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Changes in costs of debt financing

The changes to the Corporate Income Tax Act introduced by the Polish Deal also affect the limits on including costs of debt financing among deductible revenue-earning costs (CIT Act Art. 15c).
Rafał Zuchowicz
Senior TAX Specialist

The most important change is the one that, according to the justification for the bill, is intended to end the dispute that has arisen under the current regulations between taxpayers and tax authorities on whether the limit on debt financing costs that can be recognized as tax-deductible costs covers either the “safe harbour” of PLN 3 million or an amount equal to 30% of EBITDA (as the tax authorities hold), or includes the amount of the safe harbour plus 30% of EBITDA (as taxpayers and the administrative courts hold).

Existing position of taxpayers and administrative courts

In the view of taxpayers, mainly shared by the administrative courts, adoption of the higher limit is supported by the literal wording of the current regulations, indicating that the limit does not apply to the surplus of debt financing costs in the portion not exceeding PLN 3 million. Thus, a contrario, the limit should apply only to the surplus above that amount. Despite favourable rulings by the courts, the position of the tax authorities on this issue remains unchanged—they continue to rely on the provisions of the Anti Tax Avoidance Directive, which are different.

Proposed changes in the Polish Deal

To avoid further disputes, an amendment proposed in the Polish Deal expressly states that the taxpayer may include among its revenue-earning costs the surplus of debt financing costs within the limit indicated by the value of 30% of the EBITDA generated during the tax year, or may claim the “safe harbour.” But the taxpayer may not combine these two limits and claim both at the same time. Thus the proponents regard as correct the position of the tax authorities discussed above in the ongoing dispute.

A more technical change is also proposed. It is aimed at increasing the transparency and ease of determining the amount of the EBITDA ratio. The proposal would include an algorithm in the CIT Act for calculating this ratio.

Proposed algorithm:

The amount of the surplus will thus be calculated using the ratio resulting from the formula [(R ˗ I) ˗ (C ˗ Am ˗ Cdf)] × 30%, where:

R = total revenue from all sources subject to income tax

I = interest income

C = total revenue-earning costs without reductions resulting from the limit on inclusion of debt financing costs among such costs (CIT Act Art. 15c)

Am = amortization deductions recognized in the tax year among revenue-earning costs

Cdf = costs of debt financing recognized in the tax year among revenue-earning costs not reflected in the initial value of fixed assets or intangibles prior to the reduction resulting from the limit on inclusion of debt financing costs among such costs (CIT Act Art. 15c).

It should be pointed out that the foregoing does not contain an exclusion within the formula for the limitation on inclusion among revenue-earning costs of certain intangible services acquired from related entities, currently set forth in CIT Act Art. 15e. This is because, in light of inclusion in the Polish Deal of the latest concept for a minimum tax on big corporations, Art. 15e is to be repealed, as the amount of the costs that were excluded from deductible revenue-earning costs under that provision would, under the new Art. 24ca, become the basis for taxation with the alternative minimum tax.

Further changes—expanded catalogue of exclusions

Another change that introduced by the Polish Deal in relation to the restriction on debt financing costs should also be mentioned. This is a change adding to the catalogue of exclusions from revenue-earning costs set forth in Art. 16(1) of the CIT Act a provision (new point 13f) indicating that the costs of debt financing obtained from a related entity would not constitute revenue-earning costs at all in the portion earmarked directly or indirectly for capital transactions, in particular acquisition or taking up of shares, acquisition of the totality of rights and obligations in a partnership (without legal personality), surcharges on shares, increase of share capital, or buyout of the company’s own shares for the purpose of redeeming them.

According to the proponents, this change is intended to combat situations where taxable income is reduced within groups of related entities as a result of conversion of debt financing (e.g. in the form of a loan) into equity financing. This results in erosion of the tax base, because the interest on debt financing reduces the income of the taxpayer receiving the financing, but the borrower also does not report income on this basis as a result of reclassification as equity financing.

The regulations have not yet entered into force. Parliamentary work on the bill is ongoing, so the final wording of the proposed changes is not yet known. If further positions and proposals arise, we will track the situation and inform you of the changes.

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