Ambiguous principles of calculating debt financing costs excluded from tax-deductible costs

Krzysztof PUZYR
Tax Consultant at RSM Poland

As of 1 January 2018, thin capitalisation rules have been replaced by regulations limiting the tax-deductibility of certain debt financing costs. Unfortunately, the new regulations fail to provide clear rules and principles for calculating the amount of debt financing costs excluded from tax-deductible costs and raise significant doubts among experts and taxpayers. Meanwhile, since the beginning of 2018, the director of the National Revenue Information Office has issued a number of tax interpretations concerning the matter in question, in which he presented a position that is disadvantageous for taxpayers.

Amendment of the CIT Act

According to the legislation in force until 31 December 2017, limitations of the tax-deductibility of debt financing costs were regulated by Article 16 par. 1 item 60 and 61 of the CIT Act (thin capitalisation rules) and Article 15c of the CIT Act (option of abandoning thin capitalisation rules). According to the regulations on thin capitalisation rules, interest on loans granted to the company by its partner or an affiliated entity shall not constitute tax-deductible costs once certain conditions are met.

In order to implement the provisions of the Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market, the provisions of Article 16 par. 1 item 60 and 61 of the CIT Act were revoked and the provisions of Article 15c of the CIT Act were amended on 1 January 2018. Article 15c par. 1 of the CIT Act now reads that taxpayers shall be under obligation to recognise their debt financing costs as non-deductible in the part in which the surplus of debt financing costs exceeds 30% of the amount corresponding to the surplus of the total revenues from all revenue sources (less interest income) over total tax-deductible expenses (less depreciation charges recognised in the tax year as tax-deductible expenses) and debt financing costs that have not been included in the initial value of a fixed asset or intangible asset (i.e. 30% of EBITDA ratio, to put it simply).

What is also crucial for determining the amount of debt financing costs excluded from tax-deductible expenses is Article 15c par. 14 item 1) of the CIT Act, according to which, the provisions limiting tax-deductibility of debt financing costs, i.e. Article 15c par. 1 of the CIT Act, shall not apply to the surplus of debt financing costs in the portion that does not exceed the amount of PLN 3,000,000 in a tax year.

The main assumption behind the published interpretations is to present the operating principles of the new form of settlements, namely the split payment mechanism.

Position of taxpayers and tax authorities on principles of calculating the amount of debt financing costs excluded from tax-deductible costs

The aforementioned provisions of the CIT Act have been interpreted by a majority of experts and taxpayers as follows: the limit of the surplus of debt financing costs referred to in Article 15c par. 1 of the CIT Act shall apply only to the portion of the surplus exceeding the amount of PLN 3,000,000, referred to in Article 15c par. 14 item 1) of the CIT Act (see: W. Dmoch, Podatek dochodowy od osób prawnych. Komentarz (Corporate Income Tax. Commentary), Komentarz do art. 15c (Commentary to Article 15c), Legalis 2018; D. Jakubowska, Analiza nowych regulacji dotyczących kosztów finansowania dłużnego – wybrane zagadnienia (Analysis of new regulations on debt financing costs – selected aspects), Monitor Podatkowy 2018, Issue 6). As a result, if the surplus of debt financing costs does not exceed the amount of PLN 3,000,000 in a given tax year, such a surplus of debt financing costs shall not be subject to the limitations set forth in Article 15c par. 1 of the CIT Act and the taxpayer can recognise all the debt financing costs as tax-deductible. However, if the surplus of debt financing costs exceeds the amount of PLN 3,000,000 in a given tax year, such a surplus of debt financing costs shall be subject to the limitations set forth in Article 15c par. 1 of the CIT Act, yet only in its part exceeding the amount of PLN 3,000,000.

The tax effects of the above position are illustrated by the following examples:

However, according to the tax authorities, the limit of the surplus of debt financing costs referred to in Article 15c par. 1 of the CIT Act shall apply to the entire amount of the surplus of debt financing costs if this amount exceeds PLN 3,000,000. In other words, in order to determine the amount of debt financing costs excluded from tax-deductible costs, the amount of surplus of debt financing costs shall not be reduced by the amount of PLN 3,000,000 referred to in Article 15c par. 14 item 1) of the CIT Act. At most, this amount may increase the limit resulting from applying the formula, i.e. it may be the cap, if the amount of the surplus of the debt financing costs is lower than PLN 3,000,000. As a result, the limitations on debt financing costs shall not apply if:

1. there is a surplus of debt financing costs in the amount of up to PLN 3,000,000 in a tax year or
2. the amount of the surplus of debt financing costs is higher than PLN 3,000,000, yet it is not higher than the amount corresponding to 30% of EBITDA ratio, with a stipulation that if 30% of EBITDA is lower than the amount of PLN 3,000,000, the limit resulting from the application of Article 15c par. 1 of the CIT Act shall be increased to the amount of PLN 3,000,000 (see: tax interpretation of the Director of the National Revenue Information of 2 July 2018 concerning case No. 0111-KDIB2-3.4010.56.2018.2.AZE; tax interpretation of the Director of the National Revenue Interpretation of 27 June 2018 concerning case no. 0114-KDIP2-2.4010.218.2018.1.AM; tax interpretation of the Director of the National Revenue Interpretation of 25 June 2018 concerning case No. 0111-KDIB2-3.4010.61.2018.1.KB).

Tax effects of the position of the tax authorities are illustrated by the following examples:

* Depending on whichever is greater.

Summary

The new provisions of the CIT Act concerning the obligation to exclude certain debt financing costs from tax-deductible costs are complicated and ambiguous. For this reason, they may cause trouble to taxpayers trying to calculate the amount of non-deductible costs according to Article 15c of the CIT Act. The two positions presented above and concerning the principles of calculating non-deductible debt financing costs are very different and produce completely different results. And there is no doubt that the current position of tax authorities is by all means disadvantageous for the taxpayers. According to it, much higher amounts of debt financing costs may be recognised as non-deductible than in the position of taxpayers.

By the way, it is worth noting that the position presented by taxpayers is in line with the position presented in the explanations on the application of Article 15e of the CIT Act published by the Ministry of Finance. This provision sets forth an obligation to recognise the costs of purchasing certain services and rights as non-deductible and defines a limit for recognising the costs of purchasing certain services and rights as deductible in a similar way as in Article 15c of the CIT Act. However, by virtue of Article 15e of the CIT Act, the Ministry of Finance has confirmed that only the part of costs of purchasing certain services and rights that exceeds the total of 5% of EBITDA and the amount of PLN 3,000,000 shall be considered as non-deductible.

Regardless of the above, one must not forget that the provisions of Article 15c of the CIT Act are new and, as yet, they lack a well-established line of interpretation or court rulings. Thus, it is possible that the position of the tax authorities will change in the future, in particular once administrative courts make relevant rulings. However, until then, one must exert extreme caution when determining the amount of non-deductible debt financing costs in order to avoid any potential disputes with the tax authorities.