The Finnish Supreme Administrative Court (SAC) issued a preliminary ruling last week on the deductibility of interest expenses in a company distributing dividends to its only shareholder in a situation where dividends remained as a debt in the company.
In this case, a company aimed to make a profit distribution to its shareholder while leaving the distribution as a debt. Interest on a profit distribution debt to a shareholder were to be paid at an arm’s length rate.
Both the Finnish Tax Administration and the Administrative Court previously considered the cashless arrangement abusive in accordance with the general anti-avoidance rule under section 28 of the Finnish Act on Tax Assessment. However, the SAC now confirmed that the general anti-avoidance rule does not apply to this arrangement although it effectively led to leveraged capital structure and tax savings through tax deductibility of interest expenses since the interest income was partially tax-exempt for the shareholder.
Effects of the new ruling
Limited liability companies are allowed to leverage their capital structure by making a profit distribution that is left outstanding. The arm’s length interest expenses on the debt are tax deductible in accordance with the applicable tax provisions irrespective of the fact that the arrangement is carried out between related parties and may effectively be explained with tax benefits.
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See the full decision in Finnish here.