By Dr. Harold McClure, New York City
On May 21, the Finnish Supreme Administrative Court issued its ruling in the KHO: 2021: 66 case, which rejected an attempt by the Finnish tax administration to increase the intercompany interest rates charged by a Finnish financing subsidiary to its Russian operating subsidiary.
The key question was whether the intercompany interest rate should be based on the group’s credit rating or on the stand-alone credit rating of the Russian subsidiary.
The Finnish financing subsidiary had a series of loans to third parties denominated in euros with interest rates fixed with a line of credit equal to 0.5%. This subsidiary granted loans backed by the Russian subsidiary denominated in rubles with a line of credit close to 0.55%. The logic of the intercompany line of credit was that the credit rating of the Russian subsidiary should be viewed as the group’s credit rating with the small increase in the line of credit covering the administrative costs of the financing subsidiary.
The following table summarizes the position of the taxpayer as well as the position of the tax administration. The initial loan amount was just over 63 million euros in 2009, rising to over 122 million euros in 2011.
The intercompany interest rate was set at the Russian benchmark rate plus the intercompany loan margin based on the group’s credit rating.
The tax administration advocated for higher loan margins based on a stand-alone credit rating and using loan margin data derived from the Thomson Reuters DealScan database. This database provides margin data on variable rate loans based mainly on US LIBOR rates but also on some Euro LIBOR rates.
While the benchmark rates used by the tax administration for 2010 and 2011 were the same as the benchmark rates used by the taxpayer, the benchmark rate for 2009 was considerably higher than the benchmark rate used by the taxpayer.
The following table provides monthly data on Russia’s 3-month interbank rate, as supplied by the OECD. During the period 2009 to 2011, this rate was on average 7.9%. This interest rate was very high at the start of 2009, but fell below 10 percent during the last months of 2009. This rate also fluctuated around 5 percent in 2010 and 2011.
A second graph shows monthly data on the US 3-month LIBOR rate as well as the LIBOR rate denominated in euros. The US LIBOR rate averaged 0.46% during this period, while the Euro denominated LIBOR rate averaged 1.1%. The higher interest rates for Russia’s 3-month interbank rate reflect Russia’s higher inflation rate and the implication of the expected devaluation of the ruble.
The key question is what is the appropriate credit rating and its implications for the credit spread.
Loan spreads are based on interbank rates, not government bond rates. The appropriate credit spread should therefore be viewed as the sum of the loan margin and the spread between the interbank rate and the yield of the corresponding interest rate on government bonds.
The second chart shows the 3-month US Treasury bill interest rate for the period. The TED spread is the difference between the 3-month US LIBOR rate and the 3-month US Treasury bill rate. The TED spread was close to 1 percent at the start of 2009, but quickly narrowed by an average of 0.35 percent during the period 2009-2011. The credit spread is the sum of the loan margin and the TED spread. If the appropriate line of credit was 0.55%, the implied credit spread was 0.9%.
The tax administration’s position on credit rating
The tax administration convinced the administrative court that the margin on intercompany loans should be raised to levels almost as high as what Chevron Australia attempted to claim in its unsuccessful attempt to defend a higher intercompany interest rate.
The Supreme Administrative Court summarized the discussion from the previous ruling on how the Finnish tax authorities used various Moody’s credit rating models, including the Credit Cycle Adjusted Credit Cycle Adjustment Model and a Credit Cycle Adjusted Model. financial statement only.
The credit cycle adjustment model generated a higher level of credit risk by incorporating market information during a period known for credit risk issues. Even though the taxpayer argued that this model overestimated the credit risk incurred by the borrowing subsidiary, the Administrative Court accepted the position of the tax administration.
The Supreme Administrative Court, however, accepted the tax administration’s position that group rating should be used. Its ruling noted that the taxpayer was using an approach consistent with a February 2, 2009 decision of the Helsinki Administrative Court.
This decision also noted a November 2010 decision of the Supreme Administrative Court in KHO 2010: 73.
This case concerned a Finnish subsidiary which refinanced a debt of 38 million euros with an intercompany loan from its Swedish parent company in 2005. The intercompany interest rate was 9.5%. The Finnish tax administration, however, noted that the multinational was paying third-party lenders interest rates of just 3.25%.
During this period, the rate on one-year government bonds was 2.25%. If the multinational group’s credit rating was A, a credit spread of just 1% would have been demanded by third-party lenders.
Three-month LIBOR rates for the euro and the US dollar
The November 2010 Supreme Administrative Court ruling in the KHO 2010: 73 case allowed the Finnish tax administration to insist on the use of the group’s credit rating when assessing intercompany loans granted to a Finnish borrowing subsidiary by a foreign parent company.
This recent ruling argues that the taxpayer was also justified in using the group’s credit rating for an intercompany loan from a Finnish finance subsidiary to a Russian debt subsidiary.
The Finnish tax administration deducted a high loan margin using a synthetic credit rating using the principle of autonomy. His approach was rejected by the Supreme Administrative Court.
Had the Finnish tax administration been successful in its aggressive attempt to raise the intercompany interest rate, the multinational would have faced double taxation if the Russian tax authorities found that the Russian borrowing subsidiary had obtained a lower credit rating on the basis of the implicit support standard.