Whether or not the costs of financing a capital reduction or dividend payment are tax deductible has been a discussion for many years now. Recently, the Supreme Court (Court of Cassation) has explicitly recognized that the deduction is possible provided it can be demonstrated that all the conditions for the deduction of business expenses as per article 49 of the Income Tax Code (ITC) are met.
This means that the costs must have been incurred or borne during the taxable period ‘in order to acquire or preserve taxable income’. It is precisely in this proof that most companies fail.
The importance of the judgment lies in the fact that the court elaborates on the way in which this proof can/must be provided.
The discussion arises when a company wishes to reduce its capital or distribute a dividend but does not have the cash funds to do this. It therefore enters into external financing whereby it wishes to deduct the interest paid as professional expense. In many cases, the company also has certain income-generating assets that are essential to the conduct of the company's business and that the company therefore does not wish to sell.
Another case can be the debt-push down whereby the shareholder / buyer wishes to push down the acquisition-debt to the target company via an externally funded super dividend by the target.
Burden of proof
What needs to be proven is the purpose of the interest charge, in particular the link between the interest paid and the company’s activity aimed at generating or preserving taxable income.
It is by no means sufficient to just claim that there is no or insufficient liquidity available to fund the capital reduction or dividend payment and that the only option is to take out a loan. Concrete evidence will need to be provided.
It must be demonstrated that the financing was entered into in the company's own interest and therefore not in the (sole ) interest of the shareholder(s) or buyer(s). In this context it should be demonstrated that the loan prevents the loss of the company’s assets that are used to acquire or preserve its taxable income.
Proof is of course a matter of facts. It is therefore strongly advisable that the company (long) before the transaction prepares proper documentation.
Since the Supreme Court has now explicitly confirmed that interest on loans used to fund a capital reduction / dividend distribution / debt push down can be tax deductible, the company's own interest and especially the fact that the loan prevents the loss of assets being used to acquire or preserve taxable income must be demonstrated in a well-substantiated file. A good preparation is therefore essential!