2.Interest (Art. 23) 4. Introduction Interest expenses as well a the foreign exchange loss expenses are expenses with limited deduct ‘According tothe fiscal code the foreign exchange losses connected to a loan are to be treated interest expenses connected to the same loan. “The deductibity of interest expenses (and of related foreign exchange losses) is depending on: = The provider of loan . = The size of the expense = The degree of indebtedness of the tax payer 2. The provider of the loan If the loan is from one of the below credit institutions, called by us “agreed institutions’, then the interest 2s well as the foreign exchange losses are full deductible ‘The ‘agreed institutions" are: ‘+ Banking companigs, Romanian or foreign «Intemational developing banks and similar organisations (eg. BIRD, CF, ADI, BEI, BERD, + Leasing companies fo leasing operations ‘© Morigage credit companies + Crecit institutions ‘+ And any other legal entity which is entitled by Romanian law to lend money ‘© Non-banking financial nsitutions. ‘Another types of loans for which the interest expense as well as the foreign exchange losses are fully are the loans guaranteed by the Romanian State, Loans guaranteed by the State shall mean loans guaranteed by the State in compliance with Law no. 33 regarding public debt. Note: Unless otherwise specified, al eferences in this course notes material are from the Fiscal Code as et 30 September 2012. Cythe interest expenses as well as any foreign exchange loss related have to fulfl two "tp be fully or partially deductible. Fate the deductibility of interest expense related to a certain loan, we will define for any loan the = interest expense + any related foreign exchange losses, 2 defined above may be called also the cost of borrowed capital Jeans obtained from ‘not-agreed institutions", deductible loan expenses (which’ include both and the related foreign exchange losses) are limited to: National Bank of Romania reference interest rate level that corresponds to the last month in a for loans denominated in Lei (5.25% for exam purposes) and Jevel of an annual interest rate of 6%, for loans denominated in foreign currency (the relevant tage will be given in the exam questions, if applicable). apply separately for each loan, before applying the thin cepitalsation conditions (detailed in the ph. nse rate is below the above limits, then the expenses are deductible if the thin capitalisation ed below) is satisfied or may be carried forward and deducted when the thin capitalisation fied nse rate exceeds the relevant limit, the portion of the loan expense in excess is not deductible be carried forward (itis permanently non-deductble) capitalisation rule nses are fully deductible in cases where the degree of capital indebtedness (debt to equity ratio, 25 “DIE ratio’) is postive, having the value less than or equal to 3. shall be determined as the proportion of borrowed capital with a period of reimbursement of more onthe equity, as the average of existing values atthe beginning of the year and atthe end ofthe 'which the profit tax is determined. capital means the total loans with @ period of reimbursement of more than ane year in accordance with clauses withthe exception of loans from the ‘agreed institutions” as defined before. DIE ratio is higher than 3 or the equity is negative, interest expenses and net losses from foreign ifferences are not deductible. These are to be carried forward to the following periods, until the thin n condition is fulfilled. At such moments, these expenses become fully deductible, Shall comprise share capital, legal reserves, other reserves, the undistriouted profit, the result of the year and other equity elements consttuted according tothe legal provisions. otherwise spected, al references inthis course notes material are from the Fiscal Code as at 30 2012, 83® Zhog sequaidas (08 1 se pop josiy a4 woy