Late-payment interest on tax debts is deductible for Corporate Income Tax purposes

The Supreme Court judgment of February 8, 2021, cassation appeal (recurso de casación) no. 3071/2019, puts an end to the controversy that has arisen in recent years over the deductibility of late-payment interest on tax debts for Corporate Income Tax (IS) purposes. It holds that both such interest—that is, late-payment interest included in tax assessments issued by the authorities as a result of a verification procedure—and suspension interest qualify as deductible expenses for the purposes of that tax.

The issue came to the fore in recent years with a 2015 decision of the Central Economic-Administrative Court (TEAC), which we excerpt below. In it, the administrative review body stated that it had already changed, back in 2010, the position previously held—by both the TEAC itself and the Directorate General for Taxation (DGT). As a result, the bodies of the Spanish Tax Agency (AEAT) changed their approach in their proceedings and began treating this expense as non-deductible for IS purposes.

Under Law 61/1978, the deductibility of late-payment interest was contentious, since an expense was deductible only if it was “necessary to obtain income.” From Law 43/1995 onward, the requirement that the expense be “necessary” was dropped, and the law specified the items that constituted non-deductible expenses, without including late-payment interest among them. This wording has been retained in subsequent legislation, namely Royal Legislative Decree 4/2004, of March 5 (revised Corporate Income Tax Law, TRLIS), and Law 27/2014, of November 27, on Corporate Income Tax (LIS).

The literature on this subject is certainly extensive, and the AEAT has in recent times conducted a great many proceedings denying the deductibility of this expense.

BEGINNING OF THE CONTROVERSY

In the course of a tax audit (inspection procedure) of a company, the AEAT adjusted the company’s Corporate Income Tax for the 2014 tax year. It treated as non-deductible the amount of late-payment interest arising from an assessment signed in disagreement (acta de disconformidad) issued following a tax assessment that was declared lawful. The AEAT also denied the deductibility of the suspension interest, since payment of the tax debt had been suspended while the administrative and judicial proceedings were pending.

The taxpayer challenged that tax assessment, first by filing an appeal for reconsideration (recurso de reposición) and then an economic-administrative claim (reclamación económico-administrativa) before the Regional Economic-Administrative Court (TEAR) of Galicia. The TEAR dismissed the claim in a decision of September 28, 2017.

A judicial review appeal before the administrative courts (recurso contencioso-administrativo) was then filed against that decision. The High Court of Justice (TSJ) of Galicia also dismissed it, in its judgment of March 18, 2019, appeal no. 15705/2017. In short, the TSJ reasoned that an expense arising from a breach of the law cannot be accepted as deductible, since a person who commits an act contrary to the legal system cannot be allowed to benefit or gain an advantage from it.

This decision of the Court was challenged by way of cassation appeal and resolved on the terms summarized below.

THE COURT’S CASE LAW

The Chamber’s interpretive position is set out in the third legal ground of the judgment. Its reasons for holding that this expense is deductible for IS purposes are as follows:

• The tax base is determined on the basis of the accounting profit or loss. In certain cases, the tax rules adjust this figure in order to measure the taxable person’s ability to pay. For these purposes, Article 14 of the TRLIS, which lists the non-deductible expenses, must be borne in mind.
• Late-payment interest is not expressly listed as a non-deductible expense. According to the Supreme Court, for late-payment interest to be treated as a non-deductible expense for IS purposes, the law would have to expressly classify it as such, which it does not. In this regard, the Court makes the following observations:
  • Late-payment interest is compensatory in nature, as its purpose is to compensate for the delay in fulfilling the principal obligation. It is therefore not punitive in nature, and so it does not fall within subparagraph (c) of Article 14 of the TRLIS.
  • Nor is it a donation or gratuitous transfer (subparagraph (e) of the aforementioned Article 14), since its payment is not voluntary. On the contrary, it is imposed by the legal system.
  • Although Article 15(f) of the current Corporate Income Tax Law (Law 27/2014), on the non-deductibility of expenses arising from actions contrary to the legal system, was not included in the previous legislation and would therefore not apply to the case, the Supreme Court nonetheless addresses it. The Court states that late-payment interest is an ancillary obligation, triggered by the failure to fulfill a principal obligation, but in itself it does not constitute a breach. On the contrary, it is paid in compliance with a rule that legally requires it. In short, the deductibility of the expense could not be denied on the basis of this provision.
• Late-payment interest is financial in nature. This follows from paragraph 2 of rule nine of the Resolution of October 9, 1997, of the Spanish Accounting and Audit Institute (ICAC), on certain aspects of valuation rule sixteen of the Spanish General Chart of Accounts (PGC). It also follows from the ICAC Resolution of February 9, 2016, implementing the rules on recognition, measurement, and preparation of annual financial statements for the accounting treatment of income tax.
• Observance of the principle of matching income and expenses. Late-payment interest is matched with income and connected with the conduct of the business activity, and it is therefore deductible.
• Suspension interest is also compensatory in nature. Its purpose is likewise to compensate the public administration for the delay in payment caused by the filing of claims or appeals. It therefore also qualifies as a deductible expense for the purposes of the tax.
• The deduction of the disputed expenses is subject to the limits of Article 20 of the TRLIS (Article 16 of the LIS).

CONCLUSIONS

• The Supreme Court holds that late-payment interest charged as a result of a verification procedure, as well as suspension interest accrued as a result of the stay of enforcement of the administrative act, qualify as deductible expenses for Corporate Income Tax purposes.
• This case law applies to situations arising from the entry into force of Law 43/1995 onward.
• The deductibility of late-payment interest in tax years governed by the current Law 27/2014 should not be disputed, for several reasons. First, there is DGT administrative doctrine supporting such deductibility, and until it is changed—by the DGT itself or by the TEAC—the bodies of the AEAT are bound by it. The expense should therefore not be called into question in the course of a procedure. Second, even in the hypothetical event that this were to happen and the TEAC had to rule on whether the expense falls within Article 15(f) of the LIS, the Supreme Court has made clear in this judgment that late-payment interest cannot be regarded as an expense arising from actions contrary to the legal system.
• The case law laid down by the Supreme Court in this judgment must be applied to all cases in which the tax assessments have not become final because administrative or judicial proceedings are pending.

Finally, the Supreme Court’s interpretation of Article 15(f) of the LIS is a point of the judgment worth highlighting. Although it is an obiter dictum, it may prove highly useful and of considerable practical significance in other cases where the deductibility of an expense is being challenged on the grounds that it constitutes “expenses arising from actions contrary to the legal system”. One example is the recent TEAC decision of July 17, 2020. That decision denied the Corporate Income Tax deductibility of the remuneration paid to directors (managing directors) on the grounds that, since it did not comply with the provisions in the bylaws required under company law, it constituted expenses arising from actions contrary to the legal system.

In this regard, the Supreme Court states that the concept of “actions contrary to the legal system” cannot simply be equated with any breach of the legal system. Doing so would lead to clearly unsatisfactory outcomes and would be an interpretation contrary to the provision’s purpose. The idea behind that expression must be narrowly defined, avoiding expansive interpretations, since it refers only to certain types of actions, such as bribes and other similar conduct.