The Scope of Transfer Pricing Adjustments Expands from the Beginning of Next Year
Transfer Pricing Adjustment – What Changes?
The government proposal HE 188/2021 is intended to be approved by the parliament in December 2021, which would make it effective from the beginning of 2022. The main goal of the proposal is to expand the scope of the tax procedure law (“VML”) section 31, which concerns transfer pricing adjustments, beyond its current scope. The change adds entirely new 2nd and 3rd paragraphs to the section, where the first contains the definition of a transaction and the latter sets the framework for disregarding a transaction. The previous paragraphs are retained and moved to the end of the section.
Why?
The change is due to a narrower interpretation of Finnish legal practice than expected by legislators (e.g., KHO 2014:119 and KHO 2020:35). According to this legal practice, VML section 31 does not allow for the recharacterization or disregarding of artificial arrangements. In this respect, the Finnish interpretation differs from that of many other OECD member countries. This section is derived from article 9 of the OECD Model Tax Convention, which is interpreted in accordance with the commentary prepared by the OECD. This commentary is the basis for the OECD transfer pricing guidelines. In Finland, the courts have confirmed that these guidelines are a valid interpretation source for VML section 31.
Other countries allowing recharacterization or disregarding may lead to situations where, for example, income is only taxed in the state that has recharacterized the transaction under another tax treaty. If the situation had been reversed, Finland would not have been able to recharacterize, and the right to tax would still belong to this other state. The current change aims to balance the situation so that Finland would always have the same opportunity to recharacterize or disregard a legal act same way than other OECD tax treaty countries. Without the legislative change, Finland might also have to make corresponding adjustments if the matter were handled in a mutual agreement procedure and the other state had made an initial adjustment in accordance with the arm’s length principle. This would naturally mean lower tax revenues for Finland and an imbalanced distribution of tax revenues between countries.
The government proposal estimates that this balancing of tax jurisdiction will increase Finland’s corporate tax revenue by approximately 50 – 100 million euros.
Transfer Pricing Adjustment – Consequences
One of the main desired outcomes of the legislative change is the determination of a related-party transaction to the extent described by the OECD transfer pricing guidelines, in terms of defining the transaction according to its actual substance. In this respect, the taxpayer’s legal certainty improves, as it would no longer be unclear to what extent the interpretative effect of the transfer pricing guidelines could be utilized.
However, if a company has structured its actions relying on the fact that it is not possible in Finland to intervene in the characterization of a legal act or disregard its substantive form (e.g., contract text), it is now the last moment to review (and update) their transfer pricing analysis. The legislative change will therefore have larger financial impacts (either administrative or punitive) on the taxpayer, the more the company has related-party transactions that deviate from the arm’s length principle. On the other hand, if a company has already initially analyzed its transactions following the OECD’s guidance, the legislative change does not necessitate significant modifications.