New regulations for loans paid in 2015 A limited liability company has a share capital of PLN 50 thousand and no other capitals. In 2014 the company signed two loan agreements for PLN 50 thousand each with the majority shareholder. The first loan was paid in December 2014 and the second only in February 2015. The shareholder is currently planning to provide a third loan for the same amount. We have not submitted any declaration of intent to use a different method of calculating the interest treated as tax deductible expenses to the tax office. How should we calculate the value of the tax deductible interest? Where the shareholders decide to provide the company with loans instead of capital, we may be dealing with the so-called undercapitalisation, which entails restrictions on the option to recognise part of the interest on loans provided by a shareholder as tax deductible expenses. In such a situation, the taxpayer should apply the regulations under Article 16 par. 1 item 60 and 61 of the CIT Law (the so-called standard method using the value of debt) and the transitional laws relating to loans paid before and after 1 January 2015. In accordance with the latter regulations, for loans paid before the end of December 2014 the taxpayer should apply the law heretofore in force (“old” laws), and if a loan was actually provided after 31 December 2014, he should apply the laws with the new wording (“new” laws). With respect to loans accounted for in accordance with the old laws and the new laws alike, the taxpayer may – where he submitted a written notification – apply the alternative method using the value of assets, provided for in the new regulations. However, in the case concerned, the company has failed to exercise this option.

Undercapitalisation according to the CIT Law

Until the end of 2014 the regulations contained in Article 16 par. 1 items 60 and 61 of the CIT Law restricted the possibility to treat part of the interest on loans provided by the so-called significant shareholders as tax deductible expenses where on the interest payment date the total value of the borrower’s debt owed to the so-called qualified shareholders reached three times the share capital of the company using the funding. As of this year, restrictions relate to loans provided by directly and indirectly related parties who have at least a 25 per cent share (understood as the right to vote) in the company’s capital, if the borrower’s debt owed to those parties exceeded the value of the equity. In both cases, in determining the value of the share capital or the equity, respectively, the part that has not been actually provided or has been covered by receivables from loans and credit facilities provided by the shareholders and by interest on those loans and credit facilities, or covered by intangible assets not subject to depreciation deduction, should not be taken into account.

Therefore, in the case concerned, the taxpayer should begin with identifying the loans to which the “old” or the “new” laws apply. Moreover, since the laws introduce a special method of calculating the share capital and the equity, the taxpayer should verify their amounts and determine the value of the loan and the debt at a specific date. In accordance with the transitional laws, the “old” laws cover only loans actually provided (paid) before 31 December 2014, i.e. in the case of the limited liability company described in the question, only the first loan, equal to the share capital. Any interest paid on it will therefore be treated as expenses on condition that at the date of its payment the remaining debt of the company owed to the qualified shareholders did not exceed three times the share capital. There is no doubt that the company could face such a situation after receipt of the third loan of PLN 50 thousand (the debt from loans alone will exceed three times the share capital) or earlier, for instance if its trade payables exceed the limit mentioned. In the event of exceeding the limit, interest on the part of the loan exceeding three times the share capital should be excluded from the tax deductible expenses.

The other two loans (paid this February and the one planned) should be evaluated in accordance with the “new” laws. Taking into consideration the amount of the company’s capital (PLN 50 thousand) and the information on the planned debt from loans (each of the new loans exceeds the indicated value of the capital), the interest paid should be excluded from expenses in the same proportion as that of the value of the debt exceeding the value of the company’s equity to the total amount of that debt owed to related parties on the last day of the month preceding the month of the interest payment. As a result, interest on those loans will not be initially treated as tax deductible expenses due to the fact that the value of the debt (taking into account the debt from the loans) will exceed the value of the company’s capital. Over time, in connection with the gradual decrease of the amount of the company’s debt resulting from periodic repayments, the interest paid in the future will potentially be recognised as tax deductible expenses.

