Under prevailing rules, a company is generally allowed a tax deduction for accrued interest expenses. As long as the interest payable is at arm's length, it can be, for example, linked to the profits of the borrower. Note that, in addition to the arm's length principle, the deductibility of interest may be restricted under the general anti-avoidance provision.

As a starting point, interest paid on a business-related debt is tax deductible (section 18, Business Income Tax Act) (BITA).

Basically, all debt raised for the financing of the business of a corporate entity is generally regarded as business-related. This includes, for example:

In addition, debt raised for the financing of the activities of a corporate entity, without specifying in advance how the funds are to be used is deemed a debt within the meaning of section 18.

There are no specific thin capitalisation rules in Finland and, as a result, the income tax provisions set no specific limit regarding a debt to equity ratio.

However, it is possible that if the debt to equity ratio of a Finnish company is considerably high or if the loan is comparable to equity, the interest payments may be regarded as non-tax deductible based on the general anti-avoidance rule (section 28, Assessment Procedure Act).

In practice, the deductibility of interest due to thin capitalisation (debt to equity ratio) has rarely been denied under case law. In addition, the Finnish tax authorities usually do not use thin capitalisation or the general anti-avoidance rule to dispute the deductibility of interest payments on loans granted by a Finnish group company to another Finnish group company.

Finland applies the principles of the Organisation for Economic Co-operation and Development (OECD) regarding transfer pricing.

The general arm's length requirement has been incorporated into the domestic tax laws. If a taxpayer and a related party have agreed on terms or defined terms that differ from the terms that would have been agreed on between independent parties and, as a result, the taxable income of the taxpayer is reduced, or the taxpayer's loss increases (compared with the amount that the taxable income would otherwise have been), the taxable income may be increased to the amount that would have accrued if the terms had adhered to those that would have been agreed on between independent parties (section 31, Assessment Procedure Act).

The arm's length principle may affect the deductibility of interest in related party transactions as a result of either:

The tax authorities are currently subjecting transfer pricing issues to greater scrutiny.

Excessive interest rate. In relation to excessive interest rates, in 2010 the Supreme Administrative Court gave a ruling regarding the deductibility of intra-group interest expenses (2010:73 of 3 November 2010).

In this case, a Finnish limited liability company (FinCo) was a part of a Nordic group together with a Swedish limited liability company (SweCo). In connection with group refinancing, in 2005, FinCo repaid its external debt of about EUR36 million, which was replaced with an intra-group loan of about EUR38 million from SweCo (as at 1 March 2012, US$1 was about EUR0.7). The interest rates on the external debt varied between 3.135% and 3.25%. The intra-group debt was interest bearing at 9.5%, representing a blended average interest rate of the group external level and shareholder debt financing. The capital structure of FinCo was not materially altered on the refinancing.

Before the refinancing, FinCo provided securities of an aggregate amount of about EUR41 million in respect of its debt obligations. On the refinancing, the aggregate amount of securities provided by FinCo was increased to about EUR300 million relating to debt obligations of other group companies. The ruling did not disclose whether or not FinCo charged a commission for the securities provided.

The Supreme Administrative Court held that the intra-group interest charges exceeded the arm's-length amount. Having regard to, among other things, the level of interest on the external debt before the refinancing and the creditworthiness of the company (illustrated by, for example, the amount of securities provided in favour of group companies), the court held that the amount of interest payable on the loan from SweCo clearly exceeded the amount of interest that would have been paid by and between non-related parties. In addition, it had not been demonstrated that FinCo had received any financial or other services from SweCo that should have been taken into account for the purposes of determining an arm's-length interest charge.

Finally, the court stated that in a case where the creditworthiness of the company and other circumstances would have allowed for a lower interest rate, the (arm's-length) amount of deductible interest could not be determined by means of calculating an average interest rate at group level. In accordance with this, the amount of interest paid by FinCo, representing the difference between the interest rates of 9.5% and 3.25%, was added back to the taxable income of FinCo.

The Supreme Administrative Court accepted neither the group level average interest on external debt (7.05%) nor external and shareholder debt (9.5%) as an arm's-length interest rate for FinCo. Instead, it required that the arm's-length interest rate be determined solely based on FinCo's financial situation. The ruling in this respect reflects the general approach taken by the OECD.

