Settlement of an obligation by non-monetary performance – tax effects as of 1 January 2015
With the amendment to the Corporate Income Tax Act becoming effective as of 1 January 2015, the assessment of tax effects of settling an obligation by non-monetary performance has changed. The entity settling an obligation by non-monetary performance should determine income to tax.
By the end of 2014 the lack of any regulations in this regard caused disputes between taxpayers and tax authorities, the latter claiming that as a result of non-monetary performance being effected (e.g. by transfer of ownership to real estate in order to settle an obligation) the ownership of an asset is transferred, the tax effects of which should be determined in the same way as in the case of disposal against payment. Administrative courts most often did not share this argumentation and resolved disputes predominantly in favour of taxpayers because of literal interpretation of the tax regulations, which did not envisage directly equal treatment of tax effects in a transaction involving disposal of an asset against payment and in the case of settlement of an obligation by non-monetary performance.
The tax regulations effective as of 1 January 2015 provide legal grounds for charging tax on such transactions. The amended regulations seem to be of importance especially for companies paying out dividends in kind – e.g. by transfer of ownership rights to real estate or provision of shares in other entities, as well as for those which have obligations represented by loans or borrowings and want to settle those by effecting non-monetary performance.
If the taxpayer settles an obligation by effecting non-monetary performance, the taxpayer’s revenue is the amount of the obligation settled by such performance. However, if the market value of non-monetary performance is higher than the obligation settled by that performance, the revenue is determined as the market value of non-monetary performance.
The issue of tax deductible costs on the part of the debtor settling an obligation in non-monetary form has not been clarified. It seems that in such situation the costs may be assumed equivalent to the cost of acquisition or manufacture or the value of the tangible or intangible asset less depreciation/amortisation charges made. So if the obligation is settled by providing the asset whose market value is equal to the value of the obligation but which has been purchased by the company at a price lower than its current market price, the income will be a difference between its market value and cost of acquisition.
Example: Company A has an obligation under loan in the amount of 100 against company B. Because of problems with financial liquidity in A, companies A and B have agreed that the obligation will be settled by transfer of ownership to the land acquired in the past for 80 (the current market value is 100 and the land is not subject to depreciation). Following performance of the obligation in this way, company A will generate income to tax in the amount of 20.
Moreover, it is worth noting the regulation in the amended Article 15.1i of the Corporate Income Tax Act regarding the way to establish tax deductible costs on the part of the creditor. Upon disposal against payment of things or rights acquired previously as a result of settlement of an obligation by effecting non-monetary performance, such costs are assumed to be equivalent to the claim (amount due) settled by effecting non-monetary performance (in kind) less goods and services tax charged in connection with providing that performance.
Assuming that the company will settle its obligations by transfer of an asset, that is e.g. by transferring to the creditor the ownership right to the real estate whose market value is higher than the obligation being settled, in accordance with the new regulations the company’s revenue should be determined in the amount equivalent to the market value of the transferred property. However, in order to charge depreciation or sell the acquired real estate, the creditor will determine its initial value based on the value of the obligation that has been settled (and not the market value of the asset). So there is no consistency between the debtor’s revenue and the creditor’s costs. The resultant difference seems to be illogical and may cause ambiguity.
The problem does not exist when the market value of the asset transferred is lower that the company’s obligation to the creditor.
It is worth noting that settlement of obligations in kind – especially dividend payment – is a common practice among entrepreneurs. Problems with financial liquidity or a need to incur additional costs in connection with e.g. taking a loan to make payment, caused that obligations were often settled by effecting non-monetary performance. Following amendment of the regulations as of 1 January 2015, taxpayers should estimate the related tax effects before effecting such transactions.