FOURTH SECTION
DECISION
AS TO THE ADMISSIBILITY OF
Application no. 30289/96
by S.B. and Others
against Finland
The European Court of Human Rights (Fourth Section), sitting on 16 March 2004 as a Chamber composed of
SirNicolas Bratza, President,
MrM. Pellonpää,
MrsV. Strážnická,
MrJ. Casadevall,
MrS. Pavlovschi,
MrJ. Borrego Borrego,
MrsE. Fura-Sandström, judges,
and Mr M. O'Boyle, Section Registrar,
Having regard to the above application lodged with the European Commission of Human Rights on 20 February 1996,
Having regard to Article 5 § 2 of Protocol No. 11 to the Convention, by which the competence to examine the application was transferred to the Court,
Having regard to the observations submitted by the respondent Government and the observations in reply submitted by the applicants,
Having deliberated, decides as follows:
THE FACTS
The applicants are nine Directors of a limited liability company (hereinafter “the Company”). Before the Court they are represented by Mr Markku Fredman, a lawyer practising in Helsinki. The respondent Government were represented by their Agents, initially Ms Irma Ertman, Deputy Director-General for Legal Affairs in the Ministry for Foreign Affairs, and subsequently Mr Arto Kosonen, Director in the same Ministry.
A. The circumstances of the case
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 12 April 1994, the Annual General Meeting of the Company decided that a loan with option rights be offered for subscription to the company's management. The loan was designed as a part of the company's incentive programme for management. According to the conditions of the loan, the term was for four years. The maximum amount of the loan was FIM 1,500,000 (EUR 252,281.89), divided into a maximum of 1,500 bonds. Each bond would carry three stock option certificates (A, B, C), each certificate permitting the acquisition of a certain number (40) of company shares in 1996, 1997 and 1998 for a price determined according to the conditions. The stock option certificates could be transferred as follows: A as from 2 January 1996, B as from 2 January 1997 and C as from 2 January 1998. The Board of the Directors was given the right to decide on such conditions and measures related to the loan that were not determined in the conditions of the subscription.
In 1994 four of the applicants were of such an age that their earnings in 1996, 1997 and 1998, based on employment, would be taken into account when calculating their future pension.
In April 1994, all the applicants subscribed to the loan. Their loan-share varied between FIM 120,000 (EUR 20,182.55) and FIM 300,000 (EUR 50,456.38) and, correspondingly, their right for share subscription between FIM 14,400 (EUR 2,421.91) and FIM 36,000 (EUR 6,054.77).
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 realises 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 requested that some other acquisition price be applied.
According to a memorandum dated 5 September 1994, the Company's General Manager was informed about ongoing legislative plans to the effect that the tax treatment of stock options would be amended. He was of the view that the change would neutralise the incentive effects of the loan. Furthermore, he found that the change would oblige the Company to contribute to the social security scheme, which the Company had not foreseen. Finally, he considered that the change would unintentionally raise certain pensions. He, therefore, decided that the right of subscribing for shares (the stock options) be given up.
In the Company's Annual Report of 1994 it is stated that the Board of the Directors approved of the General Manager's decision but no date is mentioned.
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 the 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 considerably higher than at the option grant. From the angle of the income tax, it represented a postponed salary, which was to 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 noted that, apart from being regarded as ordinary income for the employee, a benefit from the stock options would be regarded as salary from which the employer would be obliged to withhold tax. Furthermore, the employer would be obliged to contribute to the social security scheme on the basis of this benefit.
The Government stated that the amendments were intended to enter into force as from the beginning of 1995. The amended Act would be applied on existing stock option arrangements where the option was exercisable in 1995 or later.
On 31 October 1994, the applicants sold their stock options. The average selling price was FIM 63.07 (EUR 10.61) per option.
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 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 make possible an earlier exercise of the stock options than laid down in the terms on 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 systems allowing for 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 making possible an earlier exercise of the option) should be left outside the scope of the provision. The Finance Committee stated that the provision regarding the earlier implementation should be applied, inter alia, in cases where the board of directors of the company had, after 16 September 1994, granted 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 scope of the provision, which would apply only to irregular arrangements that aimed at receiving an undeserved tax benefit.
As regards the social security scheme, the Finance Committee stated that the employer's obligations to withhold tax and to pay the employer's social security contribution were interrelated. However, the legislation concerning pensions included specific provisions as regards the scope of application of pension legislation to stock options based on employment. According to the opinion of the Central Pension Security Institute (eläketurvakeskus, pensionsskyddscentralen), the benefit made from the exercise of a stock option was not to be taken into account in calculating the employee pension and, consequently, no contribution to the employee pension scheme was required.
