The Finnish Government proposes amendments to the transfer pricing adjustment provision
The Ministry of Finance has published a draft government proposal on amendments to the transfer pricing adjustment clause in section 31 of the Tax Assessment Procedure Act. The amended provision would allow the tax authorities to ignore the legal form and characterize intra-group transactions based on their economic substance, as well as disregard irrational transactions. Even though the amendment would bring the scope of the Finnish transfer pricing adjustment provision in line with the OECD Transfer Pricing Guidelines, previous Finnish transfer pricing audit practice causes some concerns.
Traditionally, Finnish tax treatment has followed the legal form
In transfer pricing, according to the approach adopted by the OECD, transactions between related parties are always defined based on their economic substance. The 2017 version of the OECD’s Transfer Pricing Guidelines uses the term “accurate delineation of the actual transaction”. In addition, on the rare occasion when the taxpayer’s transaction lacks economic rationality, and the arm’s length transfer price is impossible to determine, the OECD Guidelines allow tax authorities to disregard the taxpayer’s transaction and substitute it with another transaction.
In Finland, the scope of the transfer pricing adjustment provision (the TPAP) in section 31 of the Tax Assessment Procedure Act (AAP) has been different. The Supreme Administrative Court ruled in case SAC 2014:119 that disregarding taxpayer’s transactions based on the TPAP was not allowed. The case concerned the recharacterization of the taxpayer’s debt as equity, which would have led to the denial of the taxpayer’s interest deductions. The Supreme Administrative Court has since confirmed this approach in its other transfer pricing rulings (for example, cases SAC 2017:145 and SAC 2020:35).
As a consequence, the scope of the TPAP has been more limited than the scope of the arm’s length principle according to the OECD approach. The most significant difference has been that, in Finland, the tax authorities are obliged to respect the taxpayer’s choices and legal form of the transaction unless they can demonstrate that the taxpayer’s purpose has been to avoid tax.
The amendment of the transfer pricing adjustment provision will bring the substance over form principle to all related party transactions
The Government has issued a draft proposal, which would broaden the scope of section 31 of the AAP and bring the TPAP in line with the OECD approach. As this proposal is included in the Prime Minister Sanna Marin’s Government’s program, it is very likely to pass in the Parliament. The amended provision will be applicable from 1.1.2022.
At first sight, the amendment of the TPAP does not seem significant. In many countries, it is permitted to characterize transactions based on their economic substance, and for tax authorities to disregard irrational transactions. In addition, in most cases, the intra-group transactions’ legal forms are in line with their economic substance and, consequently, it will not be common for the tax authorities to recharacterize or disregard the taxpayer’s transactions.
However, the companies should include the assessment of the economic substance of the intra-group transactions in their transfer pricing documentation process, or whenever they assess the arm’s length nature of their intra-group transactions. For example, when injecting debt in the Finnish subsidiary, the company should consider whether the loan capital fulfils the arm’s length criteria. In addition, for example a third-party loan to the subsidiary with the parent company’s guarantee may, under certain circumstances, be characterized as a loan to the parent company and its equity contribution to the subsidiary. Also, foreign group finance companies will be subject to review.
Vestigia terrent – some concerns based on previous tax audit practice
Based on the experiences of previous transfer pricing audits performed after the introduction of the Finnish transfer pricing documentation requirements in 2007, there is some concern as to the interpretation and practical application of the amended and broader TPAP.
Before the Supreme Administrative Court confirmed the limited scope of section 31 of the AAP, the Finnish Tax Administration had taken an aggressive approach, and recharacterized the intra-group transactions on relatively light grounds, for example if they considered that determining the arm’s length transfer price of the transaction concluded by the company was difficult. In addition, many multinational companies found it difficult to accept the Finnish tax authorities’ interpretations of the true substance of the transactions, and considered they were not based on economic reality.
It took more than ten years to get clarity on the scope of the current TPAP. Consequently, there are some concerns that the amendment of the TPAP will give rise to a second round of disagreement, and it will take years or even decades before reasonable certainty on the application of the new TPAP can be reached.
The proposal should include more concrete justification and safeguard the taxpayer’s rights
The Finnish Tax Administration has recently developed its practices and, for example, introduced the pre-emptive discussions and reduced the number of tax audits. Consequently, it is possible that the companies may find it easier than before to discuss transfer pricing issues with the Tax Administration, including the characterization of transactions for transfer pricing purposes.
However, in order for the pre-emptive discussions to be successful, the company and the Tax Administration must be able to agree on the transfer pricing treatment. In this regard, it would be important that the Government’s proposal for the new TPAP includes details and concrete examples of the interpretation of the new provision.
The Tax Administration’s recharacterization of transactions based on their economic substance means a significant deviation from the characterization and the legal form of the transaction adopted by the company. Consequently, it is important that the taxpayer’s rights are properly respected. In our view, relevant provisions should be included in the TPAP itself.
Please do not hesitate to contact us
We are happy to discuss the proposal and its effects on your transfer pricing arrangements. You are welcome to contact us directly or through your regular Roschier contact person.