Finland's Supreme Administrative Court has published two new precedential decisions regarding transfer pricing rules, KHO:2017:145 and KHO:2017:146. Transfer pricing related rulings are in short supply in Finland and thus insights as to how the court views transfer pricing matters are welcome.
Intra-group service charges for enterprise resource planning (Case KHO:2017:145)
In KHO:2017:145, a Finnish multinational enterprise had incorporated a new subsidiary in Finland for the sole purposes of obtaining an enterprise resource planning (ERP) license and to centralize the development of ERP within the group.
The Finnish tax authorities argued that when the company accrues ERP expenses, it should have on-charged the participating group companies with related expenses together with a mark-up.
The court held that the implementation of the ERP was not deemed a cost sharing arrangement between the participating group companies. The MNE could implement an ERP system by having one company responsible for ERP, then charging the participating group companies with a service fee (including full costs and markup), when each company participates in the ERP system. However, the court did not rule on the arm's-length markup required in this case; the case was referred back to the Finnish tax administration for determining the applicable market level markup.
The court had ruled in 2014 that a transfer pricing reassessment could only adjust the pricing between related entities, but such a reassessment cannot change the business model chosen by an MNE. It can be argued here that the court merely replicated its earlier ruling. On the other hand, the court specifically stated that an ERP model does not deviate from any similar arrangement which could have been agreed between unrelated parties acting under arm's length conditions. The court also ruled that it was possible for the centralized ERP company to deduct the expenses when they accrue, as long as the expenses were on-charged to group companies as they participate in the system. Therefore, the timing difference in the deductibility of expenses was accepted.
Although the court did decide in favor of the tax administration's argument that expenses incurred by the centralized ERP company ought to be on-charged, it did not rule on how the market level markup should have been determined. Such a ruling would have been welcome in Finland. In our view, the benefits of the timing difference as well as the investment risk could impact the arm's-length markup in such cases.
Although it is not mentioned in the case that the group companies that participated in the ERP were foreign entities, it may be relevant in practice to also consider how treaty partners would react to the court's approach in these cases and what may happen under a mutual agreement procedure (MAP) when relief from double taxation is sought in the foreign jurisdictions where the participating group companies are located.
Intra-group services related to global supply chain (case KHO:2017:146)
In KHO:2017:146, the ultimate parent company in Finland had provided its foreign subsidiaries with services related to the global supply chain, including marketing, trademark administration, HR and IT, with a view to coordinate and standardize such services on a global basis.
The court held that a market level markup has to be charged for the services that have been provided by the Finnish ultimate parent company; however, the market level was not to be set based on the markup charged by independent consulting companies. The court's reasoning in coming to this decision was that because the services provided by independent consultants differ from services rendered by group ultimate parent companies, it was not possible to make adjustments precise enough to eliminate the differences between the two. Instead, the markup has to be determined based on the benefit the subsidiaries received from the services. The court held that in the immediate case, such a benefit was a markup of 3 per cent on the cost of services.
Traditionally, comparable searches based on the markup of consultancy firms have been the recommended way to set the arm's length mark-up for intra-group management services. The court chose to disregard such comparables in this case as the bundled services offered by the parent company are not comparable to the standard services offered by consultancy firms. The court also changed the point of view from service provider to service recipient when evaluating the arm's length markup in this case: a low mark-up was authorized based on the benefits received by the subsidiaries.
The court's approach in this case leaves open the possibility of bypassing traditional comparable searches when intra-group services are offered as a bundle, and adopting a low markup for such services. It remains to be seen what impact the verdict has on Finnish tax audit practices.