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 the board of directors, for the earlier exercise of stock options was set as 16 September 1994, i.e. the date of issuing the Bill.
Under the fresh provision of the Income Tax Act (hereinafter “the 1994 Act”) and according to its implementation provision, the relevant tax authorities found that the applicants had received taxable income by selling their stock options in October 1994. A corresponding income tax was levied on them.
Unlike the capital 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 at 60 % or more. In practice, the application of the amended tax legislation brought the applicants, respectively, a tax burden that ranged from FIM 590,112 (EUR 99,249.71) to FIM 1,515,331 (EUR 254,860.38), in total FIM 7,500,000 (EUR 1,261,409.45) higher than would have applied under the previous legislation. For the Company, the amendment would have brought additional expenses in the form of contributions to the social security scheme, amounting to FIM 4,500,000 (EUR 756,845.67).
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 13 December 1995 and the last on 29 December 1995. 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 costs 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 Court (lääninoikeus, länsrätt) of Uusimaa. 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 right of property.
On 31 October 1997, the County Administrative Court rejected the appeals. The County Administrative Court found, inter alia, that the General Director's decision of 5 September 1994, did not meet the requirements set out in the implementing provision of the 1994 Provision and that, therefore, the permission to exercise the stock options had not been given prior to 16 September 1994.
The applicants appealed to the Supreme Administrative Court (korkein hallinto-oikeus, högsta förvaltningsdomstolen) requesting leave to appeal.
On 19 November 1998, the Supreme Administrative Court granted leave to appeal to one of the applicants, but rejected the appeal on the merits. After adopting the first judgment, the Supreme Administrative Court refused the other applicants 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 income, made by selling stock options, in the same was any other ordinary earnings. It also found that it had not been established that the Company's Board of Directors would, prior to 16 September 1994, have allowed an earlier transfer of the stock options than that laid down in the loan terms. Furthermore, it stated that the levying of income tax on the benefit made from exercising an employment-based stock option did not require that the stock option certificates had been freed from the prohibition on transfer in order to avoid tax.
B. Relevant domestic law and practice
On 6 October 1998, the Supreme Administrative Court gave a judgment (1998:53) in a case concerning the application of the 1994 Provision to a sale of stock options in 1994 in which the outcome was the same as in the cases of the applicants now in question.
On 21 October 1998, the Supreme Administrative Court gave a judgment in which it found that the profits from a sale of a stock option in October 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.
COMPLAINTS
1. The applicants complain that the application of a retrospective tax law, leading to a considerably higher tax liability than under the previous law, violated their right to peaceful enjoyment of their possessions. They invoke Article 1 of Protocol No. 1 to the Convention.
2. Moreover, the applicants allege that their rights under Article 6 of the Convention have been violated. They maintain that since it had not been possible to make any exceptions in applying the tax legislation, they had not been able to challenge before a court the application of the 1994 Act to their particular circumstances.
3. Finally, the applicants complain about the lack of an effective remedy. In this respect they invoke Article 13 of the Convention.
THE LAW
1. The applicants complain, under Article 1 of Protocol No. 1 to the Convention, that the applying of a retrospective law, leading to a considerably higher tax liability than under the previous law, violated their right to the peaceful enjoyment of their possessions. Article 1 of Protocol No. 1 reads as follows:
“Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.
The preceding provisions shall not, however, in any way impair the right of a State to enforce such laws as it deems necessary to control the use of property in accordance with the general interest or to secure the payment of taxes or other contributions or penalties.”
The Government argue that there is no absolute prohibition of retroactive tax legislation. According to an established interpretation stricter provisions with retroactive effect are contrary to the Finnish Constitution only when they are considered to violate the protection of property provided for in Section 6 of the Constitution, because of their confiscatory nature. In the present case the stock options based on an employment relationship did not create such a situation. Should the situation be interpreted differently, it would, taken to its logical extreme, mean that taxation of incomes at the highest possible rate would always amount to confiscation.
The Government recall that the amendment to the legislation concerning the taxation of stock options in the present case was applied to certain realisations of stock options taking place before the entry into force of the Act, where the intention had been to change the terms of loan for the purpose of tax avoidance. However, in all cases the amendment had legal effect on tax payers only after the entry into force of the Act. No taxes were to be paid until the 1995 tax-year.
The Government also note that neither the Convention nor any of its Protocols protect a right to obtain possessions. Expectations do not have the degree of concreteness to bring them with the idea of “possessions”. Furthermore, the applicants have been able to use their considerable incentive benefits by selling their stock options and the Act only served to reduce what they expected to receive as a result of their own departure from the original plan.
