Borrowing costs

Borrowing costs relating to loans for the distribution of dividends are deductible

The Supreme Court holds that these types of borrowing costs are business-related and therefore cannot be characterized as a gift.

The deduction of borrowing costs is limited by corporation tax legislation. As a general rule, the legislation provides that these costs are deductible up to 30% of the company’s operating profit. The law also provides that the following costs are not deductible (i) borrowing costs relating to debt incurred with group entities to purchase shares of entities from other group companies, unless economic reasons may be justified, or (ii) interest relating to equity loans. And, where the borrowing takes place between related parties, they must also comply with transfer pricing legislation.

However, the tax authorities have repeatedly called into question the deduction of loan charges for various other reasons, i.e. to go beyond cases exceeding these legal deduction limits (which, moreover, , have only existed in tax law for a few years).

The Supreme Court has considered in recent judgments handed down on July 21 (appeal 5309/2020) and July 26, 2022 (appeals 4762/2020 and 5693/2020) various cases in which the tax authorities had refused the deduction of borrowing costs because of their origin in loans received to distribute dividends or to purchase own shares with a view to their reimbursement.

In the various cases examined by the tribunal (some of which were dealt with by scrubland lawyers), the tax authorities had concluded that these expenses were not deductible because either they should have been qualified as the cost of equity, or as gifts or gratuities which are not linked to the economic activity of the taxpayer.

However, the court ruled in these judgments that these were deductible expenses. Namely, based on its findings in an earlier judgment delivered on March 30, 2021 (summarized in our April 2021 Newsletter), he recalled the following:

  1. First, borrowing costs generally cannot be characterized as the cost of equity, due to the nature of these costs.
  2. In addition, borrowing costs relating to a loan which are directly and immediately linked to the exercise of a professional activity by the company, cannot be qualified as a gift or gratuity, because they are incurred for consideration, along with the loan they took out to pay must also be taken into consideration. In this respect, the corresponding income must not result from a specific transaction or project generating a separate income for the company, but rather must take into account the economic management of the company as a whole.

Therefore, according to the court, if the expense is properly accounted for and supported by documentation, it will be deductible.