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Promoting Cross-Border Tax Structuring in (Northern) Europe
THE Northern European law firm Roschier has responded to an increased market need for optimal deal structures and restructuring alternatives. This has been achieved through the careful maximization of tax efficiency in the chosen deal structure, while ensuring simultaneously that legal, financial and business considerations are taken into account. Having an exceptional practice base in two Northern European capitals, Helsinki and Stockholm, Roschier can provide a unique perspective on cross-border transactions. Tax partner Mika Ohtonen and Senior Associate Jonathan Rosengren explain recent developments that are having an impact on cross-border tax structures in Scandinavia and Europe.
In a European context, the EU Merger Directive (2009/133/EU) offers the possibility of carrying out certain tax neutral reorganizations on a cross-border basis between EU member states. As discussed below, recent cases relating to Scandinavian cross-border restructurings are forcing the European Court of Justice (ECJ) to consider the applicability of the Directive in detail.
Multinational enterprises and groups of companies often seek to enhance the efficiency of their capital or transfer pricing structure in order to minimize their tax leakage. In an economic downturn, interesting tax issues arise in connection with the reorganization of intra-group cross-border financing. For private equity structures, debt push down structuring work is likely to face new challenges from the Finnish thin capitalization rules to be introduced in 2012 at the earliest.
FINNISH CROSS-BORDER REORGANIZATIONS
The EU Merger Directive, and its implementation into Finnish domestic law, only covers reorganizations between EU resident companies, and consequently European Economic Area (EEA) states (Iceland, Lichtenstein and Norway) appear to be excluded.
In a pending case, the Finnish limited liability company A Oy planned to exchange the shares it owned in the Finnish company C Oy for shares in the Norwegian company B AS, issued to A Oy by B AS. It was undisputed that, had the companies been tax resident in the EU, the Finnish domestic requirements for tax neutrality arising from the Directive would have been met. The Finnish lower tax court, the Central Tax Board (CTB) ruled that under the principles of freedom of establishment and free movement of capital set out in the EEA Agreement the transaction was tax neutral and should be treated as an intra-EU transaction for the purposes of the Directive. Following an appeal by the tax administration, the Finnish Supreme Administrative Court (SAC) decided in January 2011 to ask for a preliminary ruling on the issue from the ECJ.
In this instance, we support the ruling of the CTB, and leading academic commentators appear to support the ruling as well. If Finland denies tax neutrality in an exchange of shares involving a Norwegian company, including a Norwegian company in a company structure would be less attractive as opposed to the inclusion of an EU company. In previous rulings the ECJ has on occasion used the rule of reason principle to accept proportionate restrictive measures if justified by an overriding reason in the public interest. No such justifications are, however, present in this particular case, a fact made even more apparent by the existence of a comprehensive Nordic Assistance Treaty.
In March 2011, the SAC requested another preliminary ruling from the ECJ concerning the question of whether a Finnish parent company may deduct the final tax losses of its Swedish subsidiary following a cross-border merger. The Swedish subsidiary which had incurred substantial losses was wholly owned by the Finnish parent company. The tax losses in question could not be utilized in Sweden because the operations of the Swedish company were shut down and the other Swedish group companies were also unprofitable. The tax burden of the Finnish parent company could be substantially reduced if the losses of its Swedish subsidiary could be deducted from its taxable profits.
Of course, had the subsidiary been a Finnish company, the tax losses would be transferred to the Finnish parent company. Therefore, under the EU principles of freedom of establishment and free movement of capital, it could be argued that the cross-border merger should be treated in the same way as a purely domestic merger.
IS YOUR INTRA-GROUP CROSS- BORDER INTEREST LEVEL AT ARMS LENGTH?
From a Finnish tax perspective, discussions concerning the proper determination of intra-group interest levels have become more frequent. This seems to be at least partly due to an interesting ruling in 2010 in which the SAC did not accept an average financing cost as decisive in connection with a group level refinancing, but instead ruled that the arms length interest level should have been based on the terms of the existing loans of the Finnish company, taking into account the Finnish company on a stand-alone basis.
In the case, the Finnish company A Oy had settled its external debts and refinanced its business activities through internal debt from the Swedish company B AB. The range of the interest rate of the external debts had been from 3.125 per cent to 3.25 per cent, whereas the interest rate of the new intra-group debt was 9.5 per cent, based on the average interest rates of the groups external loans, bonds and shareholder loans.
According to the SAC, as A Oys financial position had not changed as a result of the refinancing, the arms length interest rate on the debt from A Oy to B AB was 3.25 per cent. Since the overall financing need and the capital structure remained the same, neither the average interest rate of external group financing (7.04 per cent) nor the interest rate in the company-specific financing conditions of A Oy (9.5 per cent) were accepted as the arms length interest rate. The SAC emphasized that the credit rating of a separate group company may differ from the groups overall credit rating and financial standing.
For practical purposes, this means that, in connection with a potential group level refinancing, the impact of the refinancing on any loans made to a Finnish company should be carefully documented, as it will be important to ensure that the arms length interest rate can be shown to be at least equal to the interest rate under the existing loans. Furthermore, it should be noted that the ruling does not affect acquisition financing as such, as it still is possible to determine the arms length interest rate by taking into account the lack of security and the subordination level of the loan compared to other debt. Restrictions on acquisition financing are, instead, likely to be implemented in the form of thin capitalization rules.
FINNISH THIN CAPITALIZATION RULES ON THE HORIZON
There are currently no restrictions in Finnish law that would prevent debt being pushed down to Finland by using a leveraged acquisition vehicle, thereby enabling the debt finance used in the acquisition to be effectively set off against the tax liability generated by the targets operating profits. Unlike many other countries, including Sweden, Finland has not imposed any thin capitalization legislation or similar restrictions on the deductibility of interest expenses. However, in light of recent press coverage, the Finnish Ministry of Finance plans to bring in new thin capitalization rules in 2012. This is likely to have a substantial impact on private equity structures which often seek to take advantage of debt push down.
Only some time ago, it could be argued that the tax obstacles to cross-border European transactions seemed to be all but vanishing, forced out by the ECJ and European legislation. However, recent Scandinavian cases show that some obstacles remain, and suggest that we have yet to reach a consensus on how best to ensure that cross-border corporate restructurings are treated as if they were taking place within a single EU member state. From a Northern European tax perspective, these cases give the ECJ a great opportunity to work towards this end. Further, in a turbulent European economic climate, interesting tax challenges and opportunities exist in the reorganization of intra-group financing structures and the structuring of debt financing.
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