axe jeuojew sejou asuncosny U S2ouereju Je ‘peyloads BsHNeIIO SSA SION uonnjog tuoymsu peaiBe se Ayjenb ip Busee| jeoueuy aup Jo Jep}oxd eu) Yup BuUAPISUED zi.0Z UI TYS A@vONY 404 of 3/0 a1 eINd.iOD pouinboy 08's oy Busee|jeoueuls ve 00s" 3g way 1207 08" ove" senesoy ove 00 FPydeo areyg (er ) Z1'iee 82 anren Lo'Love se ann, oyeo1pu 7102 J28f 247 20} soyeoppu Bumojoy ty pewuaseud Tus KeuOW Jo swueweIEyS eoUEUY eu be ardwexe aunjoo ((Pouad aun yo pus) Aunbe + (120K jeosy o Buuaq) Aynba) ale ——= = ones funbo gag 00 24 J0 pus) jeydeo pamouog + (ak jeosy yo Buluul6aq) jeydeo pamauiog) 0 2((poued e430 puo) Ainba + (se0K yeosy jo Buywuibaq) Ang) ene ———— = ones fynbe ygeq, Hd 848 40 pus) eudeo pamow0g + (x2aK je08y Jo BuLUIB=q) jeydeo pawouog) Z2(Poued ep J0 pu) Aynbe + (ea yeasy Jo BuyvuiBog) Aynbd3) = Aynbe aBesony 20 64 Jo pus) [edo pamauog + (294 je0sy yo SuvuiBeq) feydeo pemouod) = jeydeo pemowog aBeieny X@} youd Jo uoneindioo au exoyaq Jehedxe) aug fq papsooal suo ay aq jeys Uoqeue}ap 24 Jo} ndoDe OW LANE} Je—K jeoUEUY 2x0 sex up ‘OReL 3/Q au BuERO}eD Dy) suojsno eB aunby ts, ng t0 cuity yi 2 No ‘Loan expis lower than NBR rate? ‘The pat whichis higheris never deductible Forthe pat which is lower No + “The part whichis lowe is cared forward untl DIE ratio fs 0K capital isin foreign currency, consider the new interest rate computed taking into account the a8 defined before (i.e. considering the foreign exchange losses too). be applied: * “The first restriction limits the deductible interest expenses to a celling of 6% per year (for loans ‘denominated in foreign currency) or 6.25%, the interest level determined by NBR for loans in Lei (for ‘exam purposes). Interest exceeding the above mentioned limits is non-deductible and cannot be ‘caried forward to future periods. “The second limitation is the tin capitalisation rule and refers to the debt-to-equity rato. If the debt-io- ‘auity ratio is higher than 3:1, or ifthe company has negative equiy, interest assessed as deductible under the frst limitation and net losses from foreign exchange differences on long term loans are non- deductible, However, these may be carried forward to subsequent fiscal years and become fully deductible inthe year when the debt-to-equity ratio is met. equity ratio is determined by taking into account the Company's share capital, retained earings and es (as equity) and all loans with a maturity exceeding one year (as debi), excluding the loans from es mentioned above (e. financial institutions). ess othemise specified, all references inthis course notes material are from the Fiscal Code as at 30 er 2012Both debt and equity are calculated as the average of the values curent atthe beginning and end of the peri {for which proft tax is calculated Observation: If the loan is from a not agreed financial institution but itis @ short term loan then the DIE ratio cannot ‘computed and the loan expense is limited to the expense given by the NBRIFC rate. Locture example 3.2 Toast SRL's average equity in the 2012 tax period is 1,120,000 Lei. Throughout that time it has loans from a shareholder of 1,140,000 Lei at an interest rate of 6% (lower than the reference interest rate established by the National Bank of Romania (5.25%) and a loan agreement which was concluded in 2008 for the amount of 2,000,000 Lei and starting with 2010 600,000 Lei per year was paid to reimburse it. The loan was from an agreed bank at an interest rate of 12%. Required Comment on the deductibility of the expense in Toast SRL's proft tax computation for 2012. Solution Note: Unless otherwise specified, all references inthis course notes material are from the Fiscal Code as at 30 ‘September 2012. 