M.A. AND OTHERS v. FINLAND
Inadmissible
Nicolas Bratza
The applicants are 35 Directors of a limited liability company (hereinafter “the Company”). All applicants are Finnish citizens, except applicant N.L. who is a citizen of the United Kingdom. Before the Court they are represented by Mr Markku Fredman, a lawyer practising in Helsinki. The respondent Government were represented by their Agent, Mr Arto Kosonen, Director in the Ministry for Foreign Affairs. The facts of the case, as submitted by the parties, may be summarised as follows. In 1994 all the applicants were employed by the same employer, the Company. On 7 April 1994 the Annual General Meeting of the Company decided that a bond loan with warrants be issued. The Terms and Conditions for the Bond Loan with Warrants for share subscription (hereinafter “the Terms”) were determined, inter alia, as follows: “I Loan Terms 1. The maximum amount of the bond loan with warrants shall be 200,000 Finnish Marks (FIM). 2. The Loan shall be offered for subscription to the management of [the Company]. It is proposed that shareholders’ pre-emptive right to subscription be disapplied since the loan is intended as part of the incentive programme for the management of [the Company] and its various units. 3. The bonds shall be dated 15.4.1994. The term of bonds shall be five years. The loan shall be repaid in one instalment on 15.4.1999 against presentation of the bonds at the Company’s head office. ... 5. The annual interest rate on the loan shall be (2)%. ... 6. Subscription may take place on 15.4.1994 at the Company’s head office. ... 7. [The Company] shall issue not more than 200 bonds made out to a named person each with a nominal value of FIM 1,000 and carrying 1,000 warrants. The bonds and warrants shall be kept by an agent designated by [the Company] for the account of the subscriber until 1.12.1998. ... II Terms and Conditions of Share Subscription 1. Each warrant shall entitle the holder to subscribe for one [Company] preferred share with a nominal value of FIM 20. ... 2. Shares may be subscribed during the period 1.12.1998 31.1.2000. Share subscription shall take place at [the Company’s] head office or at a place later indicated by [the Company]. When subscribing for a share a warrant shall be surrendered. payment of shares subscribed shall be effected on subscription. 3. The share subscription price shall be FIM 374. ... 5. Warrants pertaining to bonds may not be transferred to a third party prior to 1.12.1998 without the written permission of the Board of Directors. After this date warrants may be freely transferred.” The Annual General Meeting noted that the loan formed a part of an incentive programme directed to the management of the Company. The purpose of the programme was to strengthen the management’s commitment to continuous and long-standing service for the Company. In April 1994, about 45 employees, including all the applicants, subscribed for bonds under the incentive programme. The applicants’ loan-share varied between FIM 2,000 (EUR 336.38) and 12,000 (EUR 2,018.26), carrying the same amount of warrants. At the time, the mid-rate of the Company’s stock was FIM 374 (EUR 62.90). Under Section 66 (1) of the Income Tax Act (tuloverolaki, inkomstskattelag 1535/1992, hereinafter “the 1992 Act”), an employee receives ordinary income under employee stock purchase programmes when subscribing for the company’s shares for a price that is under the fair market value of the stock. However, under programmes that are designed for the whole personnel, or for the majority of it, no taxable income arises if the price reduction is 10% or less compared with the fair market value of the stock. Under Section 66 (3) of the 1992 Act, as it stood, the benefit of subscribing for shares based on debenture loan or stock option was taxable income if the subscription price was lower than the fair market value at the moment when the loan was issued. However, applying the 1992 Act, the potential profits in the future, based on appreciation of stock, were regarded as capital gains. Applying the 1992 Act, as it stood in April 1994, the applicants did not receive any ordinary income at the option grant. The potential gains would in due course be taxed as capital gains. In 1994 the capital gains tax rate was 25%. The rateable value for capital gains was determined by deducting the acquisition price from the sales price. There was a legal presumption that the acquisition price was 30% of the sales price unless the taxpayer showed that some other acquisition price be applied. On 16 September 1994 the Government introduced a Bill (hereinafter “the Bill”), proposing amendments to the 1992 Act. The amendments concerned, inter alia, Section 66 (3), of the 1992 Act. According to the Bill, profits based on appreciation of stock were to be regarded as a benefit related to employment. The incentive stock options programme for directors of a company was a new way of paying salary; the employer gave a promise regarding a right to a certain subscription for shares, and the value of that right would most likely, at the exercise of the right, be significantly higher than at the option grant. From the angle of income tax, it represented a postponed salary, which should be taxed as ordinary income. Due to practical problems relating to the assessment of the benefit at the option grant, the Government proposed that the benefit would be taxed at the exercise of the stock option (i.e. purchase of shares) or when the stock option was transferred. The Government stated that the amendments were intended to enter into force as from the beginning of 1995. The amended Act would be applied to existing stock option arrangements where the option was exercisable in 1995 or later. On 19 October 1994 the Board of Directors of the Company decided, relying on Chapter II, Section 5, of the Terms, to grant to subscribers of the bond loan a permission to transfer the warrants pertaining to bonds (stock option certificates) before 1 December 1998 when the subscribtion for shares would otherwise have started. As a result, a subscriber of the bond loan could transfer his or her stock options already in 1994, during which the 1992 Act in its original form was still assumed to be applicable. On 3 November 1994 the Parliament discussed during its question time the news according to which certain companies were planning to bring forward the opportunity to exercise their stock options. In his answer to the Parliament, the Minister of Finance took up the possibility of retrospective legislation. According to his answer, an earlier implementation of the proposed amendment would be justified at least in cases where the original subscription time was brought forward. On 7 November 1994 the applicants exercised their stock options by selling them. The selling price was FIM 366 (EUR 61.56) per option, i.e. the net value of the stock options after the income taxes paid by the applicants was