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A significant precedent concerning transfer pricing and deductibility of interest

  • Finland
  • Tax planning and consultancy


The Supreme Administrative Court issued a significant precedent on 3 July 2014 concerning the characterization of debt financing for transfer pricing purposes. In the annual assessment and at the Board of Adjustment, a hybrid instrument was treated as equity and the related interest expense was treated as non-deductible. The company won its case in the Court of Appeals and in the Supreme Administrative Court.

Facts of the case

A Finnish company had obtained a loan of 15 MEUR from its main owner in Luxembourg in 2009. The company claimed a tax deduction for the interest incurred in 2009. The Luxembourg parent had granted the financing based on the demands of the banks that had financed the Finnish operative entity. According to the decision, the banks required a subordination for the intra-group financing and a seniority for the bank financing. In addition, they required that the hybrid instrument in question be treated as equity for IFRS purposes. The loan did not have a maturity date or collateral. The fixed annual interest rate was 30% and the accrued interest was added to the capital. The loan could only be repaid at the initiative of the debtor. The Tax Administration claimed non-deductibility based on a characterization as equity under section 31 of the Fiscal Assessment Act (VML). They did not refer to or try to establish tax avoidance under section 28 of the VML.

The decision of the Supreme Administrative Court concerned the debt equity characterization of the hybrid instrument and whether or not section 31 of the VML allowed the re-characterisation for tax purposes. Section 31 closely resembles Article 9 of the OECD Model Tax Treaty, and the Tax Administration had claimed that Article 9 and the OECD Transfer Pricing Guidelines supported such a re-characterisation. The majority of the Supreme Administrative Court ruled that, taking into account the severity of the outcome for the taxpayer, i.e. the non-deductibility of interest expense, section 31 of the VML did not allow for such a re-characterisation. The court determined that Article 9 of the income tax treaty between Finland and Luxembourg did not expand Finland’s domestic taxation right and hence was irrelevant. The OECD Transfer Pricing Guidelines, which the Tax Administration had relied upon, could only be used to assess the arm’s length character of the transaction within the scope of section 31 of the VML, and not to disregard the loan as such, for which section 28 of the VML would have been required. The decision was unanimous concerning the outcome, but there was a vote 3-2 concerning the argumentation. A concurring judge left in the minority pointed out, the Tax Administration failed to support its case by analysing debt equity criteria of the hybrid instrument.

The Supreme Administrative Court rejected the appeal of the Tax Recipients’ Legal Services Unit and returned the case to the Tax Administration for an assessment of the arm’s length level of the interest.

Impact of the precedent

The deductibility of interest has traditionally been broad in Finland. The present decision was not unexpected and will be important in establishing limits on the re-characterisation of transactions for transfer pricing purposes. It highlights the need for additional supporting evidence, such as the demand in this case by the banks that the additional funding be treated as equity for IFRS purposes, and timely transfer pricing documentation.