Important court rulings on the deductibility of intra-group interest expenses and international tax avoidance
On 19 May 2016, the Supreme Administrative Court (SAC) published two significant rulings relating to the question of whether a Finnish branch used as an acquisition vehicle was entitled to deduct intra-group interest expenses. Following the rulings, on 27 May, the Finnish Tax Administration issued a statement on how the Tax Administration interprets the rulings and their impact on other similar cases.
First ruling in brief
The ruling KHO:2016:71 dealt with an acquisition in which a Finnish branch of a Danish company acquired a Finnish target company from another Danish group company. The SAC found that only minor activities and personnel had been transferred to the branch and that the representatives of the branch had not de facto used shareholder's control and rights over the target company.
The shares and the acquisition debt could not be accepted as the assets and debt of the branch for tax purposes, and consequently, deductibility of the interest expenses was denied. (Tax years 2006–2010; added taxable income of approximately EUR 140 million plus tax increases of approximately EUR 5.5 million.)
Second ruling in brief
The ruling KHO:2016:72 was clearly a tougher one. It concerned an arrangement in which the shares in a Swedish target company, initially acquired by a US group company from a third party, were transferred in a chain of transactions to a Finnish branch of a Swedish group company. Like in the above-mentioned case, the interest expenses for to the intra-group debt financing were covered by group contributions (in this case, however, from another Finnish group entity).
The SAC ruled that taking the circumstances as a whole, the nature and the purpose of the transactions did not correspond to the legal forms used, and that the arrangements had been made only for the purpose of tax avoidance. The shares acquired could not be regarded as assets of the branch.
Furthermore, as the entire arrangement was deemed purely artificial, EU law and the non-discrimination article in the relevant tax treaty did not preclude the denial of the interest deductions. (Tax year 2008; added taxable income of approximately EUR 6 million plus tax increase of approximately EUR 0.3 million.)
A close call on the rulings
The reasoning adopted by the SAC (and the administrative court) is interesting, as it touches many debated topics. Especially the latter ruling is a significant borderline case.
The minority of two against three judges completely disagreed with the main conclusion and would have approved the allocation of shares to the branch, the use of branch as an acquisition vehicle as well as the entire chain of intra-group arrangements as implemented practically in connection with the external acquisition. The minority would also have held an oral hearing in the case.
Hot statement – impact on other cases
Both above cases arise from tax audit processes and subsequent litigation.
The Tax Administration has already for many years been very active in auditing intra-group acquisitions and financing arrangements. In accordance with the newly issued statement, the Tax Administration now intends to finalise the auditing of several dozens of somewhat similar cases currently pending based on the guidelines set out by the SAC rulings.
In the Tax Administration's view, debt push-down arrangements can be interpreted as tax avoidance if a Finnish branch or acquisition company is used in arranging the intra-group financing, if the nature and purpose of the transactions does not correspond to the legal forms used, and if the arrangements are made in order to avoid taxation.
Although the statement does not mention it, we note that an additional requirement should be that the arrangement is purely artificial, as indicated in the reasoning in both SAC cases.
In our opinion, the SAC rulings shall nevertheless not be interpreted so as to hinder the customary use of a Finnish acquisition company or vehicle, so long as the arrangement in whole does not cross the line of tax avoidance (as opposed to the circumstances in the two rulings at hand).
Future acquisition and financing structures
In the statement, the Tax Administration also urges taxpayers to contact it on their own initiative if arrangements including interest expenses similar to those in the published cases have been applied, "in order to solve cases faster and to minimise additional consequences".
This kind of urging is very exceptional. In our view, it is questionable if the rulings at hand should be given any restroactive effect on cases not yet pending in any instance, at least to the extent they may be seen to tighten the tax treatment from previous interpretations and tax praxis.
However, it is clear that the SAC rulings should be taken into account in future acquisition and financing structures.
In the statement, the Tax Administration also emphasises the importance of ascertaining the tax treatment in advance for example through advance rulings, the intensified client cooperation procedure with the Large Taxpayers' Office, or through informal discussions. It is easy to mainly agree with this view. However, none of these methods come problem-free.
The best way to deal with tax risks should be carefully considered in each case.