The concept of debt financing costs within the meaning of Article 15c Corporate Income Tax Act

From the top 2018 there are new rules which significantly extend the obligation to apply interest restrictions to revenue costs.

These regulations are the result of implementation Directive 2016/11641 (hereinafter: ATAD or Directive), laying down rules to counter tax avoidance practices which have a direct impact on the functioning of the internal market.

The legislature, recognising the risks to the state budget in the form of over-financing by debt of business activities, introduced provisions to enable revenue to be credited to only part of the so-called debt financing costs.

Introduction Article 15c Act on 15 February 1992 on corporate income tax (hereinafter: the Corporate Income Tax Act)[2], because it is referred to here, it lays down the amount of the limit on the so-called debt financing costs that may be included in the revenue costs.

The provision applies to all taxable persons with an unlimited tax obligation and not only to taxable persons financed by affiliated entities. The provision is universal and not optionally applicable.

It applies to financing costs from unrelated parties and intra-group financing costs (from related entities) shown as costs of obtaining revenue on a general basis, according to their tax classification.

From 1 January 2019 that provision is already to replace definitively the repealed provisions Article 16(1)(60)(61), regulating the so-called thin or undercapitalisation institution[3]. In practice, there are many doubts about the scope of the concept of "debt financing costs". The tax payers have a problem finding out which list of expenditure costs may potentially be restricted on the basis of Article 15c the Corporate Income Tax Act This publication aims to remove at least some of these doubts.

Debt financing costs in national law

As per content Article 15c(1) the Corporate Income Tax Act, taxpayers (residents, authors, etc.) are obliged to exclude from the cost of obtaining revenue debt financing costs in part in which the excess debt financing costs exceed 30% the amount corresponding to the surplus of the total revenue from all sources of revenue less the interest income over the sum of the cost of obtaining revenue less the value included in the tax year to the cost of obtaining the depreciation revenue in question under Article 16a-16m, and the costs of debt financing not included in the initial value of the fixed or intangible asset. By "surplus debt financing costs", according to content Article 15c(3), the amount by which the taxpayer’s debt financing costs, which are to be included in the cost of obtaining revenue in the tax year, are considered to exceed the taxable income of a percentage nature.

Subject to the content of the recipe Article 15c(12) the Corporate Income Tax Act, the costs of debt financing shall be understood to include all types of costs associated with obtaining from other entities, including unrelated parties, financial means and the use of such funds, in particular interest, including capitalised or included in the initial value of a fixed asset or intangible asset, fees, commissions, premiums, interest rate part of the leasing instalment, penalties and late payment charges and the cost of securing liabilities, including costs of derivatives of financial instruments, irrespective of who they are incurred.

The provision does not contain a catalogue of closed expenditure deemed to be debt financing costs. These include all the costs associated with obtaining funds from other entities and the costs associated with using them. Whether or not a given cost constitutes a ‘debt financing cost’ will determine whether it is ‘cost associated with obtaining and using funds’. The phrase used "in particular" means, of course, an example of the cost of obtaining revenue and eligible under the category "debt financing costs".

In relation to the previous provisions governing undercapitalisation, including the alternative method with Article 15c the Corporate Income Tax Act in the version applicable to 31 December

2017, the costs of debt financing have been significantly extended. They shall include, in addition to standard interest, commissions and charges on loans or loans, also interest included in the initial value of the fixed measure or intangible and legal assets, as well as interest on the leasing instalment.

The costs of guarantees and other collateral related to obtaining financing, or the costs of derivatives of financial instruments, will also be included in the total amount of debt financing.

External financing costs in Union legislation

Commented provision is in the assumption of implementation Article 2(1)) The ATAD Directives, which is why recourse to this EU provision allows for a more understanding of the content and purpose of national regulation.

Although the Directive uses the term ‘external financing costs’, the term ‘debt financing costs’ is used in the national law as an equivalent. The legislator adopted the name ‘debt financing’ not mentioned in the existing legislation.

Debt financing is related to foreign capital which the entity has acquired for the purpose of carrying out business, as opposed to equity raised by owners who obtain the right to manage and profit generated as part of their shareholding.

