The corporate income tax treatment of interest charged on financing obtained to perform certain types of corporate transactions – including distributing dividends, paying out share premiums, or purchasing own shares – has been a point of contention with the Spanish tax authorities in the past. Their view was that if there was no direct and immediate relationship between those borrowing costs and the entity’s revenues, they had to be treated as gratuities and therefore were not deductible.
The interpretation supported by the Spanish tax authorities had been confirmed, using identical arguments, by the National Appellate Court and by various regional high courts of justice.
Supreme Court ruling
The above view was overturned by a Supreme Court judgment on March 30 2021. The court concluded that borrowing costs are paid as a result of a loan agreement for consideration. Therefore, they could not, under any circumstances, be characterised as a gratuity, and it is irrelevant whether they had a more or less direct relationship with the entity’s revenues.
The Supreme Court confirmed the principle determined in its March 30 judgment in a ruling delivered on July 21 in a cassation appeal, led by lawyers from the Garrigues tax litigation department, and adopting a principle that was reiterated in two judgments delivered on July 26. The Supreme Court added that borrowing costs paid under a loan agreement cannot be characterised generally as remuneration of equity.
Consequently, according to the July 21 judgment, if the borrowing cost is adequately recorded in the accounts and supported, it will be deductible, subject in all cases to the limits set out in the Corporate Income Tax Law for expenses of this kind (the general financial expense limit). This is regardless of whether the received funds are used to distribute a dividend, pay out a share premium, or purchase own shares.
It did not stop there. In the July 21 judgment, the Supreme Court accepted that it falls within the freedom of business judgement to choose financing structures with greater or lesser debt, and they cannot be questioned simply because of the impact they may have on the corporate income tax base (in the case examined in the judgment, the foreign parent of the Spanish subsidiary provided a loan so that the subsidiary could distribute a dividend to it).
The Supreme Court acknowledged that the decision to take on debt is “a decision for the company’s managing bodies, and the conditions for deduction of the costs cannot in any way be made subject to the value judgement that the tax authorities are seeking to impose”.
However, despite acknowledging the business owner’s freedom of choice, the Supreme Court left open the option to question transactions of this kind where it is considered that the transaction is fraudulent or contrived.
Final considerations
It needs to be remembered that in September 2022, in the context of a tax audit on a Spanish company, a report was published by the Consultative Committee on Conflict in the Application of Tax Provisions (Conflict No. 9) that declared the existence of a conflict regarding a number of transactions that resulted in the use of financing from third parties for the distribution of an amount of share premium from a Spanish entity. This finding was used to deny deduction of the borrowing costs incurred by this Spanish entity.
The debate, therefore, does not appear to have ended completely, although it is likely that any future disputes of this kind with the tax auditors will be more restricted. They may be expected to centre on the types of transactions causing the borrowing costs and their potential contrived nature. This means that careful analysis of these types of transactions is necessary before they are performed.