The Finnish Supreme Administrative Court (the “SAC”) issued a precedent concerning intra-group financing on 21 May 2021 (SAC 2021:66). In the precedent, the SAC overturned an earlier decision handed down by the Administrative Court of Helsinki and ruled in favour of the taxpayer.
The main question concerned the determination of an arm’s length interest rate and the implicit support in intra-group financing that has been acknowledged in the OECD’s Transfer Pricing Guidance on Financial Transactions, which was published in February 2020. What makes the precedent interesting is that, instead of focusing on analysing the arm’s length nature of the pricing of the loan involved in the case as such, the SAC ruled that the pricing of intra-group loan financing could be construed as compensation for intra-group financial services to which the cost-plus method can be applied.
The SAC’s precedent differs from both the established tax praxis that applies to the transfer pricing of intra-group loans and the OECD’s Transfer Pricing Guidance on Financial Transactions where the credit rating of the borrower, or the group’s credit rating as allowed by the OECD’s recent guidance, has served as the starting point and the arm’s length nature of intra-group loan transactions has been assessed as though these transactions are financing transactions and not service transactions.
A Plc was A Group’s parent company. A Plc was in charge of the financing functions of A Group and responsible for obtaining external financing and for the provision of intra-group financing to the subsidiaries as the subsidiaries were not allowed to obtain external financing themselves. A Plc had provided financing to its Finnish subsidiary B Ltd, which acted as an intermediary providing intra-group loans to the Russian subsidiary ZAO C. The pricing of the intra-group loan granted to ZAO C was based on the reference rate and a margin that corresponded to the average margin of A Plc’s external financing added with a 10% mark-up.
The Finnish Tax Administration’s Large Taxpayers’ Office performed a tax audit on A Plc covering tax years 2009–2011. The Large Taxpayers’ Office held that the interest rate for the loan financing provided to ZAO C should have been determined based on ZAO C’s standalone credit rating. As a consequence, A Plc’s profits were adjusted under Section 31 of the Finnish Act on Tax Assessment on the grounds of the non-arm’s length pricing of the intra-group financing.
A Plc appealed the decision to the Board of Adjustment and to the Administrative Court of Helsinki. Both ruled that the group’s credit rating could not be applied as a reference for the intra-group financing and that the pricing should have been based on the borrower’s own credit rating in accordance with the separate entity approach and the arm’s length principle.
A Plc submitted an appeal to the Supreme Administrative Court. In its appeal, A Plc argued that the incidental benefit of the group affiliation would be acknowledged by a third-party lender and should be considered when analysing the arm’s length nature of the intra-group loans in line with the updates to the OECD’s Transfer Pricing Guidelines. Additionally, A Plc stated that there were no suitable comparables in the market and that the financing model applied by A Group constituted a de facto financing-related cost contribution arrangement.
Rather unexpectedly, the SAC referred to the OECD Transfer Pricing Guidelines’ Chapter VII, which concerns intra-group services. Instead of analysing the implicit support in terms of the impact on the credit rating, the SAC ruled that ZAO C had obtained economic benefit from the centralised financing function of A Plc for which A Plc should have been compensated as a service provider. According to the SAC, the pricing of the intra-group financing could therefore be determined by adding a mark-up to the costs of the obtained external financing in the case at hand.
The SAC ruled that A Plc’s taxable result could not be adjusted on the basis that the interest margin ought to have been determined based on the separate entity approach and ZAO C’s standalone credit rating. Additionally, the SAC highlighted that, in the matter at hand, it had not even been alleged that the interest, including the interest margin, that ZAO C had paid to A Plc and B Ltd in 2009–2011 did not constitute an arm’s length compensation for the financing services provided to ZAO C. The SAC overturned the previous decisions and ruled that no tax adjustments would be imposed on A Plc’s taxable income based on the applied interest margins.
This decision handed down by the SAC, which pertains to the years 2009–2011 and which is contrary to established transfer pricing praxis, means that intra-group financing transactions could be considered to constitute provision of services transactions. On the other hand, the SAC’s decision is not in line with the OECD’s recent guidance that relates to financing transactions. As such, the decision seems to allow for multiple interpretations, but in general, the principles described in the OECD’s guidance on financial transactions should serve as a starting point when analysing intra-group financing.
Borenius’ lawyers are available to assist in addressing any questions you may have regarding the precedent and its implications for the taxation of your business.