Inspections by tax authorities targeting interest

The tax authorities have recently been selecting taxpayers for their inspections based on analyses of their filed tax returns, financial statements, and summaries of related-party transactions for previous years. These analyses have enabled them to identify facts that may indicate potential inconsistencies in the recognition of claimed expenses. From our practice, we know that most enquiries are directed at verifying the tax deductibility of interest expenses.

Interest, i.e., financial expenses related to business activities, is generally treated as deductible for income tax purposes. However, there are certain limitations, and the thin capitalisation rule is one that the tax authorities often pay attention to. If a taxpayer incurs financial expenses on loans received from related parties, it is necessary to exclude as a non-deductible expense that part of the related financial expenses by which the aggregate of the loans from related parties in the taxable period exceeds four times the equity (six times in the case of banks and insurance companies), or the entire amount of financial expenses if the company reports negative equity.

Another case where it is necessary to treat financial expenses as non-deductible are the expenses of the parent company incurred to hold a share in a subsidiary. This includes interest on a loan received in the six months prior to the acquisition of the share in the subsidiary unless the taxpayer can demonstrate that the loan is unrelated to the holding of the share.

In the event of a tax inspection, the taxpayer should be able to provide the tax administrator with documentation (contracts, calculations of the non-deductible part of financial expenses, etc.) that confirms the correctness of the approach applied in their tax return. If the taxpayer is uncertain or has some specific questions, we recommend consulting a tax advisor to ensure that the tax authorities are not provided with incorrect or misleading information.