Profit Sharing loans: Spanish requirements for the interest tax deduction

Interest deriving from profit sharing loans granted as from June 20, 2014, by group companies, either resident or not, are not tax deductible from the Spanish Corporation taxable base.

The Spanish General Directorate of Taxes holds the view that a current change in a contract originally granted prior to said date is not subject to the interest deduction limitation in so far as the contract preserves all of its main or accessory characteristics without being modified. Such is the case of the increase of the agreed interest rate due to supervened circumstances subsequent to the granting of the loan which require the interest adjustment or in the event of the loan term extension upon its initial maturity date.

✔Profit sharing loans constitute a special type of loan contracts whose specificity lies in the interest determination:

• In this type of contracts, the lender receives a variable interest which is determined based on the enterprise activity evolution. The criteria to determine such evolution may comprise: the net benefit, the trading turnover, the total equity or any other agreed by the contracting parties.
• Besides, the parties can agree to a fixed interest rate, irrespective of the activity’s evolution.

From the Commercial Law point of view, they have the advantage that they qualify as equity for the purposes of determining whether a share capital reduction or company’s liquidation is required.

✔ As a general rule, interest derived from this instrument, either fixed or variable, are tax deductible in order to determine the company’s taxable result for Corporate income tax purposes. However, Spanish Corporate income tax Law disallows the interest deduction corresponding to contracts granted as from June 20, 2014, by group companies, either resident in Spain or not, and irrespective of the obligation to formulate consolidated accounts.

✔ At this point, it is worth wondering which are the tax implications deriving from a current change in contracts granted prior to June 20, 2014

The General Directorate of Taxes has resolved, in different binding consultations, that if the change does not extinguish the original obligations, as the main or accessory characteristics of the loan remain unchanged and keep their essential nature, the interest deduction limitation does not apply. In such a case and under a tax – related party scenario, it would be necessary that both the loan principal as well as the interest conform to normal market prices. Besides, interest should not exceed the limitation on the deduction of net financial interest of 30% of the debtor company’s EBITDA.

Consequently and should a change of the existing contracts be required, it is advisable taking this criterion into account as it may permit keeping the expense deduction deriving from this financial instrument.