Excessive debt to equity ratio. There are no published precedents regarding the application of section 31 of the Assessment Procedure Act to thin capitalisation situations. As the purpose of section 31 is to set a requirement that market level conditions should be applied in transactions between related parties, it could in theory be applied in thin capitalisation situations, if a third party in similar circumstances had not granted debt financing with similar terms.

Certain tax treaties concluded by Finland include a specific non-discrimination clause relating to the deductibility of interest expenses, basically granting a Finnish company a similar right to deduct interest in cross-border situations as it would have in a domestic situation.

Article 25 of the tax treaty between Finland and The Netherlands, for example, includes such a specific non-discrimination clause: "interest… paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State."

The ruling of the Supreme Administrative Court in Case 1999/862 illustrates the effect of this non-discrimination clause. In that case, the shares of a Finnish company (A Oy), engaged in leasing business, were held by a Dutch parent company. The Dutch parent company also had subsidiaries in several other countries and had rights to carry out banking activities in its state of residence.

The business activities of A Oy were financed by share capital and intra-group debt financing consisting of both short and long-term debt. The intention was to increase the company's debt to equity ratio to 15:1. In addition, the terms of the intra-group debt financing were supposed to be at least as favourable as those of debt obtained on the Finnish financial market. A Oy paid interest even if it made a loss. No collateral was required for the intra-group debt. The debt could be terminated on a breach of contract.

The Supreme Administrative Court ruled that, in the above circumstances, and taking into account section 18 of BITA and the specific non-discrimination clause of Article 25 in the tax treaty between Finland and The Netherlands, the intra-group debt was to be regarded as debt for tax purposes and the interest paid on the debt was fully tax deductible.

In practice, even if there are no specific limits, debt to equity ratios up to 10:1 are often seen on the market. More recently, however, the amount of debt financing has generally reduced due to the banks' requirements rather than tax constraints.

In the absence of specific interest limitation rules, tax practice regarding interest deductibility has been relatively liberal. This may have partly resulted from the anticipated disputes that would arise as a result of taxpayers claiming their rights under the four freedoms of EU law. In particular, the freedom of establishment and the free movement of capital are generally considered to potentially affect the possibilities for denying the deductibility of an interest expense in a cross-border situation, if it would not be denied in a domestic situation.

In relation to interest deductibility in a cross border situation, in Test Claimants in the Thin Cap Group Litigation (Case C-524/04) (Thin Cap Group) the Court of Justice of the European Union (ECJ) basically stated that EU member states cannot apply thin capitalisation rules that are applicable only in cross-border situations, unless:

The fact that a resident company has been granted a loan by a non-resident company on terms that do not correspond to those that would have been agreed at arm's length is, for the member state of the borrower, an objective element that can be independently verified to determine whether the transaction in question represents a wholly artificial arrangement. However, based on the ECJ's reasoning in Thin Cap Group Litigation, even if a transaction is not at arm's length it has been held that it cannot be regarded as wholly artificial, if it is nevertheless carried out for commercial reasons.

Non-resident lenders are typically not subject to Finnish tax on their interest income derived from Finland. Interest is exempt from withholding tax when paid on:

It is only in exceptional circumstances that debt has been recharacterised as equity. Accordingly, no withholding tax should in practice apply to interest payments made by Finnish companies to non-resident lenders.

A newly established Finnish limited liability company is typically used as the acquisition vehicle in corporate acquisitions. Occasionally, a branch of a foreign company is used. It is relatively common that the acquisition vehicle is highly leveraged.

Finland does not have tax consolidation rules, but profits can be transferred between group companies by way of group contributions under certain criteria. Since the acquisition vehicle typically has no or only limited profits of its own, it is important that the profits of the acquired operating company can be offset against the interest expenses in the acquisition vehicle. This can be achieved by way of a group contribution, which is tax deductible for the acquired operating company and taxable for the acquisition vehicle. It is required that:

Provided that the conditions for granting a group contribution can be met, the interest accrued on the acquisition debt can effectively be offset against the profits of the acquired company. Alternatively, a merger of the companies is another option for achieving the same result.

Having regard to the absence of specific thin capitalisation or other interest limitation rules, the interest payable on the acquisition debt has often provided a significant tax shield in Finland.