The Finnish Supreme Administrative Court´s decision on transfer pricing re-characterization Petri Saukko Judge, Doctor of Laws IATJ Assembly, October 2014 Washington, D.C., USA

 Decision on a case concerning a hybrid loan to a Finnish limited liability company from its main owner based in Luxembourg  Contrary to the views of the tax authorities, the loan from the parent company could not be deemed to be equity in taxation of the subsidiary, and the interest paid on the loan was thus deductible in the taxation of the Finnish subsidiary SAC 3 July Judgment

 The Finnish limited liability company had been financed by a 15 MEUR loan from the Luxembourgian company in 2009 to alleviate financial difficulties of the Finnish company resulting mainly from the general financial downturn  The loan was secondary in ranking of claims in comparison to bank loans and was treated as equity for IFRS purposes. The loan also had e.g. a fixed interest rate at 30 % which would be added to the financial capital and the loan could be paid back only by the request of the borrower SAC 3 July Facts

 Tax authorities had claimed that the loan should be treated as equity instrument in taxation based on the Section 31(1) of Finnish Taxation Procedure Act, whereupon the interest would not have been tax deductible  re-characterization would have been made by referring to the OECD transfer pricing guidelines SAC 3 July 2014 – View of the Tax authorities

 Section 31 of the Finnish Taxation Procedure Act prescribes the arm’s-length principle for related party transactions  Section 31 has so far been generally applied to determining and requiring that transactions between related parties follow arm’s length principles, i.e. market rates, but not to actual re-characterization of instruments  Based on the existing case law, e.g. re-characterization of debt to equity has been made pursuant to Section 28 of the Taxation Procedure Act i.e. the general anti-avoidance rule SAC 3 July 2014 – Legal question

 Disregarding the business transaction agreed upon by the parties and re-characterization the transaction would have required an explicit authorization for re-characterization under a specific regulation of Finnish Taxation Procedure Act  As Section 31 (1) did not contain such a rule, SAC ruled that the re-characterization may not be done based on it  The interpretation of Article 9 of the Tax Treaty may not overrule domestic tax regulations. This effectively meant that the OECD transfer pricing guidelines may not be used for re-characterization without specific support from the domestic tax law SAC 3 July 2014 – Reasoning of the Court

 Firstly, as previously, re-characterization shall be made under Section 28 of the Finnish Taxation Procedure Act, and not based on Section 31  Secondly, sovereignty of the Finnish tax law in comparison with international guidelines was maintained. The OECD transfer pricing guidelines may be used as indicative guidance, but not as decisive grounds for re- characterization  Thirdly, re-characterization shall also in the future be based on a specific section in law, at least if the adjustment would result in a less favorable decision for the taxpayer SAC 3 July 2014 – Outcomes (1)

 The Finnish interpretation may lead to the following in certain situations  Non taxable (/low) income in the lender´s State  E.g. different interpretation of the nature of the instrument  Right to deduct loan interest costs in Finland  Pro & contra  A strict interpretation of the wording of the law protects taxable persons, but on the other hand it can create opportunities to different tax planning arrangements  Naturally the Supreme Administrative Court and Administrative Courts are aware of these tax planning possibilities, but also the legislator has been aware of this for decades and the Finnish Court tradition is to follow the wording of the law. However, there has not been any changes to the provisions of the tax law  On the other hand  General anti-avoidance rule may apply SAC 3 July 2014 – Outcomes (2)