer’s gross salary. Nevertheless, because no exact amount of income tax is yet confirmed — at the time of preparing the employer’s Payroll Report, and at the filing deadline of the employee’s income tax return — the employer should make a computation to arrive at the probable amount of tax. The computation should be as precise as possible.

It is the position of the Finnish Tax Administration that the practical guideline derived from the ruling will be applicable to any situation where a foreign employer agrees to pay employee’s Finnish taxes. Such an agreement may cover all or only some of the taxes. In this context, ‘foreign employer’ means an employer who is not liable to carry out payroll tax withholding in Finland. 

For situations not involving other countries, it is the position of the Finnish Tax Administration that comparable assessment situations and tax decisions should be governed by the guideline derived from the above KHO 1969-II-589 ruling.

Gross salary subject to tax in Finland consists of net salary plus the amount that the employer should compute (gross up), reflecting Finnish income tax. If employer pays advance income tax, prepayments, or other supplementary amounts to cover employee’s income tax liability, these payments should be included in the grossed-up salary, as explained in section 3.2 later in this article.

Computations to gross up the net amount should include all relevant conditions of the employment contract regarding employer’s responsibility to pay tax for other income, the maximum limits of such responsibility, and also regarding the beneficiary party — agreed to be the employer or the expatriate employee — of any tax deductions or credits. 

3.1.1 Net salary

Net salary, as defined in Finland for taxation purposes, includes all payments from employer to employee during the tax year:

• Cash salary or cash wages
• Fringe benefits as valued in tax rules
• Any retroactive payments (including vacation money and corrective payments to equalize employee’s tax burden in a foreign country)
• Bonus payments
• Benefits arising from employee stock options
• Payments of taxes, on behalf of employee, to home-country tax authority 
• Amounts withheld of gross salary, by employer, to cover statutory employer’s social contributions in home country
• Payments, by employer on behalf of employee, of previous years’ outstanding back taxes and late-payment interest as explained in section 3.3 later in this article.

3.1.2 Calculated Finnish tax

Calculated Finnish tax is the Finnish tax to be paid according to the gross-up computations based on a known net salary.

Gross salary, subject to tax in Finland, should be the sum of two components: net salary plus calculated Finnish tax. Computations to gross up the net amount should include all the deductions against income, and all the tax credits to be subtracted from the taxpayer’s taxes. Some deductions and credits areex officio, which means that they are automatically deducted during the assessment procedure, others are taxpayer-declared, and depend on taxpayer’s personal and family situation. When computing the tax, late-payment interest (for additional payments or possible refunds) should not be taken into account to gross up the net.

If the employee has no other income, the outstanding tax to be invoiced later will be exactly the same as the estimated amount of income tax. In this case, the employee will receive no additional taxable benefit for the fact that his foreign employer (or the Finnish subsidiary or other related party) is paying the tax.

(The example is based on the 2008 progressive schedule of Finnish state income tax, assumptions of municipal tax rate at 17.5% and no coverage by Finnish social insurance.)

3.2 Prepayments of income tax

Pursuant to § 1, Prepayment Act, taxpayers are expected to make prepayments to the Tax Administration in order to cover their actual tax liability for the current year. The Act also requires that advance prepayments be accurate, as prescribed in § 3, Prepayment Act. If the payer of wages is not liable to withhold tax and pay it forward to the Finnish Tax Administration, the recipient/employee is expected to follow the prepayment rule and carry out the tax payments. 

Prepayments are payable on gross salary subject to tax, computed according to the instructions in this article. 

The following sections of this article discuss situations involving differences between paid-up prepayments and calculated Finnish tax.

3.2.1 Prepayments in the course of the tax year

If employer, on behalf of employee, makes prepayments during the tax year, and the sum total of these prepayments does not exceed calculated Finnish tax, gross salary will be the sum of net salary plus calculated Finnish tax.

If employer, on behalf of employee, makes prepayments during the tax year that are higher than calculated Finnish tax, gross salary will be the sum of net salary, plus calculated Finnish tax, plus the amount exceeding the latter.

3.2.2 Supplementary payments and prepayments after closure of tax year

If employer, on behalf of employee, after the tax year is over, makes supplementary payments or prepayments, in addition to prepayments in the course of the tax year, and the sum total does not exceed calculated Finnish tax, such payment will not be added to employee’s gross salary for the year of such payment. 

If employer, on behalf of employee, after the tax year is over, makes supplementary payments or prepayments, in addition to prepayments in the course of the tax year, and the sum total is higher than calculated Finnish tax, such payment (the part exceeding the calculated Finnish tax amount) will be added to employee’s gross salary for the year of such payment. 

