On 19 May 2016, the Supreme Administrative Court of Finland (the SAC) issued two decisions concerning the right to deduct interest costs within a group of companies. The SAC ruled that the Finnish branch of an international group of companies was not able to deduct interest costs paid by the branch to a foreign group entity in its taxation.
Allocation of Income and Assets to a PE
In both cases, a foreign entity belonging to a group of companies had established a branch in Finland, and shares of another operating group company had been allocated to the branch after an intra-group share acquisition. Further, the intra-group loans related to the share acquisitions had been allocated to the branch.
The specific question in these cases was whether the shares transferred to the branch could be treated as assets of the branch and whether the interest costs related to the share acquisitions would have been deductible from the taxable income of the branch. In both cases, the SAC ruled that the companies had not been able to provide sufficient business reasons for the argument that the shares could belong to the business carried out by the branch. Therefore, the branch was not able to deduct the interest costs related to the share acquisition in its taxation.
Although the outcome of the rulings on the main question was the same, it is worth paying attention to the different reasoning used in these cases. In decision 2016:71, the branch had only limited business functions and personnel. The SAC held that the representatives of the branch did not exercise control in the underlying operating company, and such control was actually held by the foreign entity of the branch or the parent company of the whole group. Thus, the shares in the operating company were not in the permanent use of the business of the branch and were not held as assets belonging to the branch.
Application of the General Anti-avoidance Rule
In its decision 2016:72, the SAC ruled by vote that the transfer of shares of the operating company under the Finnish branch was actually a part of a series of arrangements, and these arrangements should be evaluated as a whole while also taking into account the Finnish anti-avoidance rule. In this case, the shares of the operating company were first transferred from an US company to a Swedish company, after which the shares were allocated to the Finnish branch. Based on this evaluation, the SAC held that the intention of the arrangements was considered to be to avoid the payment of tax by taking advantage of the interest deductions and group contribution regime. Therefore, the SAC ruled that, as a result of the arrangements, the interest costs were not deductible.
Implications on Tax Planning
The rulings are significant, as they challenge the position of branches as holding vehicles used in share acquisitions between intra group companies. Under the circumstances presented in these cases, the court stated, among other things, that taking into account the OECD model income tax convention commentary, the shares and the loan could not be allocated to the branch. Further, the court has underlined the significance of the business reasons behind tax planning and in evaluating the applicability of the general anti-avoidance rule. There are currently similar cases pending in the Finnish courts and these rulings are likely to have effect on their outcome depending on the relevant circumstances.
The Finnish Tax Administration has issued an announcement according to which it will provide guidance on the implications of the rulings on Tax Administration’s guidelines and interpretations.