Whether default interest following verification or inspection procedures is deductible depends on the fiscal year under inspection and the date when a new CIT assessment is issued.
The question of whether or not it is possible to deduct default interest from CIT has recently caused a lot of debate in Spain. The argument started as a result of the divergent conclusions that were drawn, on one hand in a decision by the Central Tax Court and, on the other, in a reply to enquiry issued by the General Directorate of Taxation, both with regard to specific cases. As a consequence of this discrepancy, the Spanish Tax Agency issued a general report that was later addressed by a Resolution of Spain's General Directorate for Taxation, which was binding and generally applicable.
Firstly, we have to remember that a new Corporate Tax Act became enforceable in Spain in FY 2015. In addition, it should be clarified that the default interest discussed in this article refers to the interest in tax assessments issued by the Administration in cases of verification or inspection procedures.
To summarise, depending on the fiscal year that the Administration is verifying and the year in which it issued the tax assessment, the criteria below will apply when considering the deductibility of default interest:
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Clearly the most complex case is when the Administration issues a new assessment in 2015 (or in subsequent fiscal years) after a verification was carried out in FY 2014 (or an earlier year). In such cases, two situations may arise, depending on how the default interest was recorded in the accounting.
The first situation allows the default interest to be deducted, if it was recorded as an expense in the profit and loss account for the relevant fiscal year. If this is the case, the interest is considered to be a financial expense, therefore the limits that law imposes on the deductibility of financial expenses would be applicable.
The second situation is when the default interest has been recorded in a reserves account due to some accounting error. In such cases, the General Directorate for Taxation's resolution deems that the interest can only be deducted in the tax settlement period in which that interest was recorded in the accounting, providing that this does not result in a reduction in tax payableand, of course, that the limits imposed for financial expenses are respected. However, it is our understanding that the tax inspectorate might consider such default interest (deriving from FY 2014 or earlier years) as not deductible, based on the Central Tax Court's doctrine, where such interest is recorded for fiscal years prior to 2015.
Consequently, the deductibility of default interest will be a question that the Administration is sure to review and dispute when performing its verification and inspection procedures.