Tax treatment of interests on loans
Tax treatment of interests on loans
In the article we are listing the situations that are the most frequent subject of the questions regarding the tax status of interests among entrepreneurs.
1. Interests from the aspect of VAT
On the interests and default interests is not charged VAT.
Restriction in the recognition of prepayment
As usually there is some kind of “but”, and regarding the above exemption of VAT on interests, the following applies:
If the entrepreneur, who deals with credit activities in a larger scale, the share of income from interests on given loans exceeds 2% of part of the total revenue from regular business, he is limited to use prepayment on all incoming invoices for that year. For example, if the proportion of exempt deliveries is greater than 2%, then the loan provider will not be able to recognize incoming prepayment fully, but in due process (proportional share of income from interests in total business income), and in all purchase – incoming invoices.
2. Interests in favor of natural persons (with aspects of income tax)
Interests on loans to employees
When the entrepreneur gives a loan to the employee, there is also no charge of VAT on interests. However, if the entrepreneur on loan charges to the employee annual interest rate of less than 3%, eg. 2%, in this case the difference of less charged interest is considered giving preferential treatment toward the employee and, in tax terms, represents payment of the salary in kind. In particular, this means that the employer on the difference in interests of 1% (3% -2%) should charge all taxes on salary.
If it is wished, it must be charged interest of 3%.
The income tax of capital
From 1st January, 2015 in force are new provisions of the Income Tax Act that require the payment of 12% of tax on income from capital (+ surtax) in cases where the loan to trade company approves a natural person (eg. a member of the company or other domestic natural person). In recent years, this tax is charged at a rate of 40%.
3. Interests among related parties
The related parties as defined by the the Profit Tax Act (Art.13) are persons where one of them participates directly or indirectly in the management, control or capital of the other person. Generally, it is about the relationship between the companies.
They are not recognized expenditures at debtor if they are charged by the related party. If default interests are calculated by foreign related person, the Profit Tax Act prescribes that from the amount of the interest pays income taxes withholding at a rate of 15% (if the agreement on the avoidance of double taxation with the State creditor does not provide otherwise). As for the amount of this tax reduces / suspends payment of interest, the amount of tax represents a tax deductible expense, while the remaining amount of interest is not tax deductible expense.
When calculating interests (eg. on the loan) among domestic and foreign entities, we have the following situations:
- when domestic person is a creditor, then is the lowest interest rate at the discount rate of the CNB (currently 7%), and may be higher. If there is agreed a lower rate, when calculating income tax it is calculated income from interests at the discount rate.
-when domestic person is a debtor, tax is recognized the expense from interests to the amount of the discount rate of the CNB.
At the relation among domestic related parties, the Profit Tax Act sets a limit at the amount of the interest rate only in the cases when one of the related parties:
- has a privileged tax status, ie. pays income tax at a reduced tax rate (or is exempt from paying taxes),
has in the tax period the right to transfer tax losses from previous years.
In these cases must be calculated the market interest rate, the rate that is contracted between unrelated parties. The Law intends to prevent the overflow of profit, which means that the potential problem in too high interest expense, and not income of the other party (the creditors). Thus, the principle should be applied as in relations with foreign companies (CNB discount rate).
This is a general recommendation for fee agreements between related parties.
Interests on loans of shareholders and company members
The tax interests are non-deductible on loans received from the owner who holds at least 25% share in the company, if the loan amount exceeds four times the share in the company (the value of shares x 4 = max. amount of the loan). This restriction does not apply in cases where:
- a shareholder is bank or other financial institution
when on the interests are calculated income from capital (described above),
when the shareholder is domestic taxpayer of income.
As it is already mentioned, the interest rate should not exceed a market interest rate ie. the discount rate of the CNB.