Expenses that are not fully recognized in the tax basis balance sheet (part 3)

Interest payable due to untimely payment of taxes, contributions and other public fees. The provision of the Article 7a Item 5 of the Corporate Profit Tax Law prescribes that the interests in arrears payable due to untimely payment of taxes, contributions and other public fees shall not be recognized as expenditures. This means that the amounts payed for these purposes are a part of the taxable base and increase it.

Interests in arrears owed to associated entities shall not be recognized as an expenditure in the tax basis balance sheet, but the interest in arrears calculated in respect to contractual relations shall be recognized in the tax basis balance sheet as an expenditure.

       Costs of forced collection of tax and other debts and costs of tax offence proceedings and other proceedings conducted before a competent authority

According to the Law provisions, the following costs shall not be recognized as expenditures:

– costs of forced tax collection;

– costs of forced collection of other debts;

– costs of tax offence proceedings;

– other offence proceedings costs.

The expenses recorded by a taxpayer in the tax basis balance sheet and related to the forced tax collection, shall not be recognized in the tax basis balance sheet as expenditures. The costs of tax offence proceedings, as well as other offence proceedings costs such as traffic offence proceedings, offences related to payment and foreign exchange operations, shall not be recognized in the tax basis balance sheet as expenditures either.

When the taxpayer suffers expenses as a result of enforcement, the tax payer being the enforcement creditor, these expenses shall be recognized in the tax basis balance sheet. Costs of other proceedings, civil and extra-judicial proceedings, tax control proceedings, etc. shall be recognized in the tax basis balance sheet as expenditures if they are related to the performance of the taxpayer’s business activity. In those cases when creditor files a lawsuit against the taxpayer due to the failure to pay debt, the costs that the taxpayer as the defendant makes during the civil procedure (lawyer engagement and forensic expert expenses, etc.) shall be recognized as taxpayer’s expenditures.

However, if the court adopts creditor’s claims and the creditor files a motion for execution on these grounds, the expenses suffered by the taxpayer, as an enforcement debtor, during the enforcement, shall not be recognized as expenditures in the tax basis balance sheet.

The expenses suffered by the taxpayer during tax control or legal remedy proceedings (for example, engaging a lawyer to file a complaint to hearing minutes, file an appeal or a lawsuit to the Administrative Court) shall be recognized in the tax basis balance sheet as expenditures.

Fines Levied by a Competent Authority, Penalty Clauses and Penalties

According to the Corporate Profit Tax Law, the following cannot be recognized as expenditures:

– fines levied by a competent authority;

– penalty clauses and

– penalties.

When it comes to fines, we are primarily talking about fines imposed by an authority competent for offence proceedings, i.e. for economic offence proceedings. The fines payed by taxpayers on these grounds shall not be recognized in the taxpayer’s tax basis balance sheet.

When it comes to contractual relations between business entities, the Law makes difference between interest in arrears and contracted “late payment penalties”. When the “penalties” for failure to complete something by deadline are contracted, such an expense shall not be recognized in the tax basis balance sheet.

However, if an interest in arrears is contracted for a delay, the expenditure based on the interest in arrears shall be recognized in the tax basis balance sheet as an expenditure (except from the interest in arrears owed to an associated entity). Compensation for the damage owed by the taxpayer to another entity, regardless of whether this is the damage incurred as a result of an offence or failure to fulfil contractual obligations, is recognized in the tax basis balance sheet in compliance with the general rules.

      Interests in Arrears Between Associated Entities

Generally speaking, an expense incurred based on interest in arrears shall be recognized in the tax basis balance sheet. The only prescribed exception is the situation when the interest in arrears is owed to an associated entity. In that case, such an expenditure is not recognized in the tax basis balance sheet.

With that said, in terms of the interest in arrears owed by the taxpayer to his associated entity, there is no obligation to adjust those interest either in accordance with the thin capitalization rules or in accordance with the transferring price rules, since the whole interest amount is not recognized in the tax basis balance sheet as an expenditure.

  Expenses That Are Not Incurred to Perform Business Activity

Expenses, which are not incurred for the purpose of performing business activity shall not be recognized as expenditures, unless otherwise regulated by this Law. The Law prescribes a rule stipulating that the expenditures, which are not related to the business activity based on which the taxpayer gains profit, cannot be recognized in the tax basis balance sheet.

When determining if a specific expenditure is considered to be incurred for commercial or non-commercial purposes, it is necessary to determine if the expenditure has been incurred for the purpose of achieving a specific operating result (in order to increase profit, i.e. decrease the taxpayer’s expenditures). The most important thing is not if the expenditure is related to the taxpayer’s core activity or some other business activity, which is not registered as the core activity or is not defined in the taxpayer’s memorandum of association.