Start of main content

Covid-19 and the need and opportunity to review the limitation on the deductibility of financial expenses

| News | Tax

José Manuel Pumar analyzes the Corporate Tax regulations that include a limitation on the deductibility of financial expenses

Since 2012, corporate income tax legislation has included a general limitation on the deductibility of net financial expenses, according to which the amount of these may not exceed 30% of operating profit, although a deduction of up to Euro 1 million (franchise) has been permitted.

At the time, prior to its legislative implementation, the measure was mainly justified for two specific reasons. The first was to halt the erosion of taxable income in multinational groups, which, through intercompany loans, could artificially place financial expenditure in high-taxation sovereignties and financial income in low-taxation sovereignties, with the consequent tax savings at Group level. A second justification was the tax penalty suffered by companies which were not very well leveraged, as in the case of the former, remuneration of capital, in the form of dividends, was not a deductible expense, while in the case of the latter, remuneration of external financing in the form of interest was a deductible expense. Therefore, companies which were self-financing bore, on equal terms, a greater tax burden than those which were leveraged.

For the above reasons, the Spanish legislature justified the measure on two further grounds. One of a strictly fiscal nature, i.e. tax collection, at a time (2012) when there was a significant public deficit that had to be corrected, and the other, of an extra-fiscal nature, to put a brake on excessive business indebtedness, which had been a factor that aggravated the economic crisis in Spain in 2008.

The rule introduced was based on all these considerations, although the expression " taking a sledgehammer to crack a nut" is worthwhile. Firstly, because it was not limited to multinational groups, where an erosion of tax bases at group level could occur. Secondly, because through the franchise of one million euros, de facto, SMEs were left out of the limitation, discriminating negatively against non-SMEs. Thirdly, because the limit considered (30% of the operating profit), applicable to any company, did not take into consideration the sector in which it operated, and it is known that there are sectors of activity with a long cycle of investment recovery, which are much more capital intensive than others (concessionaires, real estate companies, renewable energies, etc.). Finally, because the rule had retroactive effects, at least to a medium degree, since the financial expenses corresponding to previously granted financing were not excluded from the limitation introduced.

The above reproaches are becoming much more intense at the present time with the ensuing crisis of the COVID-19, which will certainly increase the indebtedness of many companies and reduce their profits and, therefore, the operating profit on which the limit of deductibility of financial expenses is calculated.

This situation could give rise to an unbearable tax burden for certain companies, not only from a material point of view, but also from a legal point of view, as they would be forced to pay corporation tax on a scale (taxable amount) which, as a result of the limitation mentioned above - and many others - would be moving extraordinarily far away from profits and, therefore, from their true economic capacity, even to the point of having to pay that tax with significant losses.

The current situation makes it advisable to review the rule limiting the deduction of financial expenses, such as, even if only temporarily, raising the limit of 30 percent of operating profit.  Failure to undertake such a review could result in the current situation in corporate income tax being confiscated, which should not be undermined by the easy and, in many cases, unrealistic argument that the expense not deducted in a tax period can be deducted in future periods in which the 30 per cent limit on operating profit is not exceeded, as it is simply not possible for many companies operating in certain sectors of activity to exceed that limit.

You can see the article at Actualidad Jurídica Aranzadi

End of main content