Poland: Is 7.2% really the maximum interest deduction?
Justyna Bauta-Szostak and Piotr Paśko of MDDP consider whether or not interest exceeding the maximum interest rate, can still be recognised at arm’s-length.
Under Polish law, the maximum interest rate on loans (as of March 2021) cannot exceed 7.2% per annum. The rule applies in Poland irrespective of the governing law and jurisdiction of the lender. Although the rule on the maximum interest rate was implemented initially to combat usury and other forms of predatory lending to consumers, its impact on settlements within multinational enterprises operating in Poland is material.
According to the Polish Civil Code (CC), the maximum interest rate resulting from a transaction cannot annually exceed double the amount of statutory interest (maximum interest). Statutory interest is calculated as a reference rate of the National Bank of Poland increased by 3.5 percentage points. Due to the series of reductions, the reference rate amounts to 0.1% being a historic low.
The approach towards a monetary policy resulted in rather dynamic changes of maximum interest in Poland, as the rates were as follows:
7.2% since May 28 2020;
8% between April 9 2020 and May 28 2020;
9% between March 18 2020 and April 9 2020; and
10% before March 18 2020.
Despite the increasing risk for lenders, particularly in connection with COVID-19, the maximum rates are dropping. Under the formula, the maximum interest cannot fall below 7%.
Provisions of the CC stipulate that if the rate of interest resulting from a legal arrangement exceeds the rate of maximum interest, only the maximum interest shall be due.
Importantly, contractual provisions may neither exclude nor limit provisions on maximum interest even where the non-Polish law has been chosen as the governing law. In such a case, the statutory provisions shall be applied as directly expressed in the CC.
The excess interest can be paid to the lender should the borrower like to do so, however a borrower can face some significant consequences, for example with respect to a potential breach of the bank covenants regarding senior debt or tax consequences.
The difference between the interest rate resulting from the loan agreement and the maximum interest rate may not be tax deductible for the borrower. As the debtor is not legally obliged to pay such interest, the tax authorities may claim that interest is not paid with a purpose of generating income, retaining or protecting sources of income.
Such an arguable standpoint was presented in one of the tax rulings issued in this area. It should be noted however that the tax jurisprudence is still very limited (both in terms of the tax rulings issued by the Polish tax authorities, as well as court judgments) – simply because interest rates have never been so low and consequently the Polish taxpayers have not experienced the negative impact on the tax settlements of the low interest rates.
The key question which arises is whether or not the interest exceeding the maximum interest rate can still be recognised at arm’s-length. If the interest rate applied in a given loan would be recognised by the tax authorities as exceeding the market level, in the corresponding part it would not be recognised as tax deductible.
Moreover, a withholding tax (WHT) exemption under the Polish Corporate Income Tax (CIT) Act is conditioned upon market level of interest. Analogous requirements are provided for in double tax treaties specifying the conditions of reduced WHT rates or exemptions. As a result, to interest exceeding a market level, a regular WHT rate should be applied (20%) rather than WHT exemption or the reduced WHT rates under the relevant double tax treaties.
There are arguments to claim that the fact that the interest rate applied exceeds the maximum interest rate should not preclude that such interest has not been set at arm’s-length. First of all, many agreements were concluded in the past. Some loan agreements would not be concluded if the Polish maximum interest rate had to be applied without any reservations.
From the lender’s perspective, interest level determined below break-even point (just to match the Polish maximum interest) would jeopardise the assumed profitability. This could obviously result in adverse tax and transfer pricing consequences in the country of the lender’s residency. It should be noted that the interest rate of 7.2% may not even cover the costs of external financing (which may particularly be the case of e.g. German or British lenders).
The tax authorities may not be willing to accept such arguments that easily, which mainly results from a tight state budget. The loan agreements can be amended to provide for a greater flexibility in terms of the repayment or alternative forms of financing which are not restricted by maximum interest rates may be applied.
One thing is for sure, the Polish borrowers are about to face some serious disputes with the tax authorities in this respect. In consequence, it may be the last call for reviewing the group’s financing structure.
Senior manager, MDDP