86LECTURE EXAMPLE SOLUTIONS Solution 3.1 ‘Average equity = (1,500 + 2,000)/2 = 1,750 Lei Average debt = (450 + 1,800)2 = 1,125 Lei DIE. ratio = average debllaverage equity = 1,125/1,750 = 0.64 Solution 3.2 Loan 1 ‘+ tis from shareholder which is not an agreed financial institution + its interest rate is lower than the NBR rate © DIE ratio = 1.018 (see working) => the related interest exgense is fully deductible Loan 2: - itis from an agreed financial institution => the related interest expense is fully deductible Working ‘Average equity = 1,120,000 Debt as at the beginning ofthe year = 1,140,000 Debt as atthe end of the year = 1,140,000 ‘Average debt = 1,140,000 iE ratio = average debt/average equity = 1,140,000 / 1,120,000 = 7.018 Note: Uniess otherwise specified, al references inthis course notes material are from the Fiscal Code as al 30 ‘September 2012. ”‘of Bank Rupt SA show the following: Year ended 31.12.2012 (ey) 586,230 852,311 Asat 31.12.2012 (Lei) 4,200,000 1,575,000 1,680,000 7,500,000 Asal 31.12.2012 (lei) 500,000 270,000 1,223,000 1,993,000 oth 2012. a7 'erwise specified, al references inthis course notes material are from the Fiscal Code as at30 31.12.2014 (Le) 431,400 1,234,500 39.12.2011 ) 4,100,000 2,050,000 2.460.000 8,500,000 314122014 (Lei) 500,000 20,000 423.000 943,000[ Notes to the financial statements ‘The loan from BIRD. In dune 2008, Bank Rupt SA obtained a loan of 1,000,000 Euro fom BIRD repayable stating with June 2013 at an interest rate of 5% payable in arrears in June each year for one fll year. ‘The loan from SAMSON SA In October 2008, Bank Rupt SA obtained a foan of 500,000 Euro from one ofits shareholder, ‘SAMSON SA repayable stating with 31% October 2012 at an interest rate of 5% payable in areas) October each year for one ful yea. The frst ntalment of 125,000 Euro togeter with the interest for one fll year was paid on: 34 October 2012. ‘The loan from DALILA SA (on +# Api 2011, Bank Rupt SA oblained a loan of 600,000 Euro from one of the Group companies, DALILA SA repayable stating wit 1 May 2012 at an interest rate of 434 payable in arears in May each year for one full year. The fist instalment of 200,000 Euro together wit the interest for one full year was paid on 18 May 2012 td The total equity of Bank Rupt SA as at 31+ December 2010 was 993,000 Lei, CA The interest expense are detalled below: Year ended 31.12.2012 31.12.2011 (Lei) (lei) Interest expense related tothe loan from BIRD 202,500 200,000 Interest expense related tothe loan from SAMSON 101,250 100,000 Interest expense related tothe loan from DALILA, 96,640 71,100 Other interest expenses from banking operations 185.840 60,300 Total interest expenses 586.230 431,400 tl “The foreign exchange losses are detailed below: ‘Year ended 31122012 31.12.2011 (le) (Le) 100,000 300,000 Foreign exchange losses related to the loan from BIRD Not: Unis cterise spect al references in tis curse nots mati are fam the Fiscal Coe 2 90 September 2012. 88‘exchange losses related tothe loan from SAMSON 55,000 150,000 ‘exchange losses related tothe loan from DALILA, 48,500 60,000 foreign exchange losses from banking operations uaa 724,500 ign exchange losses e231 4,234,500 ign exchange rates valid through the periods were: 112.2009 :3.8 LevEuro 12.2010 : 4.4 LeilEuro 04.2011 : 4.12 LeiEuro ge foreign exchange rate for 201 was 3.95 LevEuro 3¢ foreign exchange rate for 2012 was 4.15 Lei/Euro ‘expense for any period is computed using the formula: ‘expense = interest rate * value ofthe loan as at beginning of period * no of months in period/12 Compute the debt equity ratio for Bank Rupt SA for 2011 and 2012. Comment on the deductibility of interest expenses and foreign exchange losses of Bank Rupt SA in 2011 and 2012, Compute for 2011 and 2012 the deductible interest expenses and foreign exchange losses and also the amount of interest expenses and foreign exchange losses to be carried forward (i any) less otherwise specified, al references inthis course notes material are from the Fiscal Code as at 30, 2012 89@42LelEuro | @ 41 LelEuo | @3.8 LevEuro ns from not “agreed institutions @31.122012 | @3i.12201 | @ 31.12.2010 from SAMSON 1,575,000 | 2,050,000 7,900,000 ‘from DALILA 1,680,000 2,460,000 a | 3.285.000 4.510,000 4.900.000 debt from not agreed insttutions in 2011 = (1,900,000 + 4,510,000) /2 205,000 debt from not agreed institutions in 2012 = (4,510,000 + 3,255,000) / 2 = 3,882,500 equity in 2041 = (993,000 + 943,000) / 2= 968,000 equity in 2012 = (943,000 + 1,993,000) /2 = 1,468,000 in 2011 = 3,205,000 / 968,000 = 3.3 >3, in 201 3,882,500 / 1,468,000 = 2.64 <3 from BIRD: * because BIRD is an agreed institution, ll expenses (both interest and foreign exchange losses) related to the loans from BIRD are fully DEDUCTIBLE. from SAMSON and DALILA ‘+ SAMSON and DALILA are not agreed institutions, so the loan expenses related to these loans have to full thin capitalisation condition in order to be deductible and the deductible amount cannot ‘exceed the expense related to the FC rate (for loans in foreign currencies) ‘+ The rule: only that expens® corresponding tothe FC rate is deductible and only when DIE ratio isin (0,3] (60 only in 2012) interest expenses from banking - are fully deductible in accordance with NBR rules 3s otherwise specified, al references inthis course notes material are from the Fiscal Code as at 30 2012. st©) Deductible amounts: In2014 DIE ratio >3 => the only deductible expenses are the ones related to the loan from BIRD and the other int and foreign exchanges losses related to banking activities: Deductible expenses in 2017 interest expense related fo loan fom BIRD ‘Other interest expenses from banking operations Foreign exchange losses related to loan from BIRD Other foreign exchange losses from banking operations 1,284 For the loans from SAMSON and DALILA, that part of loans expenses which is below the FC rate (of 6%) may’ carried forward and deducted when DIE rato will be in (0,3). ‘Amount to be carried forward: © For loan from SAMSON: 30,000 Lei loan expense = 100,000 + 180,000 = ‘maximum expense allowed to be carried forward = 6% * 1,900,000 = 114,000 Lei so the amount to be carried forward in respect ofthis loan = min(250,000; 114,000) = 114,000 Lei For loan from DALILA: loan expense = 71,100 + 60,000 = 131,100 Lei maximum expense allowed to be carried forward = 6% * 600,000 *4.12* 9/ 12= 111,240 Let so the amount fo be carried fonward in respect ofthis loan = min(131,100; 111,240) = 111,240 Lei 225,240 Lei ‘Total amount to be carried forward = 114,000 + 111,24 In 2012 DIE ratio <3 => in this year, we may deduct not only the expenses related to the loan from BIRD and the other interest and foreign exchanges losses related to banking activities, but also that part of loan expenses which is) below the expense given by the FC rate (of 6%) forthe loans from SAMSON and DALILA and also the amounts brought fonward from 2011: For the loans from SAMSON and DALILA, that part of loans expenses which is below the FC rate (of 6%) and may be deducted is. © Forloan from SAMSON: loan expense = 101,250 + 55,000 = 156,250 Lei ‘maximum deductible expense allowed = 6% * 2,050,000 = 123,000 Lei Note: Unless otherise specifi, al references inthis course notes material ae from the Fiscal Code as at 30 Seatember 2012, 92je amount in respect ofthis loan = min(156,250; 123,000) = 123,000 Lei DALILA: 16,640 + 48,500 = 145,140 Lei se allowed to be carried forward = 6% * 2,460,000 = 147,600 Lei to be carried forward in respect ofthis loa = min(145,140; 147,600) = 145,140 Lei in 2012 tei ‘elated to loan from BIRD 202,500 Tosses related to Toan from BIRD 00,000 ‘exchange losses related to loan from SAMSON 723,000 mn exchange losses related to Toan from DALILA 745,140 feapenses from banking operations 785,840 ange losses from banking operations B20 ‘and foreign exchange losses brought forward 225200 630.531 End of chapter ctherwise specified, al referances i this course notes material ae from the Fiscal Code as at 30, 2012 %