The Finnish Supreme Administrative Court (“SAC”) published on 12 December 2012 a decision (KHO:2012:112) where it concluded that the transfer and acceptance of securities as collateral under the ISDA Credit Support Annex (CSA) was not deemed to be a taxable transfer under the Finnish Business Income Tax Act. In short, CSA is an optional legal document regulating credit support securities for derivatives, and part of the ISDA Master Agreement. CSAs purpose is to define the terms or rules under which security is transferred between swap counterparties in order to mitigate the credit risk associated with in the money derivative positions.
The case concerned a Finnish public limited company being a parent company of a group offering banking and asset management services and insurance against loss. In the discussed matter, the company had previously used cash and book-entry securities as collateral but aimed at expanding the scope of used collateral to include title to securities generally, and government bonds in particular. The discussed structure concerned provision of collateral by transfer of title to the relevant security or securities based on the Finnish Act on Financial Collaterals. Finnish Business Income Tax Act does not contain any applicable specific provisions and it remained thus unclear whether or not such transaction would constitute a taxable transfer.
Preceding the discussed decision of the SAC, the Finnish Central Tax Board (“CTB”) noted in its preliminary ruling that a transferee receives full title to the relevant security or securities and may thus freely dispose of such security or securities to a third party. Accordingly, the CTB argued that the transfer should be subject to tax.
The SAC concluded to the contrary. In its decision, the SAC noted that in determining whether or not a transfer is subject to tax, due attention should be paid to the characteristics of the transfer, in particular whether the transfer concerns a security arrangement or a “true” transfer of title. Although the Court acknowledged that the title was indeed contemplated to be transferred to the transferee, the transfer differed from true transfers in certain fundamental ways. First, the transfer was gratuitous. Second, the actual reason for the transfer was to provide collateral for fulfillment of contractual obligations. Third, the transferor had the right to replace the collateral provided by it during the security period and, at the end of the security period, the transferee as a general rule had the obligation to return the collateral provided. Similarly, the Court noted that practical reasons argued that the transaction was not to be treated as transfer for tax purposes. In particular, the need for collateral changed on a daily basis. Further, according to the IFRS, the collateral remained in the balance sheet of the transferor highlighting the economic nature of the transaction.
Under the reasoning adopted, the SAC ruled that a transfer or acceptance of securities as collateral under the ISDA CSA does not constitute a taxable transfer under the Finnish Business Income Tax Act.
As such, the decision clarifies the taxation of securities transactions conducted under the ISDA CSA. However, the decision could also have wider implications. Firstly, the reasoning of the Court could naturally be applied to securities transactions concluded under other security annexes with similar characteristics also. Secondly, the reasoning stresses the importance of considering the nature and purpose of the contemplated transaction and structure as a whole. In the future, such kind of reasoning could lessen tax-linked obstacles to different financing structures in Finland making international financing vehicles and structures more appealing and accessible to Finnish counterparts.