Interest paid on debt (loans and credits) is generally tax deductible for the debtor when paid as long as the debt was taken for the purpose of generating taxable revenues or preserving the existing source of revenues. The general rule is therefore that interest is deductible on a cash (not on an accruals) basis.
Subject to certain exceptions, all expenses incurred by a company for a purpose of gaining, preserving and protecting taxable revenue generally are deductible. Thus, loan interest and other loan costs, (for example loan-closing costs such notary costs and legal fees, and commission paid upon drawing of the loan), constitute deductible costs for the taxpayer provided that the loan costs were incurred directly or indirectly for the purpose of gaining, preserving and protecting taxable revenue.
There are certain cases where the Polish tax authorities disallow tax deductibility of interest. For example interest arising on a loan drawn by the company to pay dividends or in order to pay redemption profits to company’s shareholders has been held to be non-deductible although a recent judgment by the Administrative Supreme Court has challenged this.
The interest on a loan drawn to finance investments on fixed and intangible assets is not deductible if paid or accrued within the period in which the investment is made. Instead, such interest increases the acquisition value of the assets, which is subsequently depreciated for tax purposes. The same applies to commissions and currency differences incurred in relation to the loan.
The repayment of loan principal does not constitute a deductible cost for the debtor, but capitalized interest on loans is deductible. However, it is not clear when capitalized interest becomes deductible, although it is generally accepted that capitalized interest constitutes a tax deductible cost at the moment of capitalization.
Thin capitalization restrictions
Legislation restricts financing granted by related entities by setting a deductibility limit calculated on the basis of a debt-to-equity ratio (the thin capitalization restriction). Related entities are:
- a direct shareholder (or direct shareholders) with at least 25% of the shares in the borrower’s share capital; or
- a sister company, provided that the same entity (or individual) holds at least 25% of the shares in the borrower’s share capital and 25% in the lender’s share capital.
A deductibility limit is applied when a loan by a Polish corporate income tax payer is drawn from related entities (the tax residence of the related entity plays no role) and borrower’s debt exceeds the 3:1 debt-to-equity ratio.
Interest on a loan must also be payable on an arm-length basis. Interest on financing granted by a related entity should always be set at a market rate. If conditions of a loan agreement between related parties differ from those agreed by independent entities, the tax authorities can make an adjustment leading to the elimination of some costs of interest from a company’s corporate income tax calculation.