The Government consider it clear that the amended Section 66, subsection 3, of the Income Tax Act was lawful in domestic terms. As regards the retroactivity of the Act, the Government also recall that retroactivity in legislation on non-criminal matters is not, in principle, prohibited either by the Constitution of Finland or by Article 1 of Protocol No. 1 to the Convention. There was an obvious and compelling general interest to ensure that incomes based on an employment relationship were treated equally. The question relates to the credibility of the system of taxation.
The applicants maintain that the benefit obtained by selling stock options was already their property when the Finance Committee initiated discussions about the retrospective implementation of the proposed amendment. The application of the 1994 Provision resulted in a tax rate of 63% instead of 25% (or, rather, 17,5% of the sales price, taking into account the legal presumption of the acquisition price). It is to be noted that from the Company's point of view the amendment brought additional expenses in the form of contributions to the social security scheme. In addition, in September 1994 it had appeared that the amendment would have excessively affected certain pensions for which the Company would have been responsible. There was thus good reason for the chosen arrangement not only from the applicants' point of view but also from that of the Company.
The applicants argue that the retrospective legislation does not fulfil the requirements of lawfulness in respect of foreseeability. In all previous and later amendments the aspect of foreseeability has been respected. In the instant case, the retrospective legislation rendered the actions taken by the applicants futile and, furthermore, unprofitable since the applicants lost the opportunity to enjoy the later increase in the value of stock. They emphasise that there was nothing artificial or secret about the arrangements in issue. The option arrangements did not constitute any form of tax avoidance. The incentive stock options programme was designed so as to achieve a certain net result. The planning was based on existing tax legislation, namely the 1992 Act, in which the choice of capital gains tax had been a deliberate one.
The applicants submit that the amendment, which was made at the end of 1994, had not been taken into account in the State budget for that year. Therefore, the higher charge could not even be regarded as taxation but as a deprivation of possessions under the guise of taxation. Furthermore, they submit that it was difficult to see what the aim of the amendment had been. If the aim was related to equality in taxation, it could not be sought by retrospective legislation. In any event the means were disproportionate to that aim. The second alleged aim was mentioned in the Finance Committee's report as being the need to protect incentive programmes. However, the reference in the report was vague and purpose-oriented. Furthermore, such an aim was alien to taxation and in any case the chosen means could not promote it.
The Court recalls its decision of 10 June 2003 in the case of M.A. and 34 others v. Finland (no. 27793/95) which was very similar to the present case and in which the application was declared manifestly ill-founded. Referring mutatis mutandis to its reasoning in the case of M.A. and 34 others v. Finland, the Court concludes that there is no appearance of a violation in the present case either.
It follows that this complaint is manifestly ill-founded and must be rejected in accordance with Article 35 §§ 3 and 4 of the Convention.
2. The applicants also complain, under Article 6 of the Convention, that their rights have been violated. They maintain that since it had not been possible to make any exceptions in applying the tax legislation, they had not been able to challenge before a court the application of the 1994 Provision to their particular circumstances. Article 6 reads, insofar as relevant, as follows:
“In the determination of his civil rights and obligations ..., everyone is entitled to a fair ... hearing ... by [a] ... tribunal...”
In this respect the Court recalls, in accordance with its established case-law, that Article 6 § 1 does not guarantee a right of access to a court with competence to invalidate or override a law.
It follows that this complaint is incompatible ratione materiae with the provisions of the Convention within the meaning of Article 35 § 3 and must be rejected in accordance with Article 35 § 4.
3. The applicants finally complain about the lack of an effective remedy as the Tax Rectification Boards did not discuss questions relating to property rights, with the result that the applicants could not in their tax appeals criticise those decision in a proper manner. They invoke Article 13 which reads as follows:
“Everyone whose rights and freedoms as set forth in [the] Convention are violated shall have an effective remedy before a national authority notwithstanding that the violation has been committed by persons acting in an official capacity.”
In this connection the Court recalls, in conformity with its established case-law, that Article 13 does not guarantee a remedy whereby a law as such can be challenged before a domestic organ. It follows from the terms of the applicants' submissions that it is basically the legislation as such which they attack. However, as stated above, Article 13 does not guarantee a remedy for such complaints. n
It follows that also this complaint is incompatible ratione materiae with the provisions of the Convention within the meaning of Article 35 § 3 and must be rejected in accordance with Article 35 § 4.
For these reasons, the Court unanimously
Declares the application inadmissible.
Michael O'BoyleNicolas Bratza
RegistrarPresident
Full & Egal Universal Law Academy