Calculation of the limit of debt financing costs under Article 15c of the CIT Act in practice: what difference do the most recent judgments by district administrative courts make?
Anyone who has read Article 15c of the CIT Act that has been effective since 1 January 2018, and which implements the ATAD1 provisions, is aware that the simplicity of its wording resembles the description of the degree of a consanguinity with a distant cousin. Although more than 18 months have passed since the amended provision became law, questions continue to be asked about its application as regards determining the so-called safe harbour limit, i.e. the upper limit of debt financing costs that can be treated as fully tax-deductible. The controversies between taxpayers and the Director of the Polish National Tax Information over this matter has led to disputes before district administrative courts, which finally take the side of taxpayers.
The approach of the Director of the Polish National Tax Information ("NTI") is that the amount by which debt financing costs exceed interest income may be recognised as tax-deductible costs in a given tax year up to the higher of:
a. PLN 3 million, in accordance with Article 15c(14)(1) of the CIT Act or
b. 30 % of EBITDA, in accordance with Article 15c(1) of the CIT Act
(the expression "30% EBITDA" will be used for simplicity, but should be understood to mean 30% of “tax EBITDA”, calculated in accordance with Article 15c(1) of the CIT Act).
However, district administrative courts tend to agree with the approach adopted by taxpayers, i.e. in accordance with the literal rule of interpretation of Article 15c of the CIT Act, which reads that:
a. the limitation of the tax-deductibility of debt financing costs does not apply where such surplus does not exceed PLN 3 million;
b. f the amount by which debt financing costs exceed interest income is higher than PLN 3 million, then the tax-deductible costs that may be recognised in a tax year must not exceed PLN 3 million plus 30% EBITDA.
This is an important difference, because the view held by courts allows taxpayers to recognise in a given tax year as much as PLN 3 million more in debt financing costs as tax-deductible expenses, as compared to NTI Director's approach presented in tax rulings, which means over half a million zloty less corporate income tax to be paid by the taxpayer.
Before looking into the most problematic aspect of calculating the limit of debt financing costs for taxdeductibility purposes, the first question to be asked is whether the amount of the tax-deductible debt financing costs exceeds the interest income in a given tax year. It is the amount of the surplus, not the amount of debt financing costs as such, that is the basis for excluding debt financing costs from tax-deductible expenses.
In practice, if the tax EBITDA is negative and debt financing costs exceed the PLN 3 million limit many times, it does not mean that any amount of such costs will be excluded from tax-deductible costs in the tax year concerned. The starting point for the applicability of the limitation provided for in Article 15c of the CIT Act is the amount of the surplus of the debt financing costs over interest income. For example, if debt financing costs amount to PLN 10 million and interest income is PLN 12 million, there will be no excess and, therefore, the limitation will not apply in that case.
An entity that continues to incur debt financing costs needs to monitor its 30% EBITDA on an ongoing basis, if its debt financing costs exceed its interest income at any time during a tax year and, as a result, the entity needs a basis for calculating the part of its debt financing costs which must not be recognised as tax-deductible costs. However, 30% EBITDA is not the only basis for limiting the tax-deductibility of debt financing costs, as the literal interpretation of the relevant provisions of the CIT Act indicates that the limit does not apply to that part the excess of debt financing costs over interest income which does not exceed PLN 3 million. And it is this PLN 3 million limit that is where the shoe pinches.
In an individual tax ruling dated 16 April 20192 the NTI Director concluded that the cost limitation does not apply to an excess of up to PLN 3 million. But if 30 % EBITDA is, for example, PLN 4.5 million, then any excess of the debt financing costs over interest income as compared to 30 % EBITDA must be excluded from tax deductible costs. If, however, 30 % EBITDA is lower than PLN 3 million, the surplus of the debt financing costs over interest income may be recognised as tax-deductible cost up to PLN 3 million.
The NTI Director stressed that the excess of debt financing costs must not be reduced by PLN 3 million, and the amount of PLN 3 million may only increase the limit calculated using the specified formula, i.e. it may be the upper limit if 30 % EBITDA is lower than PLN 3 million. This approach, disadvantageous to taxpayers, had already been presented in individual interpretations issued in 20183. In such interpretation, the taxpayer tried to argue that the purpose of Article 15c(14) (1) of the CIT Act was to apply the limit to the surplus of the debt financing costs over PLN 3 million. The taxpayer's opinion is that this provision does mean that the surplus of the debt financing costs up to PLN 3 million should not be included in the calculation of the limit of debt financing costs for tax-deductibility purposes. However, the NTI Director seems unyielding.
This negative trend in the NTI Director's tax rulings has been weakened by the recent judgements of the district administrative courts, which take the side of taxpayers. The first judgment in support of taxpayers' arguments was issued by the District Administrative Court in Wrocław on 13 November 2018, ref. no. I SA/Wr 833/184, which cancelled the negative tax ruling of the NTI Director. Subsequent court judgments also challenged tax authorities’ tax rulings and held that it is the excess of debt financing costs over PLN 3 million plus 30 % EBITDA that must not be recognised as tax-deductible expenses.
In its most recent judgment of 6 June 2019 (ref. no. I SA/Rz 253/19), the District Administrative Court in Rzeszów held that the meaning of Article 15c(14) of the CIT Act is that the tax-deductibility limit of debt financing costs did not apply to such costs if the surplus did not exceed the amount of PLN 3 million. This limit applies only to the surplus of the debt financing costs over PLN 3 million. The court concluded that a different approach was not supported by the literal, functional, systemic or historical interpretation of that provision.
It is stressed in the judgments that the NTI Director may not rely on the ATAD provisions if the consequences of its application by the Director are disadvantageous to taxpayers and against the provisions of the Directive. It is especially important given the fact that the limit indicated in Directive is higher than implemented to Polish law and amount up to EUR 3 million.
However, the above judgments are not final. The final decision will be taken by the Supreme Administrative Court, and it will take some time.
The application of Article 15c of the CIT Act as it is currently drafted is not easy for taxpayers. Starting from the calculation of the excess of debt financing costs over interest income, moving on to 30 % EBITDA (whose calculation is different from that of the economic ratio), all the way to the calculation of the limit of debt financing costs that may be fully recognized as tax-deductible costs. Things are not made easier by tax authorities or district administrative courts, with their opposing opinions.
However, bearing in mind the literal rule of interpretation of the analysed provisions and the most recent judgments of district administrative courts, there is some hope that the Supreme Administrative Court will accept taxpayers' advantageous interpretation of Article 15c of the CIT Act.
1 Council Directive (EU) 2016/1164 of 12 July 2016.
2 The NTI Director's individual tax ruling of 16 April 2019, no. 0111-KDIB2-3.4010.90.2019.1.LG.
3 Cf. the NTI Director's individual tax ruling of 2 July 2018, no. 0114-KDIP2-2.4010.226.2018.1.AM.
4 Cf. judgments issued by the same court on 4 April 2019 (ref. no. I SA/Wr 14/19 and I SA/Wr 7/19), the District Administrative Court's in Poznań judgment of 12 December 2018 (ref. no. I SA/Po 699/18), and the District Administrative Court's in Gdańsk judgment of 8 May 2019 (ref. no. I SA/Gd 287/19).
Krystyna Szlęzak, Senior Manager in the International Tax Team at KPMG in Poland
Joanna Wójcik, Consultant in the International Tax Team at KPMG in Poland
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