An expense (or lower amount of income) arising from a rent reduction is deductible for corporate income tax purposes

España - 08 / 05 / 2020

Stalled economic activity as a result of the health crisis is prompting renegotiations of commercial lease agreements due to force majeure, and reductions or deferrals are similarly being negotiated for many other contracts or activities. Here is how we recalled this in our Commentary on April 11 (see here).

This context has placed in the spotlight the recent national appellate court judgment of January 27, 2020 (appeal 466/2016), examining the case of a company that had signed a hotel lease, as lessor, entitling it to receive an annual amount of rent payable monthly in advance. Due to the difficulties that the lessee was experiencing, they reached an agreement forgiving the rent for various months, on condition that the lessee continued with the lease and, if its business improved in a later year, it would pay the forgiven amounts.

The forgiven rent payments were recorded in invoices correcting those originally issued for the months qualifying for the agreed terms; which entailed a reduction to the lessor’s income and a reduction to the lessee’s expenses, for accounting and corporate income tax purposes. The agreement was also mentioned in the lessor’s notes to financial statements and accounting records.

The tax authorities took the view that the described events in actual fact were defaulted debts, which should have led the lessor to record a provision for bad debts that would not have been deductible for the lessor because fewer than six months had run between when the default occurred and the year-end. The taxpayer argued, however, that this involved a contract novation granted to keep the lease agreement alive, giving rise to a deductible expense.

The National Appellate Court concluded that:

Price is one of the essential elements of a lease agreement, meaning that any change to it implies the existence of a termination novation (article 1203 of the Civil Code). Novation agreements of this type are not subject to any particular requirements as to their form, so tacit novation is presumed if it can be inferred from actions with an unambiguous meaning such as, in this case, issued correction invoices, entries in the accounting records, and a mention in the notes to financial statements.
Therefore, what we have is not a default, instead a meeting of minds that implies a price reduction, such that the creditor would not be able to charge the reduced price without the debtor’s consent. The only way to conclude that a default has occurred is by categorically denying the very existence of the forgiveness, discount or reduction agreement that gave rise to the issuing of correction invoices; and this is not possible based on the items of evidence mentioned.

In short, the agreement they reached does not imply a default (or a deferral), because the debt claim does not depend exclusively on a decision by the creditor, due to requiring a new agreement expressing the debtor’s intention to pay the forgiven sums.
A gift has not occurred either, because the unilateral nature required for gifts is not present; there is an agreement between the parties, which leaves open the option of another later agreement amending the terms and conditions of the previous one.

Therefore, the ability to deduct the expense (or lower amount of income) recorded by the lessor due to the agreement reached between them cannot be denied.