Legal Alert – Finnish Supreme Administrative Court’s Decision on Transfer Pricing
On 3 July 2014, the Finnish Supreme Administrative Court (SAC), rendered its decision on a case concerning a hybrid loan to a Finnish limited liability company from its main owner based in Luxembourg. Contrary to the views of the tax authorities, according to the decision, the loan from the parent company could not be deemed to be equity in taxation of the subsidiary, and the interest paid on the loan was thus deductible in the taxation of the Finnish subsidiary.
In said case, the Finnish limited liability company had been financed by a 15 MEUR loan from the Luxembourg company in 2009 to alleviate the financial difficulties of the Finnish company resulting mainly from the general financial downturn. The loan was secondary in ranking of claims in comparison with bank loans and was treated as equity for IFRS purposes. The loan also had e.g. a fixed rate of 30 %, with the interest to be added to the principal. Tax authorities had claimed that the loan should be treated as equity instrument in taxation based on the Section 31(1) of Finnish Taxation Procedure Act, whereupon the interest would not have been tax deductible. Re-characterisation would have been made referencing to the OECD transfer pricing guidelines. Section 31 of the Taxation Procedure Act prescribes the arms-length principle for related party transactions. Said Section has so far been generally applied to determining and requiring that transactions between related parties follow arms length principles, i.e. market rates, but not to actual re-classifications of instruments. On the contrary, based on existing case law, e.g. re-characterisation of debt to equity has been made pursuant to Section 28 of the Taxation Procedure Act i.e. the general anti-avoidance rule. SAC, on its part, ruled that disregarding the business transaction agreed upon by the parties and re-characterising the transaction would have required an explicit authorisation for re-characterisation under a specific regulation of Finnish Taxation Procedure Act. As Section 31 (1) did not contain such a rule, SAC ruled that the re-characterization may not be done based on it. Further, SAC confirmed that the interpretation of Article 9 of the tax treaty may not overrule domestic tax regulations. This effectively meant that the OECD transfer pricing guidelines (especially paragraph 1.65 contained therein) may not be used in re-classification without specific support from domestic tax law. The case could be seen to confirm several important aspects. Firstly, as previously, reclassification shall be made under Section 28 of the Finnish Taxation Procedure Act, and not based on Section 31. Secondly, sovereignty of the Finnish tax law in comparison to international guidelines was maintained. OECD transfer pricing guidelines may be used as indicative guidance, but not as decisive grounds for reclassification. Instead, re-classification shall also in future be based on a specific section in law, at least if the adjustment would be result in a less favorable decision for the taxpayer.