Pursuant to a recent ruling of the Finnish Supreme Administrative Court the terms of intra-group financing are required to be at arm's-length from the perspective of the specific Finnish borrower and higher interest charges cannot be justified by overall group level benefits.

The Finnish Supreme Administrative Court has on 3 November 2010 rendered a ruling in a case regarding the deductibility of intra-group interest expenses (KHO 2010:73). Pursuant to the ruling the terms of intra-group financing are required to be at arm's-length from the perspective of the specific Finnish borrower,and higher interest charges cannot be justified by overall group level benefits. Accordingly, existing intra-group financing arrangements should be re-analysed to ensure the full deductibility of interest expenses.

The case involved a Finnish limited liability company ("FinCo"), which was a part of a Nordic group together with a Swedish limited liability company ("SweCo"). In connection with group refinancing in 2005, FinCo had repaid its external debt of approximately EUR 36 million, which was replaced with an intra-group loan of approximately EUR 38 million from SweCo. The interest rates on the external debt had varied between 3.135 and 3.25 %. The intra-group debt was interest bearing at 9.5 % representing a blended average interest rate of the group level external and shareholder debt financing. The capital structure of FinCo had not been materially altered upon the refinancing.

Prior to the refinancing, FinCo had provided securites of an aggregate amount of approximately EUR 41 million in respect of its debt obligations. Further to the refinancing, the aggregate amount of securites provided by FinCo had been increased to approximately EUR 300 million relating to debt obligations of other group companies. Whether or not FinCo charged a commission for the securities provided is not mentioned in the ruling.

The Supreme Administrative Court held that the intra-group interest charges exceeded the arm's-length amount.

Having regard to, inter alia, the level of interest on the external debt prior to refinancing and the creditworthiness of the company (illustrated among others by the amount of guarantees provided in favor of group companies), the court held that the amount of interest payable on the loan from SweCo clearly exceeded the amount of interest which would have been paid by and between non-related parties.

Further, it had not been demonstrated that FinCo had received any financial or other services from SweCo which should have been taken into account for the purposes of determining an arm's-length interest charge.

Finally, the Court stated that in a case where the creditworthiness of the company and other circumstances would have provided for a lower interest rate, the (arm's-length) amount of deductible interest could not be determined by means of determining an average interest rate at group level. Accordingly, the amount of interest paid by FinCo representing the difference between the interest rates of 9.5 and 3.25 % was added back to the taxable income of FinCo.

The Court accepted neither the group level average interest on (i) external debt (7.05 %) or (ii) external and shareholder debt (9.5 %) as an arm's-length interest rate for FinCo. Instead it required that arm's-length interest rate be determined solely based on FinCo's stand alone financial situation. The ruling in this respect reflects the general approach taken by the OECD.

Whether or not FinCo had received a commission from the group companies was not mentioned in the ruling. However, it may be reasonably assumed that this was not the case, since if commission had been charged; it should have basically decreased the actual post-refinancing overall financing costs of FinCo.

While there are arguments supporting the approach of the Supreme Administrative Court, a strict stand alone approach may in certain cases lead to practical difficulties. For example in connection with group cash pool arrangements, it would appear unreasonable if the interest charge would always need to be individually assessed for Finnish borrowers, especially as the interest rates could change overnight.

It is essential that any intra-group interest charges to Finland are re-analysed so that the full deductibility of the interest payments is ensured. Should that not be the case, the non-deductibility of interest in Finland could lead to an economical double taxation at group level.

The ruling may also serve as a reminder for Finnish group companies in a lending position. The funding of foreign subsidiaries may not be deemed as arm's-length by local tax authorities if a general group level average interest rate is applied.

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