A Oyj was the parent company of the A-group, and responsible for the group’s centralised financial activities. It owned the entire share capital of D Oy and B Oy. D Oy in turn owned the entire share capital of ZAO C, a Russian company.
A Oyj had raised funds from outside the group and lent these funds to its Finnish subsidiary B Oy, which in turn had provided a loan to ZAO C.
The interest charged by B Oy on the loans to ZAO C was based on the cost of A Oyj’s external financing. The interest rate also included a margin of 0,55 % in tax year 2009, 0,58 % in tax year 2010 and 0,54 % in tax year 2011. The margins had been based on the average margin of A Oyj’s external financing plus 10 %.
The Tax Administration had considered that the level of interest to be charged to ZAO C should have been determined taking into account the separate entity principle and ZAO C’s credit rating.
In order to calculate the arm’s length interest rate, the synthetic credit rating of ZAO C had been determined and a search of comparable loans in the Thomson Reuters DealScan database had been carried out. On the basis of this approach, the Tax Administration had considered the market interest margin to be 2 % for the tax year 2009 and 3,75 % for the tax years 2010 and 2011.
In the tax adjustments the difference between the interest calculated based on the adjusted rates and the interest actually charged to ZAO C had been added to A Oyj’s taxable income.
Judgement of the Supreme Administrative Court
The court overturned an earlier decision handed down by the Administrative Court of Helsinki and ruled in favour of A Oyj.
The Supreme Administrative Court held that ZAO C had received an intra-group service in the form of financing provided by A Oyj through B Oy. The Court also considered that the cost-plus pricing method referred to in the OECD Transfer Pricing Guidelines was the most appropriate method for assessing the pricing of intra-group services. Thus, the amount of interest to be charged to ZAO C could have been determined on the basis of the costs incurred by the Finnish companies of the group in obtaining the financing, i.e. the cost of external financing plus a mark-up on costs, and ZAO C could have benefited from the better creditworthiness of the parent company of the group. Consequently the Supreme Administrative Court annulled the previous decisions of the Administrative Court and set aside the tax adjustments.
“B Oy has been responsible for financing ZAO C and certain other group companies with funds received from the parent company. The company is a so-called ‘shell company’ which has had no other activity since 2009 than to act as a company through which intra-group financing formally flows.”
“The question is whether the tax assessments of A Oyj for the tax years 2009 to 2011 could be adjusted to the detriment of the taxpayer and the taxable income of the company increased pursuant to Article 31 of the Tax Procedure Act, because the level of the interest margin paid by ZAO C to the Finnish group companies was below the level which ZAO C would have had to pay if it had obtained financing from an independent party.
The Supreme Administrative Court’s decision KHO 2010:73 concerns a situation where a new owner had refinanced a Finnish OY after a takeover. The interest rate paid by the Finnish Oy on the new intra-group debt was substantially higher than the interest rate previously paid by the company to an external party, which the Supreme Administrative Court did not consider to be at arm’s length. The present case does not concern such a situation, but whether ZAO C was able to benefit financially from the financing obtained through the Finnish companies of the group.
In its previous case law, the Supreme Administrative Court has stated that the methods for assessing market conformity under the OECD Transfer Pricing Guidelines are to be regarded as an important source of interpretation when examining the market conformity of the terms of a transaction (KHO 2013:36, KHO 2014:119, KHO 2017:146, KHO 2018:173, KHO 2020:34 and KHO 2020:35). As explained above, the transfer pricing guidelines published by the OECD in 1995 and 2010 are essentially the same in substance for the present case. It is therefore not necessary to assess whether the company’s tax assessment for the tax year 2009 could have been adjusted to the detriment of the taxpayer on the basis of the 2010 OECD transfer pricing guidelines.
According to the OECD transfer pricing guidelines described above, when examining the arm’s length nature of intra-group charges, a functional analysis must first be carried out, in particular to determine the legal capacity in which the taxpayer carries out its activities. The guidelines further state that almost all multinational groups need to organise specifically financial services for their members. Such services generally include cash flow and solvency management, capital injections, loan agreements, interest rate and currency risk management and refinancing. In assessing whether a group company has provided financial services, the relevant factor is whether the activity provides economic or commercial value to another group member which enhances the commercial position of that member. In contrast, a parent company is not considered to receive an internal service when it receives an incidental benefit that is merely the result of the parent company being part of a larger group and is not the result of any particular activity. For example, no service is received when the interest-earning enterprise has a better credit rating than it would have had independently, simply because it is part of a group.
The financial activities of the A group are centralised in A Oyj. The group’s external and internal loan agreements have prohibited A Oyj subsidiaries from obtaining external financing in their own name. Where necessary, the subsidiaries have provided collateral for debts incurred by the parent company. The financing model has been designed to provide adequate financing on favourable terms for the group as a whole. When comparing the level of interest charged by B Oy to ZAO C in the tax years 2009-2011 with the level of interest charged by ZAO C based on its own credit rating as determined by the tax audit, the group’s financing activities have been of economic value to ZAO C. ZAO C has thus received an intra-group financial service in the form of financing provided by A Oyj through B Oy. A Oyj has in turn acted as a provider of centralised financial services to the group.
The OECD transfer pricing guidelines described above have identified the cost-plus pricing method as the most useful method for assessing the pricing of intra-group services. The method involves adding an appropriate cost-plus mark-up to the cost of providing the service. Thus, the amount of interest to be charged to ZAO C could have been determined on the basis of the costs incurred by the group’s Finnish companies in obtaining the financing, plus a cost mark-up, and ZAO C could have benefited from the better creditworthiness of the group’s parent company.
Consequently, the tax assessments of A Oyj for the tax years 2009-2011 could not be adjusted to the detriment of the taxpayer on the ground that the margin added to the interest charged to ZAO C was below the market level, since the interest margin should have been determined in accordance with the principle of the separate entity principle and by taking into account the company’s own credit rating. It has not even been alleged that ZAO C was not remunerated at market rates in the form of interest, including the interest margin, for the financial services provided to it by A Oyj and B Oy in the tax years 2009 to 2011. Consequently, the decisions of the Administrative Court and the Tax Adjustment Board and the tax adjustments made to the detriment of the taxpayer must be annulled in respect of the interest margins charged to ZAO C.”