Debt financing costs at leasing companies still unclear
Despite the fact that the new regulations on debt financing costs (Article 15c of the CIT Act) have been in effect for more than 3 years, the practice in this regard is still not properly established. The Supreme Administrative Court’s verdict on March 1, 2022, although it does not explicitly refer to leasing, may be problematic for some taxpayers.
The case was initiated by a complaint from a company that received a negative individual interpretation. This company defers payment terms to its customers and receives a “financial compensation” for this. However, it is not separated on the invoice, but included in the price of the goods. The company asked whether such income constitutes “income equivalent to interest income.” It believed that its income from the described income is interest income, as it is economically equivalent to interest.
Neither the tax authorities nor the courts of both instances agreed with the company (RAC – in verdict on July 23, 2020, ref. III SA/Wa 2255/19, and SAC in verdict on March 1, 2022, ref. II FSK 215/21). The authority and the courts held that interest income is a “mirror image” of debt financing costs, which are defined in the CIT Act. Meanwhile, deferred payment consideration is an element of the price of goods and, as such, is neither a cost of debt financing nor interest income.
What is the significance for leasing?
From a leasing perspective, the issue of debt financing costs is mainly relevant in the context of operating leases. Whether the interest portion in an operating lease constitutes a debt financing cost has not been clarified in judicature to this day. So far, there have been only a handful of judgments on this issue, but at the regional level. It is expected that the first judgments of the Supreme Administrative Court on this issue will appear in 2022 or even later.
Courts of both instances have held that interest income is a “mirror image” of debt financing costs, which are defined in the law. If the “mirror image” concept persists in the case law, leasing companies will not be able to treat this portion of installments as “interest income.”
If SAC decides that the interest portion of an operating lease does not constitute a cost of debt financing, this will be good news for lessees, who, when financing with leases, will not apply the statutory restrictions for interest. Of course, it could also be good news for lessors – in the context of selling this form of financing, which would gain an additional advantage over a loan or credit.
On the other hand, from the perspective of accounting for interest expense in the tax bill, this would be a dangerous approach. However, simply recognizing that the interest portion is not a cost of debt financing would be meaningless. And here we come to the judgment described. For if it is simultaneously recognized that, just as the interest portion is not a cost of debt financing, it is also not (on the lessor’s side) interest income. It is these two elements together that result in the fact that the leasing company may be obliged to exclude from tax expenses significant amounts of financing obtained.
Undoubtedly, in economic terms, the interest portion is economically equivalent to interest. However, if the “mirror image” concept is upheld in the case law, leasing companies could not treat this portion of installments as “interest income.”
What did the legislator have in mind?
It must be admitted that the interpretation of SAC presented in the March 1, 2022 judgment is fully logical in systemic terms. Despite this, it raises significant doubts in light of the literal wording of the provision. This is because Article 15c paragraph 13 of the CIT Law provides for income “economically equivalent to interest, corresponding to the cost of debt financing.” It seems that if the legislator had wanted to fully equate interest expense and interest income, he would not have used the concept of “economic equivalence” but would have indicated that these are simply the same amounts, only from the service provider’s side.
At this stage, it would be premature to formulate clear conclusions. Instead, it is necessary to follow further case law and analyze tax risks from this perspective.