When a Taxpayer Should Deduct Interest for Tax Purposes

We reported that the Presidium of the Russian Supreme Arbitration Court passed Resolution No. 11200/09 dated 24 November 2009, clarifying when a taxpayer should deduct interest on loan obligations for profit tax purposes.

This Resolution was passed in connection with Case No. A40-79561/08-35-348 considered by the Moscow Arbitration Court. In this case, one of the episodes established that the taxpayer had deducted in 2005-2006 the interest accrued for the use of borrowed funds during these periods. The tax authority contested the deduction, citing the fact that the loan agreement stipulated that this interest was payable from 1 April 2010 to 1 November 2014. The court of first instance and court of appeal upheld the taxpayer, ruling that expenses incurred in the form of interest should be deductible for tax purposes irrespective of the actual payment of this interest to the lender. The court of cassation quashed these legal acts on this episode and dismissed a corresponding part of the taxpayer’s claims, as it concluded that the interest expenses should be deducted in the periods when the taxpayer accrued the obligation to pay corresponding interest.

In Resolution No. 11200/09 dated 24 November 2009, the Presidium of the Russian Supreme Arbitration Court confirmed the conclusion drawn by the court of cassation that the interest payable in 2010-2014 had been deducted for no good reason in 2005-2006 and upheld the decision of the court of cassation. According to the Resolution of the Presidium of the Russian Supreme Arbitration Court, published in full on the web-site of the Russian Supreme Arbitration Court on 30 December 2009, the supervisory court proceeded from the following circumstances when ruling on this case.

It follows from clauses 1 and 8, article 272 and clause 4, article 328 of the Russian Tax Code that a taxpayer may deduct the interest that is accrued (payable) in a corresponding tax period[1].

According to the terms of the loan agreement, the payment (and, accordingly, the accrual) of interest should be made after 1 April 2010. Before this date, the taxpayer is not obliged to pay interest to the lender, in other words, it does not incur expenses that are deductible for profit tax purposes. (Special attention should be paid here to the potential link between the emergence of an obligation for a taxpayer under a civil law contract and the emergence of a deductible expense for tax purposes within the scope of public relations.)

The Presidium of the Russian Supreme Court acknowledged that the court of first instance and the court of appeal were right in their assertion that the actual payment of interest is not key to deciding when the expenses should be recognised in accordance with article 272 of the Russian Tax Code. At the same time, however, the Presidium stressed that the provisions of the Russian Tax Code establish a rule, which stipulates that a taxpayer should form its tax base proceeding from the actual time when it will generate or incur the corresponding income or expenses by virtue of the terms and conditions of a contract or other circumstances stipulated by chapter 25 of the Russian Tax Code.

In connection with this fact, the Presidium of the Russian Supreme Court concluded that the taxpayer could not incur expenses relating to the payment of the interest before the deadline established by the loan agreement. Therefore, it had unlawfully deducted interest charges for tax purposes in 2005-2006.