The Finnish Supreme Administrative Court (“SAC”) has recently issued a significant ruling (KHO:2017:5) in which it confirmed that a company may freely determine its capital structure and allowed a deduction for arm’s length interest expenses on a shareholder loan.
The case related to a distribution by a Finnish limited liability company of all its distributable funds to its sole shareholder. The amount of distribution was not paid out, but instead left outstanding as a debt. According to the published version of the case, the shareholder was a federation of municipalities, which was exempted from tax on the interest income.
The SAC stated in its reasoning that it was characteristic for a limited liability company to distribute funds to its shareholder either as a dividend or other distribution of funds, and that a shareholders’ meeting may resolve on such distribution. Therefore, the debt originating from the distribution was connected to the company’s business, rendering the interest expenses on the debt deductible, subject to the specific interest limitation rule. In brief, the specific interest limitation rule provides a cap of 25% of EBITDA (for tax purposes) on the deductibility of a company’s related party net interest expenses. Overruling the earlier decisions of the Tax Administration and the Administrative Court, the SAC stated that the general anti-avoidance rule (GAAR) was not applicable in the case.
There are three items in the SAC’s ruling that are of particular interest for Finnish businesses:
- The ruling implies that, from a tax perspective, a company may freely choose its capital structure. Whether a distribution is paid in cash or left outstanding as a debt has no impact on the applicability of the GAAR;
- It clearly indicates that any tax implications at the shareholder/recipient level are irrelevant; and
- The arm’s length requirement, as stated by the SCA, seems to relate only to the interest rate on the shareholder loan (i.e., the SAC did not extend the arm’s length requirement to the capital structure of the debtor following the distribution).
By allowing a company to modify its capital structure within the limits of the Companies Act, the SAC ruling basically indicates that a company may freely choose its capital structure from the outset.
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