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Administrative Court of Helsinki disallows reclassification of a hybrid loan from a Luxembourg parent as capital contribution due to a TP adjustmen — Orbitax Tax News & Alerts

The Administrative Court of Helsinki (Helsingin hallinto-oikeus) gave its decision on 29 May 2013 in the case of 13/0844/4. Details of the decision are summarized below.

(a) Facts. A Finnish company (FIN Co) paid interest on a hybrid loan taken from its parent company resident in Luxembourg (LUX Co) and owning 95.7% of the share capital in FIN Co. The Finnish tax authorities as part of the normal tax procedure made a transfer pricing (TP) adjustment and reclassified the hybrid loan as a capital contribution and subsequently disallowed the deductibility of the interest expenses. Under the loan terms, the annual interest rate on the loan was fixed at 30%, the interest was added to the principal, no collateral was provided and there was no repayment by a definite date. Furthermore, FIN Co could repay the loan and the interest at any time and LUX Co did not get any rights in the decision making of the company.

(b) Legal background. Article 9 of the Finland-Luxembourg tax treaty stipulates that transactions between associated enterprises have to be at arm's length. Section 31 of the Law on Tax Procedure (Verotusmenettelylaki, VML) stipulates that transactions between resident and non-resident companies may be corrected if the tax authorities believe that they are not at arm's length, whereas the legal form of a transaction can be disregarded under section 28 of the VML provided that a transaction is given a legal form which does not correspond to its actual character.

(c) Issue. The issue was whether the hybrid loan provided by LUX Co could be reclassified as a capital contribution due to a TP adjustment.

(d) Decision. The Court first pointed out that both the tax authorities and the Central Appeal Board referred to section 31 of the VML but not to section 28 of the VML in their rulings. Section 28 of the VML provides a special rule which enables the tax authorities to disregard a legal form of a transaction but also sets strict conditions for it in order to guarantee taxpayers' rights. Thus, disregarding a legal form of a transaction as a TP adjustment (section 31 VML) without applying section 28 of the VML should only be done with caution. The Court also emphasized that FIN Co had demonstrated that the hybrid loan was the most appropriate way to finance its activities Consequently, the Court disallowed the reclassification of the loan as a TP adjustment made under section 31 of the VML and referred the case back to the tax authorities to decide on whether the loan was at arm's length.