Foreign currency leasing at risk after judgment of Regional Administrative court in Warsaw
The taxpayer raises the risk of his business, including the risk related to the volatility of currency exchange rates, the Regional Administrative Court in Warsaw said in a case concerning the possibility of selling the subject of a currency lease agreement at a price lower than the market price in a situation where the sum of receivables under the agreement – after converting it into zlotys – does not correspond to the initial value of the subject of the agreement. In the Court’s opinion, the books are kept in Polish zlotys and only the entries made in this currency are relevant for tax purposes.
One of the basic features of a lease agreement, which distinguishes it from a lease agreement from a tax perspective, is the condition that the initial value of the object be paid in full. While any default in repayment does not affect the accounting of installment income, the problem becomes the redemption of the object and the transfer of its ownership to the lessee. If the terms of the lease are not met, the financier loses the possibility of applying Article 17c of the CIT Act, which allows the sale of the object at the residual value, being obliged to sell at market value – according to Article 14 of the CIT Act.
Court: the financier bears the exchange rate risk
The parties to the leasing contract agree on the value of the installments and the redemption price before the conclusion of the contract. If the object of the contract is worth, for example, 100,000 euros, 99,000 euros will be repaid in installments over the course of the contract, and the buyout will be made at a price of 1,000 euros, on the surface it is obvious that the initial value will be repaid.
However, the matter becomes more complicated when we move to accounting for the contract in the books. Then it may turn out that the installment income – converted into zlotys – no longer corresponds to the – established in zlotys – initial value, converted at the historical exchange rate. In such a case, does the lessor have the right to sell the object for a price lower than the market price? One leasing company raised doubts in this area and applied for an individual interpretation. The solution – issued by the Director of the KIS on 26 November 2021 in individual tax ruling no. 0111-KDIB1-1.4010.403.2021.2.BK – was not favorable to it and it challenged it in court.
Unfortunately for the company, the Warsaw Regional Court dismissed its complaint in a judgment dated 20 October 2022, ref. III SA/Wa 290/22. The written justification is now available in the Central Database of Administrative Court Judgments. The key passage of the judgment seems to be the one in which the Court points out that the taxpayer raises the risk of its business, including that associated with exchange rate volatility. It is difficult to understand this argument, especially bearing in mind that negative exchange rate differences are not tax-neutral, but constitute a tax expense. So, it is impossible to accept the reasoning according to which exchange rate risk is also a tax risk. After all, by design, the construction of exchange rate differences is intended to neutralize the taxpayer’s losses due to changes in exchange rates (or force him to recognize the resulting income).
At this point, foreign exchange contracts do not pose a significant risk due to the fact that exchange rates have been rising rather than falling in recent years. The risk of defaulting on the initial value of the leased asset is also reduced by the high interest rate environment. However, these economic conditions will probably change sooner or later and affect “old” foreign exchange contracts.
The second important element highlighted by the Warsaw Regional Court is the issue of converting the initial value into zlotys and adjusting it for exchange rate differences. According to the Court, the books are kept in Polish zlotys and only entries made in this currency are relevant for tax purposes. Court did not accept the argument that such an approach unjustifiably discriminates against – permitted, after all – currency contracts.
Now it’s time for the Supreme Administrative Court?
The case will probably find its finale before the Supreme Administrative Court. Although the view presented by the Director of the KIS and the Warsaw Regional Court is difficult to accept, it cannot be ruled out that the Supreme Administrative Court will also adopt an extremely pro-fiscal interpretation and dismiss the complaint, as the Regional Court in Warsaw did earlier.
What in such a case? At this point, it seems that foreign currency contracts do not pose a significant risk due to the fact that exchange rates have been rising rather than falling in recent years. The risk of defaulting on the initial value of the leased asset is also reduced by the high interest rate environment. However, these economic conditions will probably change sooner or later and affect “old” foreign exchange contracts.
Is it possible to reduce risk?
So what risk reduction options do leasing companies have? The first option is to try to protect themselves with their own interpretation. However, this is a risky move – a positive ruling will be hard to come by at this point, and it seems better to wait for the Supreme Administrative Court to take a position.
The second option is to stop entering into such currency contracts, where the redemption value is low and certainly grossly deviates from the market value. However, this idea also seems to be of little benefit – companies are unlikely to give up the possibility of generating profits due to risks that are hypothetical at the moment.
A third option is to include a clause in the contracts whereby the “missing” value would be made up, for example, by increasing the redemption price. This option is potentially very attractive from the perspective of financiers, but its drawback is that implementation would result in the risk of a significant increase in the cost of leasing for users, who would not necessarily be willing to sign contracts containing such clauses.