Profit sharing loans have proven to be an effective tool to balance companies equity while at the same time allowing for the possibility to deduct variable interest based on the evolution of borrower’s business.
The future of this type of financing can be at challenge by the Spanish tax reform currently under process by the Spanish Government.
✔ Profit sharing loans are hybrid instruments whose speciality consists on interests based on the evolution of the borrower’s business.
Such criteria include the borrower’s profit, its turnover, its net equity or any other agreed by the parties.
Besides, the parties can agree to a fixed interest rate, regardless of the borrower’s activity evolution.
✔ Their extensive use is mainly due to the fact that they are qualified as equity, for the purposes of the mandatory share capital reduction and companies’ dissolution, set forth in mercantile regulations, when the equity is below their limits.
✔ As a general rule, interest derived from this type of instruments is tax deductible from the Corporate income taxable result, for the borrower.
✔ The Spanish tax reform qualifies interest deriving from these instruments as equity contributions, when profit sharing loans are granted by entities forming part of the same group of companies (as defined by article 42 of Spanish Commercial Code), irrespective of their residency and of the obligation to file consolidated accounts.
Although the text is only a draft, we recommend paying attention to its evolution as it might imply a critical change to the tax treatment of an instrument that has proven to be effective in the recent years.