In accordance with tax rulings of Polish tax authorities, expenses incurred to pay interest on bank loans contracted to fund the purchase of shares in other entities should only be deducted indirectly as being related to capital gains, regardless of the business purpose of the purchase, and there is no basis for the purchaser (acquiror) to recognise such interest expense (even partially) as general business deductions for income tax purposes.
The tax authorities were not persuaded by the fact that a share deal may well not have exclusively investment purposes where it’s main goal is to derive long-term economic benefits from the business rather than to obtain dividend income or share sale income (capital gains). In practice, a business acquisition may be intended to increase ordinary business revenue, such as where the deal allows the acquiror to enter new markets, obtain new know-how to support its own product development, or earn additional income from services provided to the acquiree (which becomes a new client).
The tax authorities’ approach did not find favour before the top tax court NSA, which noted that share purchase loans should be reviewed as to their purpose. If the purpose is related also to the acquiror’s operating activities pursued to generate general business revenue rather than capital gains, then the interest expense is not related exclusively to capital gains but also to income from ordinary operating activities. And if the acquiror is unable to precisely attribute such interest expense to a particular source of income (capital gains income vs. ordinary income), which is what happens in the subject cases, then it is entitled to allocate the expense to both sources according to an income-based key, i.e. according to the ratio between ordinary business income and capital gains income.
We have recently obtained a favourable tax ruling for our client where the tax authority shared our conclusion that if interest on a share purchase loan is related not only to capital gains but also to ordinary business income, then such interest expense should be allocated to both sources of income. At the same time, the ruling authority confirmed that interest on the loan extended to the applicant should be deducted for tax purposes in accordance with the above allocation key.
This is the first ever favourable tax ruling from the Director of National Revenue Information on the subject.
If this issue pertains to your business and you are interested in our assistance, please contact us.