The case concerned the deductibility of interest on a loan from a foreign parent company to its Swedish subsidiary. The loan was used to finance the acquisition of an operating Swedish group from an external party. Since the loan was from a foreign parent company, the so-called correction rule (Chapter 14 § 19 IL) shall be applied to determine if the interest rate on the loan is arm’s length. The rule states that the result of a transaction shall be adjusted if it has become lower due to pricing that deviates from what two mutually independent companies would have agreed to in a similar situation. In the case at hand the Swedish Tax Agency had adjusted the interest deduction with reference to the Diligentia case.
Since the Diligentia case concerned loans between Swedish companies, its significance has been unclear in cross-border situations and when external loans with higher seniority exist. In two previous cases, the Administrative Court of Appeal has found that the Diligentia case has little value as precedence in these situations and the taxpayers have been granted full tax deduction for the agreed interest rate, see TaxNews Nos. 16 and 20, 2012.
In the case at hand the Swedish Tax Agency also argued that the principles outlined in the Diligentia case are applicable and that it is possible to entirely ignore the fact that other loans have a higher seniority when the credit risk is assessed on a loan from the shareholder. According to the Swedish Tax Agency the market interest rate on the loan was 8 percent in the current case. The Administrative Court accepted the Swedish Tax Agency’s estimated interest rate on the loan from the parent company.
The Company appealed the administrative court judgment.
The Administrative Court of Appeal finds that the correction rule is a special rule for international relations, which takes precedence over general rules for establishing the result of a business operation. In its judgment the Administrative Court of Appeal refers to the OECD Guidelines, noting in particular that "According to the Guidelines a correct arm’s length price is achieved by establishing the conditions of the commercial and financial relations that one could expect to find between independent enterprises in comparable transactions under comparable circumstances (1.3). Every individual company in a group of companies shall be treated on a stand-alone basis when reviewing their agreements with one another, the so called separate entity approach."
In its assessment the Administrative Court of Appeal states that the Swedish Tax Agency has the burden of proof in the application of the correction rule. In addition, the court also comments that the Swedish Tax Agency has based a significant part of its reasoning on the Diligentia case and its arguments on the significance of insight and control. In this context, the Administrative Court of Appeal states that the arguments presented by the Swedish Tax Agency mainly consist of arguments why a parent company’s insight and control generally influences the credit risk on a loan to a subsidiary. The Administrative Court of Appeal further concludes that it is not clear from evidence put forward by the Swedish Tax Agency why an average interest rate on some of the external loans, granted with security and with higher seniority, would be appropriate comparables.
The court concluded:”The Swedish Tax Agency has not presented any analysis how it has arrived at the conclusion that the shareholder’s factual insight and control in the case at hand means that an arm’s length interest rate on the shareholder loan is 8 % instead of 16.5 %” the Administrative Court of Appeal concludes that the Swedish Tax Agency has failed to meet its burden of proof and that there are no grounds for making an adjustment.
Once again the Administrative Court of Appeal has stated that the arm's length price for cross-border loans shall be obtained through a comparison with what two completely independent companies would have agreed to.
Nils von Koch