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Finland Balances Competition by Restricting Interest Deductability

Finland

Taxand's Take

At the moment, interest expenses are widely deductible in corporate tax. Deductibility can only be restricted by applying the transfer pricing regulation or the general provision for tax avoidance. On 12 April 2012, the Finnish Ministry of Finance published a draft for a law proposal on restricting the deductibility of interest expenses in business taxation. The intention is to amend the Finnish Business Income Tax Act (360/1968) in June 2012, and the new rules would come into force as of 1 January 2013. The goal of this proposed regulation is to secure Finland's tax base and to balance competition between domestic and foreign groups of companies. Taxand Finland examines the draft law proposal to assess the impact it will have on the tax burden of multinationals with businesses in Finland.

The draft for a law proposal has been widely criticised. The final bill is expected before Autumn 2012 - the contents of which may change from their current form.

Main aspects of the proposed regulation
According to the draft, limitations would be applicable to:

  • corporations
  • partnerships
  • corresponding foreign entities and their permanent establishments
  • cases where the foreign entities have some other income subject to taxation under the Finnish Business Tax Act (360/1968).

The draft introduces a general limitation on the deduction of interest payments and applies irrespective of whether the purpose of the loan arrangement was to minimise the tax burden.

The proposed limitations would be applied only if the interest expenses exceed the interest income received by the company, i.e. if the company has net interest expenses. An interest expense would become non-deductible if the net interest expenses exceed 30% of the company's EBITDA (earnings before interest, taxes, depreciations and amortisations). In the proposed regulation, group contributions would be included in EBITDA. However, interest expenses would remain deductible to the extent that the net interest expenses exceed interest expenses paid to related parties. The parties are deemed to be related, if one party has direct or indirect control over the other.

In addition, back-to-back and collateral arrangements would be taken into account when assessing the deductibility of interest.

According to the draft, a general safe haven of always deducting EUR 500,000 would apply, but this amount would include all interest expenses, whether paid to related parties or not.

The proposed regulation would allow an indefinite carry forward of non-deductible interest expenses. The use of this interest carry forward would require unused EBITDA in the fiscal year of use. Change of ownership would not affect the possibility to carry non-deductible interest expenses forward. In a merger, interest expenses carried forward would pass to the acquiring company. In a division, they would pass in so far as they have obviously resulted from the transferring business, or for the part that equals to the transfer of net assets. Interest expenses carried forward could not be passed in a transfer of business.

The proposed regulation would be carried out by adding a new Section 18a to the Business Tax Act. The regulation would also be applicable if the taxpayer does not conduct active business activities for Finnish tax purposes, but instead is taxed according to the provisions of the Income Tax Act (1535/1992) (for example, with respect to rental activities). This would require an amendment of Section 58 of the Income Tax Act where a new subsection would be added. Also, an amendment to Section 65 of the Tax Procedure Act (1558/1995) is proposed in order to provide a possibility of appeal against decisions concerning non-deductible interest.


Taxand's Take


As mentioned, the proposed legislation has been widely criticised. The amount of deductible interest expenses is hard to estimate because the deductible amount is based on the same fiscal year's EBITDA.


Issues to consider:
  • An important factor is that the proposed legislation does not define the concept of interest, whilst other financial expenses will remain fully deductible.
  • A large volume of third party loans will be affected by the proposed legislation as, for example, bank loans are usually secured with collateral by a related party.
  • The proposed legislation will most likely have an effect on Finnish acquisition financing structures, as foreign funding will be harder to receive.
  • There is a risk of double taxation as the paid interest will be fully taxable in the hands of the creditor, even though the interest would not be fully deductible for the debtor.
  • Accordingly, the effective tax rate of group companies may rise.

It is possible that the contents of the final bill will change. However, companies should be aware of the potential legislative changes as they are supposed to come into force as of 1 January 2013. To be prepared, multinationals should review the impact of possible limitations to the deductibility of interest before they come into effect.

Your Taxand contact for further queries is:
Janne Juusela
T. +358 9 6153 3431
E. janne.juusela@borenius.com

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