The Supreme Administrative Court has recently rendered a judgment (KHO:2010:73) on the determination of the arm’s length interest level in intra-group financing.

A Finnish limited liability company had settled its external debts and refi-nanced its operations with an internal debt from a Swedish group company in connection with the reorganisation of the group’s finance. The interest rate of the external debts of the Finnish company had varied between 3.125% and 3.25%. The interest rate of the new intra-group debt amounted to 9.5% and was, according to the company, based on average interest rates in the group’s external loans, bonds and shareholder loans.

According to the Court’s ruling, for taxation purposes the interest rate level in intra-group financing may not be determined based on a group level external financing. In this case, it meant that the average interest rate of external group financing (7.04%) was not accepted as basis for determining the intra-group interest rate for taxation purposes. Instead, the level should have been based on a company-specific analysis of credit rating and financial position. The capital structure of the company had not been materially changed, the external financing had merely been replaced by the internal refinancing and the company had not received any financial services from the Swedish company. Therefore, the Court held that the arm’s length interest rate for the internal debt would have been 3.25%.

In conclusion, the financial terms of a group’s external loans do not determine the arm’s length terms between group companies. A general consequence of the ruling is that the terms of internal financing of each group company may need to be separately reassessed.