The Finnish Supreme Administrative Court Decides on Anti-Hybrid Rule in Private Equity Fund Structure

Authors: Kerttu Kaksonen, Stefan Stellato and Heikki Vesikansa

In April 2023, the Finnish Supreme Administrative Court (the “SAC”) issued a ruling concerning the applicability of anti-hybrid rules to a private equity fund structure (KHO 2023:31).

The ruling provided clarification on important questions such as in which relation the 50% requirement for associated enterprises must be fulfilled. Additionally, the ruling clarified whether limited partners of a fund were acting together. It was undisputed that the structure was not a structured arrangement.

As anti-hybrid rules are based on EU directives, the ruling might have an impact on the interpretation of the concepts also in other EU Member States.

Background

The case concerned a Finnish limited liability company (A Oy) of which 66.9% was owned by a Finnish private equity fund (E Ky) having the form of a Finnish limited partnership. The fund’s limited partners were independent Finnish and foreign investors, each holding between 1.3% and 20% of the fund.

The fund was characterised as tax transparent in Finland. However, it was characterised as a taxable entity in the jurisdictions of its foreign limited partners G B.V, H S.à r.l and I Fund (Netherlands, Luxembourg, UK), which held in total just under 25% of the fund.

A Oy had financed a transaction, inter alia, by borrowing funds from its shareholders, including the fund. When A Oy paid interest to the fund, a mismatch outcome arose between Finland and the jurisdictions of G B.V, H S.à r.l and I Fund.

The structure can be illustrated as follows:

SAC Ruling

The SAC found that the Finnish anti-hybrid rule on payments to a hybrid entity did not apply to deny A Oy’s interest deductions. The SAC did not at least expressly assess the applicability of other anti-hybrid rules, such as the reverse hybrid rule.

There are three key takeaways from the SAC’s decision:

1. The 50% requirement must be fulfilled in the relation in which the tax mismatch arises

The 50% requirement for associated enterprises must be fulfilled in the relation between the company making the payment and the limited partners of the fund receiving the payment, i.e. in the cross-border relation in which the tax mismatch arises.

As A Oy and the fund were both Finnish entities, the SAC held that a hybrid mismatch could not arise between the two. The hybrid mismatch could only arise between A Oy and the fund’s investors established in other jurisdictions. None of these investors, separately, fulfilled the 50% requirement and were therefore not associated enterprises with A Oy.

2. Limited partners of the fund were not acting together

Although none of the limited partners of the fund alone fulfilled the requirements for an associated enterprise in relation to A Oy, the anti-hybrid entity rules could apply if the limited partners were deemed to be acting together.

In this case, the limited partners of the fund were not considered to be acting together. The limited partnership agreement (LPA) authorised the general partner to represent the fund, take care of the fund’s day-to-day matters and make investments without the limited partners’ approval, unless otherwise agreed in the LPA. The LPA did not require the limited partners to make unanimous decisions, nor did it enable any one limited partner to veto or force certain decisions to be made by other partners. The limited partners were independent of each other and most of them institutional investors.

The SAC held that partners could in principle be considered acting together on the basis of an LPA or another arrangement. However, this could be the case only if the agreement or other arrangement had significant effect on the capital ownership or voting rights in question, a requirement that the SAC had derived from OECD guidance.

3. The private equity fund structure was not a structured arrangement

It was undisputed before the SAC that the structure in question was not a structured arrangement, which would have caused the application of the anti-hybrid rule even below the 50% threshold.

The mismatch was not priced into the loan agreement or into the fund, a tax mismatch was not the objective of the loan agreement or the fund, and the mismatch nature was not used in the fund’s marketing.

No Request for a Preliminary Ruling

The SAC did not find it necessary to refer the case to the European Court of Justice for a preliminary ruling although the case concerned the interpretation of concepts defined in the Anti-Tax Avoidance Directive II (ATAD2).