As per content Article 2(1)) The ATAD Directives, ‘costs of external financing’, shall mean interest on all forms of debt, other costs economically equivalent to interest and expenditure incurred in connection with the acquisition of financing, as defined in national law, including, but not limited to, interest on participation loans, interest on the calculation of interest on instruments such as convertible bonds and zero bonds, amounts under alternative financing arrangements such as Islamic financing, interest on financing in the case of financial leasing payments, capitalised interest, included in the carrying amount of the asset in question, or depreciation of capitalised interest, amounts determined by reference to the reimbursement of the financing under the transfer pricing rules, where appropriate, nominal interest amounts in the derivatives or collateral arrangements for external financing, which the entity benefits, certain gains and losses on exchange differences resulting from the borrowings and financing instruments, guarantee fees related to the financing arrangements, fees related to the arrangements and similar borrowing costs.

Interest on the lease instalment

The legislator listed, among the expenditure catalogues recognised as debt financing costs, the ‘interest part of the leasing instalment’. In practice, doubts arise as to the part of the leasing agreement of which the provision refers.

It is worth noting at this point that in this provision of the ATAD Directive, the term ‘interest element of financing for financial leasing payments’ is used. The Directive does not explain what is meant by ‘financial leasing’.

Nor does it indicate which provisions should be applied to distinguish operating leasing from financial leasing. However, as described below, the interest obligation is a tax parameter typical only for the financial leasing in question under Article 17f the Corporate Income Tax Act

This is not the case with tax representatives. In one of individual interpretations Director of National Tax Information[4] considers that the concept of external financing contained in the ATAD Directive has a very broad scope and refers not only to interest on loans but also to interest on other forms of debt, including interest paid for the use of the lease.

On the one hand, to the Director of KIS stated that the regulation on limiting the value of debt financing costs applies to all types of leasing contracts (i.e. the financial and operational leases) and indicated that, in the event that the legislator intended to exclude from tax the interest rate of the operating leasing instalment, such a wording would be included directly in the provisions of the tax laws.

On the other hand, in the same interpretation, considered that the division into operating leasing and financial leasing existing in the Polish legal system was only linguistic, since from the economic side operating leasing is equivalent to financial leasing and should thus be recognised for accounting purposes by economic operators. In order to justify its position, the Director of the CIS further emphasises that the Law the Corporate Income Tax Act direct reference to the application of the so-called “financial leaching” provisions in relation to “operational leaching” contracts[5].

Such a statutory reference, together with the lack of use by the legislator of the concepts of operational leasing and financial leasing under the tax law, causes that in the assessment of the body the restriction of the application of regulations with Articles 15c(12) and 15c(13) the Corporate Income Tax Act only to contracts concluded under financial leasing conditions, would be contrary to the rules contained in Polish tax rules and the principle of equality of entities with respect to the law (economic entities could shape their relationship under the lease agreement so as not to apply restrictions resulting from Article 15c the Corporate Income Tax Act).

Both the Corporate Income Tax Act and the Personal Income Tax Act do not use the term ‘operating leasing’ or ‘financial leasing’. If the contract meets the parameters in question under Article 17b:

• the lease agreement has been concluded for a specified period, representing at least 40% the standard depreciation period, if the leasing contract is subject to depreciation of movable or intangible assets, or has been concluded for a period of at least 5 years where the subject matter is subject to write-offs of the immovable property;
• the sum of the established charges in the lease agreement, less the due tax on goods and services, corresponds at least to the initial value of fixed assets or intangible assets, and, in the case of the conclusion by the sponsor of the subsequent lease of a fixed asset or intangible and legal property previously the subject of such a contract, corresponds at least to its market value at the date of conclusion of the subsequent lease agreement;

the charges laid down in the lease agreement, borne by the recipient during the basic period of the contract for the use of fixed assets and intangible assets, constitute the financing income and, respectively, the cost of obtaining the revenue of the beneficiary.

Depreciation write-offs are made by the funder (leasing provider). The contract usually provides for an option to buy out the lease. Such a contract is commonly called an operating lease agreement.

