Supreme Court holds that these types of borrowing costs are connected with the business and therefore cannot be classed as a gift.
The deduction of borrowing costs is restricted by the corporate income tax legislation. As a general rule, the legislation provides that these costs are deductible to the extent of 30% of the company’s operating income. The law also provides that the following costs are not deductible (i) borrowing costs in respect of debts with group entities incurred to purchase shares in entities from other group companies, unless valid economic reasons can be substantiated, or (ii) interest in respect of participating loans. And, where the borrowing takes place between related parties, they also have to observe the transfer pricing legislation.
The tax authorities have nevertheless repeatedly questioned the deduction of borrowing costs for a variety of other reasons, in other words, going beyond cases breaching these legal limits on deduction (which, moreover, have only existed in the law on the tax for a few years).
The Supreme Court has examined in recent judgments delivered on July 21 (appeal 5309/2020) and July 26, 2022 (appeals 4762/2020 and 5693/2020) various cases in which the tax authorities had denied the deduction of borrowing costs due to having their origin in loans received to distribute dividends or to purchase treasury shares for their redemption.
In the various cases examined by the court (a few of which were handled by Garrigues lawyers), the tax authorities had concluded that these costs were not deductible because either they should have been characterized as cost of equity, or as gifts or gratuities which are not matched with the taxpayer’s economic activity.
The court held in these judgments, however, that they are deductible expenses. Namely, based on its conclusions in an earlier judgment delivered on March 30, 2021 (summarized in our April 2021 Newsletter), it recalled the following:
Firstly, borrowing costs cannot be characterized, generally, as cost of equity, due to the nature of these costs.
Additionally, borrowing costs in respect of a loan that is related, directly and immediately, to the performance of a business activity by the company, cannot be characterized as a gift or gratuity, because they are incurred for consideration, in the same way as the loan that they were incurred to pay for is for consideration also.
In this regard, the matching revenues do not have to result from a specific transaction or project generating a separate revenue at the company, instead regard must be had to the company’s economic management as a whole.
Therefore, according to the court, if the expense is properly accounted for and supported by documents it will be deductible.