Tax year 1

Tax year 2

3.3 Outstanding tax/Refunds of tax

Outstanding tax

If employer, on behalf of employee, after the tax year is over, pays an invoice for outstanding tax, any portion of its amount that exceeds the tax year’s calculated Finnish income tax will be added to the employee’s net salary for the year of such payment. 

Any portion of a paid-in prepayment, either during or after the tax year, which exceeds the tax year’s calculated tax, will be added to the employee’s subsequent year’s gross salary. However, if the employer-provided prepayment has been included in either the tax year’s or the subsequent year’s gross salary, the payment of an invoice for outstanding tax will be added to the net salary for the year of payment insofar as its amount exceeds the sum total of calculated Finnish tax and prepayments already reported as part of employee’s salary.

If employer, on behalf of employee, after the tax year is over, pays late-payment interest on an outstanding tax amount, it should be added to net salary for the year of such payment.

Refunds
Tax refunds and any interest on them should be subtracted from the sum of net salary for the year of payment and calculated Finnish tax (the grossed-up salary), if prepayments in the course of tax year were included in gross salary. However, the subtraction is dependent on the clauses of the employment contract: if the tax refund is agreed to be restored to the employer.

3.4 Payments from employee to employer

If it is agreed in the employment contract that the foreign employer withholds money from the expatriate employee’s pay, these amounts are to be deducted from the employee’s net salary during the year of payment. 

It is not uncommon that too little home-country hypothetical tax has been withheld through the payroll system, so a further settlement will be due to the company. An additional payment back to employer, during a subsequent year, may thus be related to a corrective calculation of hypo tax (in this case the sum total of hypo tax paid abroad would grow). 

4 How to declare gross income

4.1 Employer’s reporting requirement

The foreign employer should deliver annual information to the Finnish Tax Administration on all payments made, cash or cash equivalent, any corrective entries or corrective payments related to them, on the identity of recipients/employees, and on the reasons for payments if the employee is staying in Finland for a consecutive period longer than six months (§ 15 and § 15a, Act on Assessment Procedure). 

The form to use is Veroh 7801e: Annual information return—Summary and Itemization. For the 2008 reporting year, gross wages are to be reported as Type of Payment ‘P’. Gross wages subject to tax are computed according to the instructions in this article. Furthermore, if the employee is not covered by the Finnish social security system, gross wages subject to tax should be entered in line 36 (for Payments of wages not included in the base of health insurance contributions ). 

The employer should report employee’s gross salary on form Veroh 7801e, computed according to the instructions in this article. Computations to gross up the net amount should include deductions ex officio, i.e. the automatic deductions during the assessment procedure. Fringe benefits are entered in lines 20 to 49 and cash salary in line 14 (for Amount of cash wages/remuneration without fringe benefits), computed according to the instructions in this article, but with the sum total of fringe benefits subtracted.

For the 2009 reporting year, in respect of employment contracts that define pay in terms of net salary, Type of Payment will be ‘7N’ instead of ‘P’. The new code 7N has the explanation text “Wages paid by foreign employer having responsibility to pay employee’s taxes (Ulkomaisen työnantajan maksama palkka työntekijälle, kun työnantaja maksaa työntekijän puolesta verot)”. 

4.2 Employee’s obligation to file tax returns and declarations

Pursuant to § 7, Act on Assessment Procedure (18 December 1995/1558), taxpayers should declare their incomes to the tax authorities. Taxpayers should also specify the details on their tax deductions against their income, explain their assets and liabilities, and give other details that have an effect on the assessment of their annual taxes. The income tax return form should be used for declaring the gross salary amount in Finland, computed according to the principles outlined above. As additional information relevant to the income tax return, the taxpayer should set out the total amount of cash, or cash equivalent, viewed as net salary. 

Furthermore, the taxpayer should give complete details on other matters affecting the computation of gross salary in Finland. Such details include specification of the consistent parts of the net salary, and explanation of what has been agreed between employer and employee on the responsibility to bear the cost of any personal tax liabilities resulting in Finland.

 
The employee should use the Additional Information section of the tax return form to give details:

Net salary is 85,000.00
- It is the employer´s responsibility to bear the cost 
of any personal tax liabilities resulting in Finland.
- Employer is to receive any resulting benefits or refunds,
if due to employee’s personal tax deductions the employer
has prepaid more than sufficient tax to cover the actual tax liability. 

5 Readjustments of gross income

If a taxpayer disagrees with a tax assessment decision or finds it erroneous, s/he can appeal the decision. Appeals should be made within five (5) years from the beginning of the year following the year when the tax assessment was made. (§§ 61—64, Act on Assessment Procedure). Appeals should be addressed to the regional tax office that carried out the assessment. 

