Cancellation of part of the loan together with interest and the creation of income.

Entrepreneurs, when developing their company, often use financing provided by banks. They are exposed to many factors, such as economic fluctuations, changes in customer tastes or competition. It may cause that the taxpayer will have problems paying back the loans taken out. Entrepreneurs in such situations usually try to restructure their debt, but the redemption of part of the loan with interest does not necessarily have to bring profits.

What is subject to personal income tax?

In accordance with art. 9 item 1 of the Personal Income Tax Act (i.e., Journal of Laws of 2018, item 200, as amended), hereinafter referred to as the “PIT Act”, all types of income are subject to income tax, except for the income listed in art.21, 52, 52a and 52c and income on which tax collection was waived pursuant to the provisions of the Tax Code.

As stated in art. 11 paragraph 1 of the PIT Act, the revenues are received or made available to the taxpayer in the calendar year, money and monetary values ​​as well as the value of benefits received in kind and other free benefits. In addition, pursuant to art. 20 clause 1 of the PIT Act for revenues from other sources referred to in art. 10 paragraph 1 point 9, in particular, free benefits not belonging to the revenues specified in art. 12-14 and 17.

In addition, pursuant to art. 20 clause 1 of the PIT Act for revenues from other sources referred to in art. 10 paragraph 1 point 9, in particular: the amounts paid after the death of a member of an open pension fund of a person or a member of his immediate family indicated by him, within the meaning of the provisions on the organization and functioning of pension funds, cash benefits from social insurance, alimony, scholarships, subsidies (subsidies ) other than listed in art. 14, surcharges, awards and other free benefits not belonging to the revenues specified in art. 12-14 and 17 and revenues not found in the disclosed sources.

What is a loan? – statutory definition

According to art. 69 clause 1 of the Act of August 29, 1997 – Banking Law (i.e., Journal of Laws of 2017, item 1876, as amended), by the loan agreement, the bank undertakes to make available to the borrower, for a specified period of time in the contract, the amount of funds cash intended for a specific purpose, and the borrower undertakes to use it under the conditions specified in the contract, return the amount of the loan used together with interest on the specified repayment dates and pay commission on the loan granted.

The loan agreement should be concluded in writing and specify in particular:

1. parties to the contract;
2. loan amount and currency;
3. the purpose for which the loan was granted;
4. loan repayment rules and dates;
5. in the case of a loan agreement denominated or indexed to a currency other than the Polish currency, detailed rules for determining the methods and dates for determining the currency exchange rate, on the basis of which, in particular, the amount of the loan, its tranches and principal and interest installments are calculated, as well as the rules for converting to the payment currency, or loan repayment;
6. the interest rate on the loan and the conditions for changing it;
7. method of securing loan repayment;
8. scope of the bank’s rights related to the control of loan use and repayment;
9. dates and method of providing funds to the borrower;
10. the amount of commission, if the contract provides for it;
11. conditions for making changes and terminating the contract.

The tax nature of interest on the loan

Interest on the loan is a fee for using the lender’s funds. In accordance with art. 22 paragraph 1 of the PIT Act, the costs of obtaining revenues are the costs incurred to achieve revenues or to maintain or secure a source of income, except for the costs listed in art. 23.

The above provision contains a basic definition of tax costs, specifying the features that a given expense should have in order to recognize it as income tax deductible. Therefore, it should be assumed that meeting the following conditions specified in this provision allows the expense to be included in tax costs:

1. was incurred by the taxpayer,
2. remains in relation to the income, retention or security of the source of income,
3. was not mentioned in the negative cost catalog indicated in art. 23 of the PIT Act,
4. has been properly documented.

However, according to art. 23 clause 1 point 8 lit. a) of the PIT Act, it is not considered as tax deductible expenses expenses for the repayment of loans (credits), except for capitalized interest on these loans (credits), except that the tax deductible expenses are expenses for the repayment of the loan (credit) if the loan (credit) was indexed to a foreign currency exchange rate if:

• the borrower (borrower) returns the capital amount greater than the amount of the loan (credit) received – in relation to the repayment of the loan (credit) – in the amount of the difference between the amount of the capital return and the amount of the loan (credit) received,
• the lender (creditor) receives cash constituting a repayment of capital in the amount lower than the amount of the loan (loan) granted – in the amount of the difference between the amount of the loan (loan) granted and the amount of returned capital.

They do not constitute accrued costs, but unpaid or canceled interest on liabilities, including loans (credit) – as stated in art. 23 clause 1 point 32 above Act.

Cancellation of part of the loan and tax income

In accordance with art. 508 of the Civil Code, the obligation expires when the creditor releases the debtor from the debt and the debtor accepts the release, and the result of the debtor’s release from all or part of the debt is his permanent increase in property. The cancellation of part of the loan means, therefore, a reduction or liquidation of the monetary liability, with the result that the debtor has a specific advantage. The act of redemption is therefore a different source of income (not listed in the basic catalog).

Income from business activities is also the value of benefits received in kind and other free benefits calculated in accordance with art. 11 paragraph 2–2b, subject to art. 21 paragraph 1 point 125 (Article 14 (2) point 8 of the above-mentioned Act).

In accordance with art. 11 paragraph 2a above of the Act, the monetary value of other unpaid benefits is determined:

1. if the subject of the service are services falling within the scope of economic activity of the service provider – at prices charged to other recipients,
2. if the subject of the services are services purchased – at purchase prices,
3. if the subject of the services is the provision of the premises or building – according to the equivalent of the rent that would be due if the lease agreement for the premises or building were concluded,
4. in other cases – on the basis of market prices used for the provision of services or access to items or rights of the same type and species, taking into account in particular their condition and degree of consumption as well as the time and place of access.

At the same time, the legislator did not specify what should be understood by the term ‘free’. The provisions of the Income Tax Act only specify the methods and criteria for determining the value of items (rights) acquired free of charge or unpaid benefits. In Polish, “free” means the same as: “not requiring a fee; one that you don’t pay for; free ”(New Dictionary of the Polish Language, PWN, 2003).

Considering the above, it should be considered that for tax purposes, a free benefit is understood as all legal or economic events that result in free of charge, i.e. unrelated to costs or other form of equivalent, an increase in the taxpayer’s assets having a specific financial dimension.

To sum up, the mere receipt of a loan and its repayment under the conditions provided for in the loan agreement is tax neutral. Revenue on the part of the borrower occurs when a part of the loan is redeemed, because the borrower achieves specific financial gain.

Cancellation of part of the loan with interest – effects

The cancellation of part of the loan, together with interest from taxpayers conducting business activity is an increase resulting in taxable income. This applies to both capitalized interest (which actually becomes the amount of debt after capitalization) and interest payable, i.e. interest which, according to the provisions of the loan agreement, has expired.

Cancellation or change of interest that has not expired, as well as penalty interest or the obligation to pay benefits that do not arise directly from the loan agreement, remain indifferent to the creditor. Revenues from non-agricultural business activities of the taxpayer will be redemption of part of the loan with interest.