Swedish judgment on the arm's length principle and the Swedish Tax Agency’s comment

Swedish judgment on the arm's length principle

Section 14 paragraph 19 Income Tax Act (ITA) can be applied when an agreement with certain contractual terms and conditions is replaced by another agreement with not as beneficial terms and conditions, although they by themselves are considered to be at arm's length, according to the Supreme Administrative Court (SAC).



Annika Lindström

Partner & Head of Tax & Legal

KPMG i Sverige


In 2003, three loan agreements were signed between a company (the borrower) and its parent company. The receivables were immediately transferred to a sister company of the borrower in the Netherlands. The agreements contained terms regarding the maturity (15, 25 respective 30 years), amortization and interest, but no conditions that enabled the lender to adjust the interest rate during the term of the agreement. In 2008, during the term of all three agreements, the loan agreements were replaced, whereby the parties agreed on an increased interest rate, without any other compensation being offered to the borrower. Seen by itself, the new interest rate was considered to be at arm's length. The new receivables were then transferred to another sister company in Switzerland.

The Swedish Tax Agency (STA) has denied the borrower a deduction for the interest costs where it exceeds the interest that would have been due to the loan agreements entered into in 2003, with reference that an independent party in the same previous contractual relationship would be reluctant to enter in to the agreement with less beneficial terms and conditions, without being offered any form of compensation.

The borrower stated that the interest that was due to the 2003 years agreements were not at arm’s length, thus implying that there was a reason for the borrower to agree to an adjustment of the agreements. The STA shared the view that terms and condition regarding interest rate that is not at arm’s length can be adjusted, without activating section 14 paragraph 19 ITA, but that this would be a compensation objection, whereby the borrower holds the burden of proof. The Administrative Court of Appeal (ACA) finds that the borrower has not shown that the interest rate agreed on 2003 years agreements were not at arm’s length. Among other it is noted that the borrower in previous taxations has stated that the interest rates are arm’s length, and that the borrower does not pay interest to external parties that could have been used as comparable interest rates.

The SAC granted leave to appeal the issue if section 14 paragraph 19 ITA can be applied when an agreement with certain contractual terms and conditions is replaced by another agreement with not as beneficial terms and conditions, although the new terms and conditions are considered to be at arm's length. The review is limited to whether the interest terms in the agreement entered into 2008 shall be considered by themselves or if the previously entered agreement and the terms already in place between the parties must be taken into account.

The SAC announced in the passed judgment that not only should the new interest rate level in the agreement from 2008 be the basis for the assessment of arm's length, but all of the terms and conditions that the parties agreed upon when entering the agreements. The agreements from 2003, during which terms the new agreements were entered into, contained no conditions enabling the lender to increase the interest rates. An independent party would not have accepted an increase in their interest rates without any other compensation when the current agreements did not regulate such a possibility for the lender.

Thus, the SAC has found that section 14 paragraph 19 ITA can be applied also on terms and conditions that in themselves are at arm's length, if they in relation to what previously have been agreed in agreements that have yet not expired do not reflect how independent parties would act. According to the SAC, this interpretation is consistent with the OECD guidelines on transfer pricing.

The Swedish Tax Agency’s comment

1 July 2016, STA published their comment on the SAC's judgment. The SAC's judgment is consistent with the STA view. However, the STA consider that it is possible for companies to change the agreements concluded on non arm's length terms to what would have been arm's length terms when the agreement was concluded, without historic adjustments.

KPMG's comment

This case changes the legal position as it has been, and implies a more far-reaching interpretation of section 14 paragraph 19 ITA than before, compare to the ACA case no. 6565-6569-10 in which the conclusion was that it was the latter loan agreement which should be assessed against section 14 paragraph 19 ITA, and that it was up to the STA to show that the terms and conditions in the latter agreement differs from what is regarded as arm’s length.

The judgment seems to imply that it is not only the pricing between the affiliated companies that needs to be at arm's length, but an overall assessment of all relevant factors between the companies must be made, including the actions of the affiliated companies in relation to each other needs to reflect how independent parties would act.

It's yet to be shown what the consequences will be and how far this new case law will be drawn in relation to "when an agreement with a certain term or condition is replaced with another agreement with a less beneficial, but rather arm's length, condition". A possible result could be a greater focus on the formulation of transfer pricing related agreements, and the terms and conditions entered into, including what possibilities the parties have to terminate the agreements. Implementing a new transfer pricing policy would require the termination of previous agreements, unless the agreements provide the possibility for adjustments.

It is important to clarify that the SAC has judged on the renegotiation of the agreements and not whether the previous agreements are arm´s length or not. The judgment should therefore only be regarded as applicable as guidance in situations where an arm´s length agreement is replaced by another arm’s length agreement. This view seems also to be shared with the STA commentary on the SAC's judgment.

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