Is the controversy surrounding the deductibility of late payment interest finally over?

Written on 12 Apr 2016

It seems aparent that, by issuing its Decision dated 4th of April 2016, the Spanish General Directorate of Taxes (Dirección General de Tributos or DGT) is willing to put an end to the controversy surrounding the deductibility of late payment interest from Spanish corporate income tax. This issue has been unnecessarily riddled with uncertainty, following the contradictory approaches taken by different organs of the Tax Administration, namely the Spanish Central Tax Tribunal (Tribunal Económico-Administrativo Central) and the DGT.

In this Decision dated 4th of April 2016, the DGT reaffirms that late payment interest deriving from tax assessments should be deductible, since such interest is financial in nature. As such, therefore, deductibility would be subject to the general corporate income rules limiting financial interest payments deductibility. The DGT also makes a specific reference to the rules governing temporary differences and reminds taxpayers that late payment interest, deriving from previous tax years but accounted for in subsequent years, should be deductible in the tax year where such interest has been accounted for, provided that this does not lead to an overall lesser tax burden. Additionally, the DGT, probably with a view to bridging the gap with the Central Tax Tribunal, states that the deductibility of late payment interest is based on the provisions of the new Spanish Corporate Income Tax Law (Law 27/2014, dated 27th of November).

It is worth remembering that the controversy over the deductibility of late payment interest arose when the Central Tax Tribunal revised the approach which the Administration had taken until then, on the basis of a ruling from the Spanish Supreme Court dated 25th of February 2010. For the Central Tax Tribunal and the Supreme Court, the deductibility of interest payments hinges on the nature of such payments. Thus, on the one hand, financial interest and late payments interest deriving from requests for deferrals or from instalments would be deductible. On the other hand, late payment interest resulting from a tax assessment would not be deductible. Non-deductibility results from the fact that such interest is designed to compensate the damages suffered by the tax authorities as a result of a breach in the taxpayer’s duties. Thus, late payment interest deriving from a tax assessment should be viewed as an expense connected to a breach of law and, hence, non-deductible.

By contrast, the DGT issued several rulings (for instance references V4080/2015 and V0603/2016), maintaining a totally opposite position and contending that late payment interest should be deductible, without the need for further distinctions on the basis of the facts of each case. Moreover, the DGT specifically states that late payment interest should not be considered as an expense deriving from a breach of legal duties.

The Spanish Tax Agency (Agencia Tributaria) subsequently issued a report, dated 7th of March, probably with the view to settling the issue but, unfortunately, only adding further confusion over the matter. Indeed, the Tax Agency’s attempts to reconcile opposing stances only resulted in overly subtle differentiations, of difficult practical application. The report makes a distinction between non-deductible late payment interest, stricto sensu, and “adjournment” interest payments accruing as a result of lodging appeals or reviews against the original tax assessment. This last type on interest would be deductible. Such a distinction can only lead to a case-by-case approach, especially in view of all the possible outcomes and partial successes to which judicial proceedings give rise.

The Decision from 4th of April, to which this comments refer, should be seen in light of this confusing context of contradictory statements. The new legal framework afforded by Law 27/2014 on corporate income tax grants the DGT a much-needed opportunity to finally put an end to the debate, without entering into hierarchical disputes with the Central Tax Tribunal. It does seem therefore that the Tax Authorities are more than willing to close a matter which, it seems, should not even have been “opened” in the first place.

The previous corporate income tax law contained no specific provisions addressing the deductibility of late payment interest. There were provisions governing the non-deductibility of fines and penalties, gambling losses, gifts etc. Law 27/2014 changes very little, in terms of the provisions affecting non-deductible expenses, which would be relevant in the present case. It is, therefore, surprising for the DGT to invoke this change in the law. There has indeed been a general change of the law governing Spanish corporate income tax; but in terms of the specific regulation of the deductibility of late payment interest, there is very little which is new (except, perhaps, the general limits on the deductibility of financial interest and the applicability of such provision to late payment interest precisely implies that such interest should be deductible). If anything, Law 27/2014 would allow for a stricter interpretation since it now includes a specific prohibition on the deductibility of expenses contrary to the legal order. This provision could be read as supporting the view of the Central Tax Tribunal whereby late payment interest deriving from a tax assessment should be viewed as an expense connected to a breach of law. The DGT, however, has specifically ruled out this interpretation in its Decision dated 4th of April 2016.

Thus, late payment interest should also be deemed deductible under previous corporate income tax provisions. The position of the Central Tax Tribunal, however, entails that companies taking this view would assume an effective tax risk. It is true that Spanish Tax Authorities may not be in agreement with the Central Tax Tribunal and that the DGT’s Decision makes apparent that there is currently no willingness to issue tax assessments in these cases. Nonetheless, it is compulsory for Spanish Tax Authorities to follow the criteria from the Central Tax Tribunal and such criteria are still applicable to tax years governed by the previous law and not closed by the statute of limitations.

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