FIM 19,266,448 (EUR 3,240,383.94) altogether. On 9 December 1994 the Parliament’s Finance Committee (valtiovarainvaliokunta, finansutskottet) gave its report on the Bill. The Finance Committee found that the proposed amendment was based on good reasons relating to fiscal policy. However, it found that the proposed entry into force was problematic. It reported that after the Bill had been introduced, companies had started to make strenuous efforts to modify their incentive programmes so as to make possible an earlier exercise of the stock options than laid down in the terms of the subscription. The Finance Committee found that, when considering the general equality aspects in levying taxes and the need to protect the incentive programmes from such artificial modifications that were made only by reason of taxation, the proposed amendment should enter into force earlier in order to make the described plans unprofitable. Taking into account expert opinions, the Finance Committee found that the goal could not be achieved by applying Section 56 of the Income Tax Act (concerning tax evasion). Therefore the Finance Committee found that the implementing provision should include an explicit clause as regards arrangements which permitted an earlier exercise of stock options. On the other hand, the so-called pure cases (i.e. cases in which the company had not initiated any artificial arrangements with the aim of making possible an earlier exercise of the options) should be left outside the scope of an earlier implementation. The Finance Committee stated that the provision regarding the earlier implementation should be applied, inter alia, in cases where the Board of Directors of a company had, after 16 September 1994, exercised its right to give a permission to exercise the stock option. It found that the proposed implementation would not be contrary to the right of property, at least if the “pure” cases were left outside the earlier implementation, which would apply only to irregular arrangements that aimed at producing an undeserved tax benefit. The proposed amendment to the 1992 Act was adopted on 21 December 1994, ratified on 29 December 1994 and published on 31 December 1994. The implementing provision included a clause to the effect described above. The decisive date as regards permission, given by Boards of Directors, to an earlier exercise of stock options was set at 16 September 1994, i.e. the date of introducing the Bill. Under the new provision of the Income Tax Act (hereinafter “the 1994 Provision”) and according to its implementation provision, the relevant tax authorities found that the applicants had received taxable income by selling their stock options in November 1994. A corresponding income tax was levied on them. Unlike capital gains tax, the income tax was progressive. The applicants’ incomes in 1994 were such as to put them in the highest tax band, resulting in marginal tax rates of 60% or more. In practice, the application of the amended tax legislation imposed on the applicants, respectively, a tax burden varying from FIM 333,060 (EUR 56,016.67 euros) to FIM 1,998,360 (EUR 336,100.02), and amounting in total FIM 21,000,000 (EUR 3,531,946.46) more than would have applied under the previous legislation. The applicants lodged claims for rectification with their respective Tax Rectification Boards (verotuksen oikaisulautakunta, skatterättelsenämnd). They referred, inter alia, to Article 1 of Protocol No. 1 to the Convention. The first decision was made on 18 December 1995 and the last on 11 February 1997. The Tax Rectification Boards rejected their claims. The tax authorities found that the relevant profits were to be taxed as ordinary income. In assessing the taxable gains, they did not accept that a 30% deduction, based on the presumption of the acquisition price, be made from the sales price. Instead, they found that the assessment of the taxable gains was to be made by deducting the purchase price and sales cost from the sales price. Since in the relevant cases there were no purchase prices, only the sales costs were deducted. The applicants appealed to the County Administrative Courts (lääninoikeus, länsrätt). They requested that the profit on sale be taxed by applying the 1992 Act, i.e. as capital gains and not as ordinary income. They also requested that the legal presumption as regards the acquisition price be taken into account and a corresponding amount be deducted when assessing the taxable gains. They maintained, inter alia, that the interpretation, based on retrospective legislation, according to which the profits on sale of the stock options were taxed as ordinary income, infringed the principle of equality as well as the right of property and, furthermore, was contrary to Article 1 of Protocol No. 1 to the Convention. On 13 February 1997 the first decision was given by the County Administrative Court of Turku and Pori. It rejected the appeals lodged by the applicants living in the relevant county. The above-mentioned applicants, living in the County of Turku and Pori, applied to the Supreme Administrative Court (korkein hallinto-oikeus, högsta förvaltningsdomstolen) for leave to appeal. On 6 October 1998 the Supreme Administrative Court granted leave to appeal to one of the applicants, but rejected the appeal on merits. The court decided to publish the judgment in its yearbook of precedents (1998:53). The key words in the summary of the precedent are, inter alia, “right of property” and “equality”. After adopting the first judgment, the Supreme Administrative Court refused the other four applicants, who had already received a judgment from the County Administrative Court, leave to appeal. The Supreme Administrative Court stated in its reasoning, inter alia, that the relevant tax on income was not a confiscatory measure which could be regarded as infringing the right of property. It noted that the applicant’s taxable income, based on the sale of the stock options, corresponded to the actual gains from that sale. The Supreme Administrative Court found that it had not been contrary to Article 1 of Protocol No. 1 to the Convention to tax an income, made by selling stock options, as any other ordinary earnings. Had the applicants sold their stock options on 1 December 1998, which was the originally planned first possible day to transfer the warrants pertaining to bonds, the total net value of the stock options after income tax would have been FIM 189,349,569 (EUR 31,846,311.39). Had the stock options been sold on 30 December 1999, the total net value after income tax would have been FIM 882,739,513 (EUR 148,466,128.30). On 21 October 1998 the Supreme Administrative Court gave a decision in another case in which it found that the profits from a sale of a stock option in December 1994 were to be taxed as capital gains since the original loan conditions had not been altered and since the relevant company had agreed to the transfer prior to 16 September 1994.