Changes to transfer pricing adjustment provision
Finland’s Ministry of Finance on 21 October 2021 issued a proposal to revise the transfer pricing adjustment provision in Section 31 of the Tax Assessment Procedure Act. The goal of this proposal is to broaden the scope of the domestic transfer pricing adjustment provision to bring it into closer alignment with the OECD transfer pricing guidelines.
If the proposal is enacted, the accurate delineation of an actual transaction would be allowed to the extent provided in the OECD transfer pricing guidelines, and the Finnish tax authorities would be allowed to disregard intercompany transactions in exceptional circumstances.
If Parliament approves the proposed amendment, it would enter into force on 1 January 2022.
According to the OECD’s approach, intercompany transactions are characterized based on their economic substance; in exceptional circumstances, the tax authorities may disregard intercompany transactions.
Finland’s Supreme Administrative Court has ruled that the country’s current transfer pricing adjustment provision does not allow the Finnish tax authorities to delineate transactions by their economic substance to the full extent provided in the OECD transfer pricing guidelines, or to disregard or recharacterize transactions. The tax authorities are obligated to respect the legal form of an intercompany transaction when evaluating whether the transaction follows the arm’s length principle; thus, the tax authorities can adjust only transaction terms that do not result in the recharacterization of the transaction. For example, debt cannot be recharacterized as equity, but an intercompany loan’s interest rate or maturity date can be adjusted.
Disregarding a transaction and substituting it with another transaction requires the application of the general tax avoidance provision (Section 28 of the Tax Assessment Procedure Act). Therefore, the current scope of the national transfer pricing adjustment provision has been more limited than would be permitted under the OECD transfer pricing guidelines.
Revised transfer pricing adjustment provision
The goal of the revised transfer pricing adjustment provision is to widen the scope of the national transfer pricing adjustment provision to be in line with the OECD transfer pricing guidelines. Under the revised provision, before evaluating an intercompany transaction’s compliance with the arm’s length principle, the factual substance of the transaction must first be accurately delineated. The transaction must be identified by analyzing the commercial and financial relations and its economically relevant characteristics.
The economically relevant characteristics of a transaction can be divided into the following categories:
- The contractual terms of the transaction
- The functions, risks and assets of the parties
- The characteristics of the transferred property or services provided
- The parties’ economic circumstances
- The markets in which the parties operate and their business strategies.
Based on these elements, a transaction can be delineated in accordance with its factual substance. As a result, transactions delineated by the tax authorities could deviate from the legal form of the transaction, because the contractual terms would be only the starting point for identifying the transaction.
An accurately delineated transaction may be disregarded and substituted with another transaction only in exceptional circumstances. More specifically, only economically irrational transactions for which an arm’s length transfer price cannot be determined may be disregarded. According to the government’s proposal, the threshold for disregarding an intercompany transaction would be high. However, a transaction could be disregarded for transfer pricing purposes even if the general tax avoidance provision would not be applicable.
The government proposal is likely to pass in Parliament, in which case the new revised provision would be effective as of 1 January 2022. The revised transfer pricing adjustment provision would introduce the substance-over-form principle to the Finnish tax practice, because in some cases transactions delineated by the tax authorities may differ from the transaction’s legal form and the taxpayer’s characterization of the same.
In light of this potential development, it is important for multinational groups to maintain their contract terms up to date. Multinational groups with operations in Finland should evaluate their current transfer pricing models and if concerned, apply for the preliminary discussions procedure with the Finnish tax authorities to ensure that their transfer pricing models comply with the arm’s length principle.