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Court Case on Determining Arm’s Length Interest in Group
The Supreme Administrative Court has issued a precedent on determination of arm's length interest level in intra-group financing structures. According to the ruling the level of interest rate in intra-group financing should be based on a company-specific analysis of their financial position. Hence, the internal arm's length interest rate may differ between companies of the same group. Taxand Finland highlights the outcome of the ruling and the internal financing terms each group company faced.
In a case of the Supreme Administrative Court, a Finnish limited liability company, Company A, had settled its external debts in connection with a reorganisation of the group's financing. This resulted in Company A refinancing its business activities with an internal debt from a Swedish group Company B. The interest rate of the external debts had been from 3.125 to 3.25% whereas the interest rate of the new intra-group debt was 9.5%. The intra-group interest rate was determined based on interest rates in group's external loans, bonds and shareholder loans.
In its ruling the Supreme Administrative Court stated that the arm's length interest rate of Company A's debts to Company B was 3.25% due to that fact that the financial position of Company A had not changed in the refinancing and neither had Company A received any financial services from Company B that could have been taken into account when determining arm's length interest rate. Also it should be noted that overall financing need or capital structure of Company A had not changed either. Consequently neither the average interest rate of external group financing (7.04%) nor the interest rate in the company-specific financing conditions of Company A (9.5%) were accepted in taxation.
In its reasoning, the Supreme Administrative Court stated that the financial position and credit rating of a separate group company may differ from the overall financial standing and credit rating of the group. In case the credit rating and other circumstances of a company enable substantially more profitable financing terms, the arm's length interest cannot be determined based on the financing terms of external loans of the whole group.
Based on the ruling, it seems that the financial terms of the external loans of the whole group do not dictate the arm's length loan terms, especially interest rates, between group companies. The internal rates have to be determined separately for each relation considering the arm's length principle.
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