Market terms do not give preference

The shareholder of our company is the State Treasury. Funding is provided by a financial institution which is also related to the State Treasury. We have been informed that this means that part of the interest paid to the bank will not be treated as tax deductible expenses. Does this rule also apply to interest on loans and credit facilities provided on market terms? Yes. The taxpayer’s question concerns the issue of determining the list of related parties. Until the end of 2014 the restrictions of undercapitalisation related only to the closest related parties, i.e. sister companies, mother companies and, to a limited extent, grandmother companies. Currently, the regulation relates to parties directly or indirectly holding no less than 25 per cent of the shares in the company being funded and the special method of calculating that percentage causes the restrictions to cover a wide range of entities from that group, including great-grandmother companies, cousin companies or even the ultimate shareholder of the group. Where such an ultimate shareholder controls all the companies in the group, its indirect share can even amount to 100 per cent.

At the same time, the CIT Law lacks an exclusion of restrictions in cases justified by reasonable business operations, i.e. in the case of entities from financial groups (e.g. banks or leasing companies), entities from the State Treasury group, or entities incurring small debts and applying market terms. On the other hand, entities from the financial industry have been given the option to use the alternative method without any additional restrictions and the unfavourable wording of the new regulations does not affect them directly. In turn, entities applying market terms – at least in theory – do not operate fully rationally since they remain undercapitalised despite their increased financial needs. There is no reasonable explanation why a taxpayer’s debt owed to a domestic financial institution on account of a loan or credit facility provided on market terms, available to any entity on the market, should make it impossible for the taxpayer from the State Treasury group to recognise tax deductible expenses. The fact that tax authorities confirm this unfavourable interpretation can be attested to by the interpretation of the Tax Chamber in Katowice of 17 March 2015 (IBPBI/2/4231505/14/MO).

Early principal repayment lowers the value of debt

We are planning to sign a loan agreement with our related party. Our previous agreements provided for an early repayment of the loan principal, meaning that the debt was considerably lower at the interest payment date. Will such contractual arrangements apply to the new agreement? Yes. The standard method assumes that interest recognised as tax deductible expenses will be determined by comparing the value of the share capital to the value of the debt on any legal account (cf. Supreme Administrative Court judgement of 28 November 2012, II FSK 699/11), including the debt incurred but unmatured. Before 2015 such calculation was performed as at the interest payment date. If on that date the company was no longer indebted to its shareholders, or at least had no debt from a loan, the calculation could be substantially beneficial to it.  

The current calculation uses the value of debt determined as at the last day of the month preceding the month in which interest was paid. This is rather an obstacle to the taxpayers but does not make it impossible to repay the loan principal early to decrease the value of debt at the indicated date. It should also be noted that after the amendment the value of debt should “also take into account the debt from loans”. It is not clear in this respect whether the law only literally confirms what has been clear thus far, i.e. that the existing but unmatured debt from a loan should be taken into account in the calculation as “the value of debt”, or means that it is necessary to add the value of the loan on which interest is paid, even if its major part has already been repaid in previous years, each time to the value of debt. At this moment, the tax authorities confirm that early principal repayment lowers the value of debt, therefore lowering the value of the interest which could be considered as not recognisable as tax deductible expenses (cf. interpretation of the Tax Chamber in Katowice of 17 March 2015, IBPBI/2/4510262/15/MO).

Debt is not offset by trade receivables

Our company is involved in various agreements with entities from the group and the loans we have been provided usually exceed the permitted limits and we have to determine the value of the debt for the purposes of the calculation of the restrictions of undercapitalisation. At the same time, some months there are receivables due to the entities from the group, arising, for example, from agreements for the supply of goods and services or trade credits. Some of those receivables are still unmatured. Can we offset the value of debt by our receivables due to the entities from the group? No. Unfortunately, there is no such possibility in principle. The legislation has introduced the option of offsetting but only with respect to the value of loans. In particular, the value of the debt owed to related parties should also take into account the debt from loans (i.e. credit facilities, issues of debt securities, an irregular deposit, deposits) and can be decreased by the value of the loans provided to related parties.

This means that an entity indebted towards its group of companies has the right to deduct the value of the loans it provided to the entities from the group but may not deduct the value of its trade receivables. In some cases, the taxpayer may consider providing the companies from the group with short-term loans for the purchase of certain goods or services, which can lower the value of the debt for the purposes of undercapitalisation but has specific consequences in accordance with the VAT Law. In fact, such activity can be deemed as exempt from VAT, possibly resulting in the need to settle VAT using the so-called turnover rate.