On 2 April 2020, the Supreme Administrative Court (“SAC”) issued new transfer pricing precedents on the concept of re-characterization of transactions and on transfer pricing of a loss-making subsidiary. In addition, on the same day the SAC issued a precedent on the utilization of final losses in a foreign subsidiary through cross-border group contribution. All these cases are of importance for multinational groups and further clarify the interpretation of the transfer pricing adjustment provision and the Group Contribution Act.
Re-characterization of transactions (SAC 2020:35)
A group had reorganized its financing function by establishing a new group financing company in Belgium. The Finnish parent company transferred intra-group receivables to the new financing company as a contribution in kind. The parent company and the new financing company had agreed on target thresholds for return on invested capital. The financing company had been obliged to pay any exceeding return to its parent company and correspondingly the parent company paid compensation in case the return was below the agreed threshold.
The Finnish Tax Administration (“FTA”) considered that based on a functional analysis the Finnish parent company continued to act as the group’s financing company despite the transfer of the intra-group receivables into the Belgian financing company. The FTA adjusted the transfer pricing based on this view and considered that the transactions were not re-characterized but the transfer pricing adjustment was only based on the transactions actually carried out between the companies.
Contrary to the FTA’s position, the SAC ruled that by disregarding in particular the transfer of intra-group receivables to the new financing company, the FTA has in fact re-characterized the transactions between the group companies. Since re-characterization of transactions is not allowed under the transfer pricing adjustment provision, the SAC accepted the taxpayer’s appeal.
This precedent further strengthens the SAC’s position that re-characterization (or non-recognition) of transactions between related parties is only possible when the general anti-avoidance provision is applied and not within the transfer pricing adjustment provision’s scope of application. The first precedent on this topic was issued in 2014 and the question has been dealt in several precedents after that. By issuing again a new precedent on the re-characterization of transactions through transfer pricing adjustments, the SAC highlights the importance of basing the transfer pricing on the transactions chosen and carried out by the group companies.
Loss-making subsidiary (SAC 2020:34)
The other transfer pricing precedent concerned the acceptability of a long-time loss-making distributor. The Finnish group company had been loss-making for nearly ten years with the exception of one profitable year. The company purchased the goods sold from related party contract manufacturing companies. The transfer prices were based on modified cost plus/TNMM method and the contract manufacturing entity was chosen as the tested party for the benchmarking study. The group had set the intra-group prices based on its transfer pricing model despite the fact that it resulted the Finnish group company being loss-making while the group as a whole was profitable.
The FTA considered that due to the long-time loss-making nature of the Finnish operations, at arm’s length, the Finnish group company would not have agreed to continue its operations without some sort of compensation. Further, the FTA considered that due to the long-time loss-making, it is not reliable to use the manufacturing company as the tested party and instead used the Finnish full-risk distributor as the tested party. The FTA adjusted the taxation in accordance with the benchmark study it carried out.
The SAC stated that the loss-making nature of the Finnish operations was only an indication to analyse the transfer pricing further and not an indication that a consideration has been left unpaid between the group companies. The SAC accepted the use of the contract manufacturers as the tested party since it was in accordance with the OECD Transfer Pricing Guidelines taking into account the functions, risks and assets of the companies. It was undisputed that the group companies had followed the transfer pricing documentation and that the comparables used in the benchmarking study were appropriate. Due to this as well as the fact that the Finnish group company presented business reasons for its loss-making operations, the SAC accepted the taxpayer’s appeal.
The main take-away from this precedent is that the transfer pricing model and the basic principles set in the OECD Transfer Pricing Guidelines should be respected by the FTA even where these result in a longer loss-making period for a group company. The case also highlights that in case of loss-making group company, the FTA should demonstrate what is the transaction it adjusts and on what grounds. Several years of losses is not a sufficient reason as such to adjust the transfer pricing. This case is particularly important for groups of companies operating with de-centralized transfer pricing models.
Utilization of final losses in a foreign subsidiary (SAC 2020:36)
The case concerned an advance ruling issued by the Central Tax Board on deductibility of cross-border group contributions to cover a subsidiary’s final losses. The Finnish parent company’s Swedish subsidiary had incurred losses in 2001–2003 and in 2008. In 2008, the operations in Sweden had been terminated but the company had not been dissolved. The Finnish parent company was contemplating to grant a group contribution to its Swedish subsidiary to cover the final losses in the company. According to the Group Contribution Act, cross-border group contributions are not deductible. The company based its reasoning on the EU’s freedom of establishment.
The Central Tax Board denied the group contribution’s deductibility mainly by stating that the group contribution was not granted for business operations in accordance with the then applicable provision in the Group Contribution Act. As the group contribution would not have been deductible in case granted to a Finnish company, the non-deductibility did not constitute a restriction on the freedom of establishment. The SAC reached the same conclusion but with different reasoning. The SAC considered that the requirement of granting the group contribution for business operations was fulfilled but since the losses in question would have been expired in case of a Finnish subsidiary (in Finland tax losses are carried forward for ten years) the group contribution was not deductible. Since the treatment would have been the same in a domestic group contribution, the SAC did not consider that the non-deductibility constituted a restriction on the freedom of establishment.
Despite the outcome of the case being negative for the taxpayer in question, the precedent can be concluded to confirm the deductibility of a cross-border group contribution to cover final losses provided that such losses have not expired under Finnish tax legislation.
The Government of Finland has already before this ruling stated that it will initiate a legislative process to amend the Group Contribution Act to allow cross-border group contributions to the extent the group contributions cover final losses. The process was initiated after Finland received a formal notice from the EU Commission on 7 March 2019 to amend legislation to allow group contributions covering final losses to EU/EEA companies. Finnish companies having foreign subsidiaries with final losses should review their possibilities to utilize the final losses through group contributions.
D&I’s tax team is happy to discuss these precedents and their effects further.