Supreme Administrative Court perpetuates line of case law - leasing without cost limitations
In a recent judgment, the Supreme Administrative Court (SAC) again ruled that the restrictions provided for debt financing costs do not apply to operating leases. The second analogous ruling in this case demonstrates the formation of a line of jurisprudence favorable to lessees, which may already be the basis for creating tax policy on this issue. The ruling may put leasing companies at a disadvantage, for whom the SAC’s interpretation entails a greater risk of excess debt financing costs.
Recall that since the beginning of 2018, Article 15c has been in effect in the CIT Act, which has revolutionized the rules for accounting for financing costs for CIT purposes. They are now capped – regardless of whether the financing is provided by a related party. The indicator on which the statutory limit is based is the so-called tax EBITDA – that is, income “cleared” of interest (income and expenses) and depreciation. As of January 2022, a maximum of 30% of tax EBITDA, or PLN 3 million, can be included in tax expenses, while until the end of 2021 the two could be added together. At the same time, it should be remembered that the described limit applies only if the taxpayer has an excess of debt financing costs (an excess of costs over revenues).
The obligation to exclude interest from tax costs does not apply to banks, among others, but already leasing companies do not enjoy any preference.
Costs of debt financing are recognized in financial leasing, because in the tax sense – with this type of leasing – the interest portion is separated. Will it be identical for operating leases?
Supreme Administrative Court: there is no interest portion in operating leases
Under the provisions of the CIT Act, operating leases are treated in most areas analogous to leases. The lessee includes the entire net amount from the invoice in tax costs – both the principal portion and the interest portion of the installment (limitations appear in the case of leasing passenger cars with a value above PLN 150,000). As a result, in a tax operating lease, the interest portion is not distinguished – it is treated as part of the installment, constituting income and expense, respectively – similar to rent in the case of a “regular” lease. Thus, it can be argued that such a category as “interest portion of the lease installment” in operating leases does not exist, and consequently – that the interest portion does not count towards the debt financing cost limit. This position was shared by the Supreme Administrative Court in a judgment of 26 April 2022 (ref. II FSK 2197/19). We wrote about it in the article “Breakthrough judgment on debt financing. Threat or opportunity?”.
The ruling was a good prognosticator, but a one-off ruling should not usually be a determinant of action for taxpayers. However, in a subsequent ruling, issued on 3 March 2023 (ref. II FSK 1956/20), the SAC reiterated the same opinion. The second such ruling – issued at the level of the SAC – means that taxpayers have an extremely strong argument in a potential dispute with the tax authorities.
This is not the first battle lost by the fiscal on the issue of debt financing cost regulations. A few years ago, taxpayers pushed through – through the courts – the possibility of aggregating limits of 3 million zlotys and 30% of EBITDA. However, the Ministry of Finance decided to make this impossible by amending the regulations accordingly. The same may happen with Article 15c of the CIT Law and the interest portion will be included in the statutory limit.
Of course, it is impossible to guarantee that the SAC will not change its approach in subsequent rulings. However, the probability of such an event is very low. The most cautious taxpayers may consider obtaining an interpretation in this regard, but the rest may feel quite confident in including the entire lease payments in operating leases as expenses without looking at the statutory limit.
The second important piece of news is that some indebted entities may exclude restrictions on debt financing by abandoning credit in favor of leasing (this possibility applies mainly to financing the use of assets – replacing leasing with, say, a working capital loan would be impossible). This is good news for leasing companies’ sales departments. For companies in a more difficult financial situation, obtaining lease financing will not only be easier than in the case of a loan, but such a solution may be more advantageous for them in terms of taxes. As an aside, it can be added that after the changes made under the Polish Deal 2.0, operating leases will also be an attractive form of financing in the context of the minimum tax regulations to be applied starting in 2024.
Will there be a change in the law?
This is not the first battle lost by the taxpayer over the regulation of debt financing costs. A few years ago, taxpayers pushed through – just through the courts – the possibility of adding up the limits of PLN 3 million and 30% of EBITDA. Unfortunately for taxpayers, in the end the Ministry of Finance stood its ground – as a result of the defeat in the courts, making the appropriate changes to the regulations. It can be expected that also in the context of the interest portion of the installment in operating leases, the shape of Article 15c of the CIT Law will be amended so that the interest portion will be included in the statutory limit.
A problem in leasing company accounting?
While the SAC’s seemingly well-established approach to this issue is great news for lessees and lessors’ sales departments, it is not necessarily good news from the perspective of a leasing company’s CIT accounting. We recently described the SAC’s judgment, which concluded that interest income must be legally equivalent to the cost of debt financing. If the SAC considers that the interest portion of the installment is not a debt financing cost, then the income from the interest portion of the installment will probably not be treated as interest income either. This, in turn, increases the risk that the company will have an excess of debt financing costs, which will mean that a calculation will have to be made to verify that the excess does not exceed the limit provided by the current wording of the law.
It is therefore worthwhile for lessors to carry out at least a working simulation of the settlement at their company. If its result would be negative, it seems that as long as the tax authorities have not yet changed their approach under the influence of the SAC rulings, there is still a chance for a positive interpretation on this ground.