The Supreme Administrative Court ("SAC") has ruled in its decision SAC 2017:128 on 11th August 2017 regarding the deductibility of interest expenses in the situation where a foreign company had taxable and non-taxable operations in Finland. SAC has denied the deductibility of interest expenses, which according to the company has at least partly related to the company's taxable rental income in Finland. Our full text tax alert regarding the above mentioned decision has been published on 18 September, 2017 and is available in Finnish here.
In the mentioned case, a taxable non-resident company A LLC was carrying real estate rental activities in Finland through the wholly owned mutual real estate companies. A LLC received two types of income in Finland, an interest income that was not subject to tax in Finland and a rental income that was taxed as company's income from immovable property in Finland. A LLC had a loan from an external bank and the intra-group subordinated loans. A LLC pushed the subordinated loans down into the Finnish mutual real estate companies in order to finance the acquisition of the real estate property. It has been established by the SAC that the subordinated loans were no doubt debt capital of the company. According to the company, the purpose of the whole arrangement was to expand its real estate portfolio in Finland with the ultimate purpose to maximize the rental income flows. The company claimed that the interest expenses in question have directly related to its rental activities in Finland. As the interest expenses were expected to generate taxable income in Finland, it was obvious that the interest deductions should have been allowed in the company's taxation in Finland.
SAC has disagreed with the company. SAC stated that the interest expenses and the loans in question were not connected to the company's rental operations but rather generated the interest income that was not taxed in Finland. Based on this reasoning, SAC stated that interest expenses were not even partly deductible in the company's taxation in Finland. According to the court, the lending activity of A LLC was completely separate so that when assessing the deductibility of interest expenses, it did not have connection with the company's taxable operations in Finland.
In addition to the deductibility of the interest expenses SAC focused in its decision more on procedural questions and despite the fact that the subject matter is open for interpretation, the decision does not provide further reasoning on the allocation of interest expenses in the circumstances where a foreign company has taxable and non-taxable income in Finland. Could there be a different outcome were the mutual real estate companies financed with the equity instruments?
The aforementioned decision gives grounds to reassess the present structures in the real estate business, especially if the foreign investors are involved. The very narrow conclusions of the above mentioned decision imply tax risks for the foreign investors and should not be disregarded when planning the future real estate investments in Finland.