By Erik Koponen, Transfer Pricing Specialist at Thorning Koponen Consulting, Sweden
The Swedish Lower Administrative Court on 4 January upheld the Swedish tax agency’s denial of a deduction for losses related to a currency conversion of a loan to an affiliate and included a 40% tax penalty on the unpaid taxes.
According to the court, the taxpayer, Swedish telecommunications operator, Tele2 Treasury AB, had options realistically available to avoid the loss. It was not in accordance with the arm’s length principle to incur the currency conversion losses, the court said.
The court’s main argument was that independent parties would have used an available option to recall the currency conversion and thereby avoid significant losses.
Tele2 has already announced that it will appeal the ruling.
Tele2 Group
The case concerned Tele2 group’s investments in Kazakhstan and the financing of an affiliated entity, Kazakhstan MTS.
Kazakhstan MTS was owned via a joint venture with an external party where the Tele2 group owned 51%.
Kazakhstan MTS was financed by Tele2’s financing entity, Tele2 Treasury AB, which, during 2011-2015, issued multiple Kazakhstani tenge currency loans.
In 2015, Kazakhstan MTS was loss-making, and the investors searched for cooperation alternatives on the local market to increase market share and profit potential.
On 20 August 2015, the Kazakhstani tenge currency was made free-floating, and the tenge value significantly decreased compared to other currencies.
On 1 September 2015, the currency on existing internal loans was changed from dollars to tenge. A ‘Form of Selection Note’ was signed where Tele2 Treasury AB could recall the currency denomination within six months and thereby significantly lower the risk of the update.
On 22 October 2015, a new loan agreement, replacing the existing agreements, was signed between Tele2 Treasury AB and Kazakhstan MTS denominating the loan in tenge and updating the interest rate from LIBOR+4.6% to a fixed rate of 11.5%.
Tele2 Treasury AB incurred a total currency loss of SEK 745 million (approx. EUR 73.8 million or USD 89 million) between 1 September – 21 October 2015.
The loan’s business reasons
Tele2 Treasury AB argued that the redenomination of the loan currency was based on business reasons, claiming that Kazakhstan MTS otherwise would have risked going out of business.
In addition, since Kazakhstan MTS was 49% owned by an external party, this was a strong indication that the transaction was made in accordance with market terms.
Tele2 Treasury AB had no other realistically available options, the taxpayer argued. The ‘Form of Selection Note’ was signed as a precaution if a deal with a new external business partner on the local market was not reached.
In November 2015, a new business deal was made, including terms where Kazakhstan MTS had to meet certain financial ratios for the deal to go through. A recall of the conversion would have been in breach with the contractual terms with the external party, and therefore, the conversion recall option could not be used, the taxpayer argued.
Moreover, Tele2 argued that it was not an option to use other capital injections since Kazakhstan MTS was only 51% owned by Tele2, and it would therefore have disproportionally benefited the external party.
The agreement terms need to be analysed considering the whole business context, and it is not common business practice to state detailed purposes of various agreement clauses.
Furthermore, the Tele2 Treasury AB stated that it was compensated for the increased risk via the significantly higher interest rate after the conversion. The interest payments going forward would thereby also compensate for the 2015 currency loss.
Options realistically available
The court agreed with the Swedish tax agency that the separate entity approach should be upheld and that Tele2 Treasury AB would not have incurred the currency loss if the parties were unrelated.
The main argument from Tele2 Treasury AB was that there were no other options realistically available and that the currency conversion and internal agreement terms needed to be interpreted in relation to the ongoing business negotiations with external parties.
The court stated that independent entities would not have considered business reasons for other affiliates in other jurisdictions. An independent lender would not have considered the benefits for the group rather than the specific loan transactions.
The court stated that independent entities would not have considered business reasons for other affiliates in other jurisdictions. An independent lender would not have considered the benefits for the group rather than the specific loan transactions.
The court further stated that, due to the importance of the deal and the significant amounts, independent parties would most likely have clarified the purpose of key terms, such as the recall option in the ‘Form of Selection Note’, to avoid potential disagreements.
The Kazakhstan MTS operations had been loss-making for years and, during that period, Tele2 Treasury AB had issued several loans without considering the risk of non-payment. Tele2 Treasury AB did not show that the financial situation was more critical in 2015 compared to prior years.
The level of interest rates pre- and post the conversion were not disputed in this case.
However, the interest rate increase did not compensate for the immediate currency loss according to the court. The interest rate reflects the risk for the specific loans and not the conversion itself.
The fact that Tele2 made a capital injection into the new entity 2016 further reaffirms that this was a realistic option available also in 2015.
Swedish tax penalty
The court also addressed tax surcharges and open disclosure formats in the tax return.
Tele2 Treasury AB had included a note in the tax return about the currency conversion loss and a reference to a specific footnote in the annual report. This was not considered sufficient as an open disclosure since key circumstances were not included.
Key circumstances, in this case, were considered to be the currency loss, the tenge volatility, that Tele2 Treasury AB had the possibility to recall the denomination and the increased risk of Kazakhstan MTS’ non-payment.
Since such details were not included, the court agreed with the Swedish Tax Agency and included a tax penalty of 40% on the additional tax to be paid.
In a 5 January press release, Tele2 said it will appeal the decision.
Erik Koponen
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