However, regardless of the name, the same parameters often meet other contracts, including long-term leases, the purpose of which is not to de facto finance the purchase of the lease by using the buy-out option. The purpose of such contracts is to use assets in business activities without including them in assets of the undertaking.

Therefore, should the charges charged for the use of assets, where the normal effect of the contract is not its redemption (although due to the high buy-out price which, in the case of long-term leases, corresponds to the market price) actually be regarded as costs corresponding to interest-rate debt financing?

How the taxable person is to determine the percentage of the long-term rent that meets the conditions in question under Article 17b the Corporate Income Tax Act?

From the point of view of the provisions of the Act, the breakdown of the leasing instalment into equity and interest is applied in the case of the leasing contracts in question under Article 17f the Corporate Income Tax Act, and therefore for the so-called financial leasing contracts. However, it should be noted that even in this situation, the national legislature does not use the concept of ‘part of the interest lease’ — Article 17f the Corporate Income Tax Act points out only that revenue and revenue costs do not include fees, in the part which reflects the initial value of fixed assets and intangible assets.

On the ground the Corporate Income Tax Act, in the case of business lease contracts, the term ‘part of the interest lease’ does not occur in any way as a separate item constituting income or tax cost. Provisions Article 17b the Corporate Income Tax Act indicate only that in the case of operating leasing contracts, the financing income and the corresponding cost of obtaining the proceeds of the beneficiary are the charges laid down in the lease agreement, borne by the recipient during the basic period of the contract.

In view of the objective of introducing Union rules on the inclusion in the cost of obtaining income from the cost of debt financing, it should be concluded that the concept of ‘interest rate part of the leasing instalment’ should refer only to the so-called financial leasing — the contracts in question under Article 17f the Corporate Income Tax Act, where depreciation is made by the beneficiary and the normal consequence of the performance of the contract is the transfer of ownership.

Such a contract is similar in its design, which has been stressed many times in the doctrine, to sale in instalments and a form of lending the purchase of assets. This financial lease is similar to a loan where the object of the ‘loans’ is a fixed asset rather than cash.

Increase interest

investment value

For the debt financing costs referred to under Article 15c(12) the Corporate Income Tax Act, The act shall include in particular interest, including capitalised or included in the initial value of the fixed asset or intangible asset. In calculating the cost of debt financing, account should be taken of any expenditure that meets the definition of revenue costs in a given year, and thus can be classified by an economic operator as a burden of the tax costs of its business.

Credit costs (loans), i.e. accrued interest on credit may be included in the cost of obtaining revenue at the time determined in accordance with

Article 16(1)(10) point (a) or Article 16(1)(11) the Corporate Income Tax Act According to Article 16(1)

point 10 point (a) the Corporate Income Tax Act the cost of obtaining the revenue of the expenditure on repayment of loans, except for capitalised interest on those loans (credits) (...).

In turn, according to Article 16(1)(11) the Corporate Income Tax Act not the cost of obtaining accrued revenue but not paid or decommitted interest on liabilities, including loans.

However, according to content Article 16(1)(12) the Corporate Income Tax Act the cost of obtaining interest income, commissions and exchange rate differences on loans (credits) increasing investment costs during the period of implementation of these investments is not considered to be the cost of obtaining interest income, commissions and exchange differences on loans (credits).

The purchase price or cost of production, which is the initial value of the fixed asset, shall be increased, inter alia, by interest on loans/credits calculated by the date of transfer of the fixed asset for use. Accrued interest shall also be understood as unpaid interest, calculated by the taxpayer.

In determining the depreciation base, account shall therefore be taken of accrued interest which, although not paid, increases the initial value of the amortised assets. Interest only becomes at the expense of depreciation write-offs from the fixed assets transferred to use. On the other hand, after the fixed measure has been transferred to use, the accrued interest is included directly on the date of payment as tax costs.

Given the above regulations and the definition of debt financing costs, it should be clear that the costs of loans/credits charged to investment outlays during the investment period are not part of the calculation of the limit in question under Article 15c(1) the Corporate Income Tax Act – are not considered as revenue costs[6].

On the other hand, as a result of the transfer of fixed assets for use, the expenditure is included in the initial value of the fixed measure and becomes at the expense of depreciation write-offs.

