A recent decision by the Central Tax Board demonstrates that for purposes of the balance sheet test exemption the consolidation shall be made at the fund level.
The Balance Sheet Test
The deduction of interest costs from intra-group loans has been limited through a specific set of rules implemented in 2014. An exemption from the limitation of interest deductions is included in the so-called balance sheet test rule, according to which intra-group interest costs are always deductible when the company’s equity ratio (equity / balance sheet total) is higher than the equity ratio of the consolidated group at the group parent level.
In the ruling KVL 015/2017 (not yet binding), the Central Tax Board stated that a balance sheet prepared at the HoldCo level (see picture below) was to be regarded as a sub-group balance sheet which could not be used for purposes of the balance sheet test exemption.
Instead, the Central Tax Board implied that the consolidated balance sheet shall be prepared at the fund level. In the case at hand, the fund was a Guernsey partnership which is not regarded as an independent legal entity or an accounting subject. Accordingly, under Guernsey law, the fund did not prepare a consolidated balance sheet.
The ruling of the Central Tax Board could lead to a situation where no qualifying consolidated balance sheet for balance sheet test purposes is available, thus denying the group’s possibility to use the balance sheet test altogether.
If the controversial ruling gains legal force, it is likely to have an impact on how Finnish private equity funds and investments are structured. If the consolidated balance sheet shall be prepared at the fund level, the investors (limited partners) may be encouraged to finance the fund through debt instead of equity, to maintain a low equity ratio and thereby facilitating the deduction of intra-group interest costs.
The current interest deduction rules will be replaced by a new set of rules set forth in the EU Anti Tax Avoidance directive, estimated to come into force on 1 January 2019. The described ruling by the Central Tax Board, if it gains legal force, obscures the applicability of the balance sheet test until the EU Anti Tax Avoidance directive enters into force. Meanwhile, we hope to see a final resolution to this ruling by the SAC.