In case of errors in the tax assessment, the regional tax office is entitled to perform readjustments ex officio (§§ 55—56, Act on Assessment Procedure).

Such a readjustment may be related to an error in the computation of gross salary subject to tax in Finland, including the following situations:

• The net salary used has been incorrect
• The deductions have been incorrect.

Pursuant to § 57a, Act on Assessment Procedure, if the amount to be added to the taxable income in readjustment stays below €4,000, it is permissible to adjust the current-year income only, for which the assessment has not yet been closed, and not go back to reopen a previous tax year’s assessment (“Readjustment transfer over taxable periods”; in Finnish: Verotuksen oikaisun johdosta lisättävän tulon siirto).  The transfer procedure is designed to simplify correction of minor errors. It may cover periods of one, two or five tax years (§ 56, subsections 2 to 4, Act on Assessment Procedure). Nevertheless, if a taxpayer is appealing a tax assessment decision under §§ 61—64, Act on Assessment Procedure, the adjustment will always concern the tax year in respect of which the taxpayer has appealed. 

More advice on appeals (in Finnish): ohje Muutoksen hakeminen tuloverotukseen. Specific instruction (in Finnish) Verotusmenettelyn muutoksista (dnro 236/38/2007, dated 19 April 2007)

6 Net salary during post-repatriation period

If employer pays amounts, related to performance of labour or personal services in Finland, to or on behalf of a Finnish tax nonresident employee, after the employee has left Finland, and the amounts should be considered part of net salary, as outlined above in section 3, employer should pay Finnish tax at source during the year of payment. 

In an inverse situation, the employee’s salary can be reviewed afterwards and it may be established that too much salary was paid. In this case, employee would, after repatriation, refund some of his wage income to his employer. 

Similarly, an employer-paid amount on behalf of employee may later be corrected so as to become smaller. These situations would lead to readjustments of the gross salary for the relevant tax year, which is the year when the amounts concerned were included in the employee’s income. 

7 Protection of legitimate expectations

Protection of legitimate expectations; protection of confidence; transfer to new definition of gross salary

Act on Assessment Procedure, in its § 26, includes regulations on the protection of a taxpayer’s confidence, in other words, the protection of legitimate expectations. Accordingly, if a disputed tax matter is unclear, or there is room for interpretation, and if taxpayer has carried out his actions in good faith, abiding by and adhering to guidelines or practices of tax authority, the disputed matter should be resolved in taxpayer’s favour.

The Supreme Administrative Court ruling 2008:31, cited above in this article, will effectively change the assessment practices of the Finnish tax authorities, because the judgment is laying down some new attribution rules of income in respect of different tax years, and also laying down some new rules governing sourcing, and a nonresident taxpayer’s liability to tax. Whereas previous practice would not include taxpayer’s outstanding taxes during his post-assignment period as income of the income year, the new practice, in light of ruling 2008:31, will do so. Similarly, whereas previous practice would not see Finland as the source of income for employer-provided payments of outstanding tax, the new practice, in light of ruling 2008:31, will do so. In this connection, the Finnish Tax Administration is of the opinion that protection of taxpayers’ confidence and legitimate expectations will continue to be justified up to the payments and reporting of invoiced outstanding taxes for tax year 2007.

Starting at tax year 2008, taxpayers filing their income tax returns should compute their gross incomes according to the instructions of this memorandum. Invoiced outstanding taxes, or reassessment taxes, for tax years 2006 and 2007, should not be included in computations of gross income 2008, and similarly, any refunds from employee to employer should not be subtracted from gross income 2008.

8 Using Tax Percentage Calculator

To compute gross salary and Finnish tax, go to Tax Percentage Calculator (www.tax.fi/taxcalculator). Remember that the results of the Calculator are a rough guide only.

1. First enter your own rough estimate of the grossed-up salary in calculator’s Wages from principal occupation with fringe benefits line. If employee will not be covered by the Finnish residence-based social security system, tick the box for Social insurance in another country. Similarly, if no deductible insurance premiums will be payable in Finland for pension or unemployment coverage, enter zeros in calculator’s relevant lines (under “Deductions”).
2. Press Calculate. Then figure out the difference between gross Total annual income, as shown by calculator, and Total annual taxes, as shown by calculator (the difference is the net salary).
3. If it does not match your planned net salary, figure out the difference, i.e. exactly how far from the planned net salary you still are. Then divide the difference by (100 - marginal tax rate) and multiply the result by 100. This will show the amount to add or subtract from gross Wages (the amount of correction).

If net salary, shown by calculator, is greater than your planned amount, subtract the correction from gross Wages. If net salary is smaller than your planned amount, add the correction to gross Wages. Reiterate as necessary to arrive at your planned net salary.