The proposed tax changes under the Polish Deal programme enshrine in law a method of calculating the debt financing cost limit which is disadvantageous for taxpayers. They offer a carrot to buyers of shares in the form of a deduction from the tax base of qualified expenditures on the acquisition of shares as part of consolidation relief, but also a stick in the form of a complete ban on treating interest on debt financing obtained from related parties for the acquisition of shares as a tax-deductible cost.
An unfavourable way of calculating the limit of debt financing costs
The Corporate Income Tax Act currently provides that CIT payers may not recognise debt financing costs as tax-deductible costs to the extent that the debt financing costs to be recognised in a tax year exceed the interest income earned in that tax year by more than 30% of tax EBITDA.
Pursuant to the CIT Act, the surplus of debt financing costs not exceeding PLN 3,000,000 in a tax year is not subject to exclusion from tax-deductible costs.
“Tax” EBITDA consists of the surplus of total revenues from all sources of income, less interest income, over total deductible expenses, less the value of depreciation and amortisation write-offs and debt financing costs not included in the initial value of tangible or intangible assets recognised as deductible in a tax year.
Therefore, it is the amount of the surplus of the debt financing costs incurred in the tax year (considered as deductible costs) over the interest income earned in the tax year, and not the amount of the debt financing costs as such, that constitutes the benchmark for excluding debt financing costs.
In tax practice, there are currently two interpretations of the method of calculating the limit on debt financing costs.
According to the tax authorities, which adopt a position unfavourable to taxpayers, in a given tax year, the surplus of debt financing costs may be classified as tax-deductible costs in the maximum amount of either:
- PLN 3,000,000, or
- 30% of tax EBITDA,
whichever is higher.
On the other hand, the case law of the administrative courts reflects an approach favourable to taxpayers, based on a literal interpretation of the current provisions, according to which:
- The surplus of debt financing costs not exceeding PLN 3,000,000 in a tax year does not apply at all to the limit of recognition as tax-deductible costs.
- When in a given tax year the surplus of debt financing costs exceeds PLN 3,000,000, the taxpayer may include up to PLN 3,000,000 and 30% of tax EBITDA as tax-deductible costs.
The position adopted by the administrative courts is of great importance for taxpayers, as in practice it allows them to include in tax-deductible costs in a tax year as much as PLN 3,000,000 more in debt financing costs than under the unfavourable approach of the tax authorities.
The proposed tax changes are aimed at enshrining in the CIT Act the interpretation of the tax authorities disadvantageous for taxpayers.
According to the bill, taxpayers will have to exclude debt financing costs from tax-deductible costs to the extent the debt financing costs in a tax year exceed PLN 3,000,000 or 30% of tax EBITDA.
There is no doubt that these changes would generate additional tax burdens for companies.
Ban on deducting as tax costs the costs for financing debt from related parties for acquisition of shares vs. the possibility to deduct qualified expenses for acquisition of shares from the tax base
The proposed rules provide for:
- A total ban on deduction of costs for financing debt from related parties, allocated directly or indirectly to capital transactions, in particular acquisition or subscription of shares, acquisition of all rights and obligations in a partnership (not a legal person), surcharges on shares, increases in share capital, or buyout of the company’s shares in order to redeem them.
The proposed regulation is aimed at counteracting the tax practice of capital groups, where a taxpayer reduces its income by recognising interest on loans from related parties as tax-deductible costs and allocates the proceeds of the loan to finance another related party (e.g. by making a cash contribution), which results in reclassification of the loan as equity financing and, as a consequence, does not generate income for the taxpayer.
- Consolidation relief, which would allow taxpayers obtaining revenue other than from capital gains to deduct qualified expenditures for the acquisition of shares in companies from their CIT tax base, up to the amount of the taxpayer’s income in a tax year other than capital gains.
Not only could qualified expenses be tax-deductible pursuant to the CIT Act, but they could also (additionally) be deducted from the tax base in the tax year in which the shares are purchased. This deduction could not exceed PLN 250,000 in a tax year.
Qualified expenses for acquisition of shares would include expenses directly related to the transaction for the purchase of shares, incurred for:
- Legal services for the purchase or valuation of shares
- Notary fees, court fees, and stamp duty
- Taxes and other public and legal dues paid in Poland or abroad.
Qualified expenses would not include the price paid for the shares or the debt financing costs related to such acquisition.
If, within 36 months from acquisition of the shares:
- The taxpayer or its legal successor disposes of or redeems the shares
- The taxpayer or its legal successor goes into liquidation or is declared bankrupt, or
- There are other circumstances foreseen by law in which the taxpayer or its successor in title ceases to exist
the taxpayer or its legal successor will be obliged to increase the tax base by the amount of the deduction made in the tax year in which the above event occurred.
The deductibility of eligible expenses would be subject to the following prerequisites:
- The company whose shares are acquired is a legal entity and has its registered office or management board in Poland or another state with which Poland has concluded a tax treaty containing a legal basis for the exchange of tax information.
- The main object of the company’s activity is the same as that of the taxpayer, or the activities of the company can reasonably be considered activities supporting the taxpayer’s activities (but the activities of such a company may not constitute financing activities).
- The taxpayer and the company conducted such activity for at least 24 months before the date of acquisition of the shares.
- Within two years before the date of acquisition of the shares, the company and the taxpayer were not related entities.
- In a single transaction, the taxpayer acquires shares in the company in an amount representing an absolute majority of the voting rights.
The simultaneous introduction of consolidation relief and the ban on deducting interest on financing debt from related parties is a sign of inconsistency on the part of the proponent of the amendment. On one hand, it encourages taxpayers to acquire shares in other companies, and on the other hand makes it difficult to obtain financing for acquisition of such shares from related parties.