In such a situation, the difficulty of accounting is to adequately separate from the amount of the depreciation deduction ‘interest included in the initial value of the fixed asset or intangible asset’[7].

The limit is subject to part of the depreciation write-down, which corresponds to the proportion in which the value of all the debt financing costs included in the initial value of the asset or intangible asset remains to the entire initial value of that asset. The moment of payment of such interest, as tax-neutral, included in the costs by depreciation deductions, should not be taken into account when calculating the amount of the limit in question under Article 15c(1) the Corporate Income Tax Act 8.

The depreciation deductions are part of the calculation of the limit in question under Article 15c(1) the Corporate Income Tax Act In such calculations, the sum of revenue from all sources of revenue, less interest income, shall be deducted by the sum of the cost of obtaining revenue less the value included in the tax year into the cost of obtaining the depreciation revenue in question. Under Article 16a-16m, and the costs of debt financing not included in the initial value of the fixed or intangible asset.

Such an editorial means that the financing costs charged to investment outlays during the investment period are not part of the calculation of the limit and that the moment of their payment could remain tax neutral.

Exchange rate differences

Obtaining external financing in foreign currency results in the risk of a change in the value of the currency over time. This risk is realised by negative or positive exchange rate differences.

For both positive and negative exchange rate differences, these differences are linked to financing costs, only the difference that, in the event of an increase in the exchange rate, the cost of financing increases and, in the event of a fall in the value of the currency, the cost decreases accordingly.

Appropriate application of the provisions on exchange rate differences relating to financing costs means that, in the event of positive or negative exchange rate differences, this cost is subject to appropriate adjustment.

The exchange rate differences (both positive and negative) recognised by the taxpayer in relation to liabilities arising from debt financing in foreign currency adjust the value of the debt financing costs in question under Article 15c(12) the Corporate Income Tax Act 9.

This is not affected by the fact that according to Article 15a(1) the Corporate Income Tax Act the taxable person shows separately the revenue and costs of obtaining exchange rate income for tax purposes.

Bond issue costs

The issuance of bonds is an increasingly used way to enable companies to obtain funds for their planned investments. The acquisition of foreign capital by issuing private bonds has the advantage over bank loans that in the case of bond issuance, the issuer determines their interest rate.

In addition to the interest paid to the bond issuer, the bond issuer must also bear other costs directly related to the issuance of bonds, such as the costs of legal advisers, financial advisors, credit rating agencies, marketing costs and other costs associated with the preparation of bond issuance transactions.

In principle, these costs may be included by the entrepreneur in the cost of obtaining revenue.

The cost of obtaining revenue is not considered merely to be expenditure on the redemption of bonds, less the amount of the discount (Article 16(1)(23) the Corporate Income Tax Act). Where the allocation of the funds obtained from the issuance of bonds remains linked to a number of ongoing or planned projects, these expenditure shall constitute costs other than those directly linked to revenue (indirect costs).

This in turn means that they are deferred on the date of their payment[10]. Of course, having regard to the wording of the provision already cited Article 16(1)(11) the Corporate Income Tax Act, the interest on the bonds itself may be included in the cost of obtaining revenue at the time of their actual payment[11].

Summary

Given the way in which the concept of ‘debt financing costs’ is defined in the provisions of the Act and the concept of ‘outside financing costs’ in the ATAD Directive, in addition to the fact that we are dealing with an open catalogue of various types of expenditure related to the raising and use of capital, it should be considered that the scope of these definitions is broad. In the case of expenditure incurred on the issue of bonds, the costs of advertising in the media in which the issuer announces its offer should be considered as such.

This means that accounting systems need to be adapted in a way that identifies expenditure considered as debt financing costs. In doing so, the taxpayer should have regard to the transitional provisions adopted.

As per content Article 7 Amending Act[12], up to interest on loans for which the amount of credit granted to the taxpayer was actually transferred to that taxpayer before the date of entry into force of this Act (until the end of the 31 December 2017), The provisions shall apply Article 15c or Article 16(1)(60)(61) and section 6 and 7b and 7g and 7h in the existing version, but no longer than 31 December 2018