Implementation of the directive ATAD
The beginning of 2018 brought about significant changes in the scope of the corporate income tax. Some of the amended CIT provisions result from the implementation into the Polish legal system of Council Directive 2016/1164 of 12 July 2016 (Anti Tax Avoidance Directive (ATAD)). The aggressive tax optimization applied by groups of entrepreneurs, leading to erosion of tax bases and to transfers of profits to the places, where tax rates are more beneficial, forced the European Union to implement the provisions that counteract such practices.
One of the most important, or even the most important, tool aimed at limiting such activities, implemented with that directive on 1 January 2018 in the Polish tax system, is limitation of the possibility to include debt financing in tax costs to a certain level. Although the Polish Act had already included the provisions (on the so-called “insufficient capitalization”) limiting the possibility to classify interest as tax-deductible expenses, they only referred to the loans granted to a taxable person by the entities related to it. Since 2018, the relationships do not matter anymore, because the law-makers has applied the limit to all the interest, including the interest resulting from the credits and loans granted to it by unrelated entities, including banks.
The previous “general” provisions on “insufficient capitalization” excluded, from tax-deductible expenses, the interest on the loans granted to a company by an entity holding at least 25% shares in that company (counteract such practices since 2015), if the total indebtedness of the company to that type of entities (including loans as well as trade liabilities) excluded the value of:
1) its equity (for the loans granted since 1 January 2015),
2) three times its share capital (for the loans granted prior to 1 January 2015).
In such a case, the company had to calculate the proportion of the surplus of that type of debt over capital based on the following formula, and then multiply it by the amount of the interest paid.
The provisions of the CIT Act implemented in 2015 also included an “alternative” method of calculation of insufficient capitalization which required reporting the intention to use to the head of the tax office and “keeping” it for at least 3 years. Apart from applying a different limit based on the reference rates of the National Bank of Poland and the enterprise profits, the limitation applied not only to the interest paid to related entities, but also to others, and in that regard it was similar to the new regulations.
We should not forget completely about the old provisions, because, due to temporary provisions, they are going to apply in this year (2018) to the loans from shareholders granted prior to 1 January 2018. From 1 January 2019, they are going to be completely removed and the new provisions will apply also to the current costs of debt financing associated with the agreements concluded prior to 2018.
The credits and loans granted already in 2018 will be subject only to the new provisions based on the ATAD directive and completely altering the rules of “thin capitalization”. What is the new method of classifying the debt financing costs as tax costs based on?
First, on calculating the surplus of the costs of that financing over the interest revenues. In order to be able to “exclude” some of the costs of debt financing from tax costs, a taxable person must record, in a financial year, their surplus over the interest revenues, by at least PLN 3,000,000. The plan for the original draft changes covered implementation of a much lower limit, i.e. PLN 120,000, but it was increased at the very end. One might say: fortunately, although the ATAD Directive allows a member state to introduce a much higher surplus to be deducted without applying the limit (referred to below). In it, the upper limit was set at 3,000,000 euro, not zloty.
In order to calculate the surplus, we need to get to know the definition of the costs of debt financing and interest revenues. Therefore:
1) The costs of debt financing are all kinds of costs associated with obtaining funds, from other entities (including unrelated ones), and those associated with using those funds, in particular interest (including capitalized interest or the interest included in the initial value of a fixed asset or intangible and legal assets), fees, commissions, bonuses, interest parts of leasing installments, penalties and fees from untimely payments of liabilities, as well as the liability security costs (including the costs of derivative financial instruments).
2) In turn, interest revenues are the revenues from interest (including capitalized ones) as well as other revenues, of the economic character similar to interest, tantamount to the costs of debt financing.
* when calculating the surplus, one does not take into account the costs resulting from the credits or loans used for financing long-term projects in the scope of public infrastructure, meeting the conditions stated in the act (art. 15c, section 8 points 1-4).
So, what are we obliged to do, if our surplus calculated in that manner exceeds PLN 3,000,000 in the given financial year? Then, we will be forced to calculated the limit that may be classified as tax-deductible expenses. The limit is 30% EBITDA of the taxable person, i.e. the profit taking into account interest, amortization and taxation (to quote the act: “30% of the amount tantamount to the surplus of the sum [of the revenues from all the revenue sources minus the interest revenues] over the sum [of the tax-deductible expenses minus the value of the amortization write-offs, referred to in art. 16a-16m, classified in the given financial year as tax-deductible expenses, as well as the costs of debt financing not included in the initial value of the fixed assets or intangible or legal assets]”). If the limit calculated in that manner is higher than PLN 3,000,000, the surplus of the costs of debt financing exceeding it will be excluded from costs. If the limit calculated in that manner is lower than PLN 3,000,000, the surplus of the costs of debt financing exceeding PLN 3,000,000 will be excluded. For example:
Example 1. A taxable person generated, in the given financial year, a surplus of the costs of debt financing over interest revenues, in the amount of PLN 5,000,000. In that year, its EBITDA amounted to PLN 15,000,000. The limit of the surplus for that financial year will be: 30% * 15,000,000, i.e. PLN 4,500,000, so PLN 500,000 of the costs of debt financing will be excluded from the tax costs in the given financial year. However, it will be a temporary non-tax deductible expense (mentioned after the examples).
Example 2. A taxable person generated, in the given financial year, a surplus of the costs of debt financing over interest revenues, in the amount of PLN 3,500,000. In that year, its EBITDA amounted to PLN 9,000,000. The limit of the surplus for that financial year will be PLN 3,000,000, because the limit calculated from the following formula: 30% * PLN 9,000,000, i.e. PLN 2,700,000 is lower than the amount specified in the act. IN that case, PLN 500,000 of the costs of debt financing will be excluded from the tax costs in the given financial year (3,500,000 – 3,000,000).
However, the exclusion of that surplus from tax-deductible expenses will not be definitive, like the exclusion of some of the interest paid to shareholders, calculated based on the previous “general” provisions on insufficient capitalization. Although the amount of non-tax deductible expenses calculated based on the new method will have to be included in calculation of the CIT for the given financial year, the law-makers allow to classify them as tax-deductible expenses over the next 5 financial years, if actually, over the 5 consecutive years, the taxable person is going to have less costs of debt financing and is not going to exceed the annual limit.