New Ruling Clarifies the Scope of Interest Deduction Limitations in Relation to Collateral Arrangements and Exchange Gains/Losses

A new ruling from the Supreme Administrative Court (“SAC”) (KHO:2024:103) continues a series of decisions clarifying Finnish interest deduction limitations (see these previous Borenius legal alerts here and here). This time, the SAC ruled that using a debtor company’s loan from its parent company as collateral for an external loan does not change the external loan into an intra-group loan. Additionally, the SAC clarified when foreign exchange gains and losses are considered interest expenses or income subject to interest deduction limitations.

The ruling concerned a Finnish company that owns both real estate and shares in real estate companies. The company had taken out an external loan of EUR 102 million from a third party, which was senior to its other debts. Additionally, the company had an intra-group loan of EUR 62 million from its Norwegian parent company, which was denominated in Norwegian kroner.

The third-party lenders required a comprehensive security package for the external loan, including e.g. the shares in real estate companies and the real estate owned by the company. The fair value of the company's real estate holdings exceeded the external loan amount, providing full security for the loan. The security package also included the intra-group loan from the parent company.

It is common market practice for external lenders to require internal receivables from debtor companies as collateral, facilitating the sale of the debtor company's shares in potential realisation situations.

The first question resolved by the ruling was whether the interest expenses on the external loan should be considered as being paid to a related party because the loan was secured by the company’s loan from its parent company. This question is relevant because intra-group interest expenses are subject to stricter interest deduction limitations than external ones.

Pursuant to Section 18a(7) of the Finnish Business Income Tax Act (“BITA”), a third-party loan is considered an intra-group loan to the extent that it is secured by a receivable of a related party.

Both the Central Tax Board (“CTB”) and the SAC concluded that using the company’s loan from its parent company as collateral did not change any part of the external loan into an intra-group loan under Finnish interest limitation rules.

The ruling confirmed that an external loan secured by a debtor company's intra-group receivable does not "contaminate" the interest expenses of the external loan – at least not when the following conditions are met:

The intra-group loan from the parent company was denominated in Norwegian kroner. The second question resolved by the ruling was whether the realised and unrealised foreign exchange gains and losses from the loan principal and the interest of the loan should be considered interest income and expenses subject to interest deduction limitations.

The SAC recognised, in line with its previous decision, that Section 18a of the BITA is based on the Anti-Tax Avoidance Directive (“ATAD”), which includes a broad definition for interest expenses, encompassing foreign exchange gains and losses related to raising finance. While the directive leaves discretion to the national legislator, its interpretative effect must be considered.

Following the advance ruling of the CTB, the SAC concluded that realised foreign exchange gains and losses are part of the loan's interest expenses to the extent that they arise from the interest on a loan denominated in a foreign currency. Therefore, these realised foreign exchange gains and losses are considered interest expenses or income as referred to in Section 18a(2) of the BITA.

However, the SAC concluded that realised foreign exchange gains and losses arising from the loan principal denominated in a foreign currency do not constitute interest expenses or income. In this respect, the SAC’s ruling deviated from the advance ruling of the CTB.

This case sets a precedent clarifying the definition of interest expenses in respect of foreign exchange gains and losses and the tax treatment of interest expenses when a bank loan is collateralised with a comprehensive security package commonly used in the market that includes other group companies’ intra-group receivables.

Following the SAC’s ruling, it should be clear that the mere fact that an external loan is secured by another group company’s intra-group receivable does not "contaminate" the interest expenses of the external loan at least in typical market-standard financing structures where the intra-group receivable has no value as collateral as such due to its subordination and other securities  providing full collateral for the bank loan.