The cost of hypothetical interest is deductible in the year in which the additional contribution is made or the supplementary or reserve capital is increased, and in the two immediately following tax years. The decisive factor in determining whether the cost can be deducted is the moment when the supplementary capital is actually increased, rather than the year in which the profit allocated to that capital was made.
Client's situation
Our client – a limited company – made a profit in 2023 and 2024, which, in accordance with a decision by the shareholders, was retained within the company. The client considered the possibility of availing itself of the preference set out in Section 15cb of the CIT Act, which involves recognising as tax-deductible expenses the so-called cost of hypothetical interest on retained profits transferred, amongst other things, to the reserve fund.
In view of the planned adoption in 2026 of a resolution to allocate the profits from 2023 and 2024 to the reserve fund, the Client had doubts as to in which tax years they would be entitled to claim the cost of hypothetical interest. It was crucial to determine whether the decisive factor for eligibility for the tax relief is the year in which the profit arose, or the moment when the resolution to transfer the profit to the reserve fund is adopted.
The issue
DMS TAX’s task was to analyse the current positions of the tax authorities and the regulations concerning the cost of hypothetical interest, and then to set out for the client the rules for accounting for this preference
Our approach
We analysed the current positions of the tax authorities and the regulations concerning the cost of hypothetical interest, and then set out the rules for accounting for this tax relief to the client. We pointed out that, in accordance with Article 15cb(2) of the CIT Act, the cost of hypothetical interest is deductible in the year in which the additional payment is made or the supplementary or reserve capital is increased, and in the two immediately following tax years. We explained that the decisive factor for the possibility of claiming the cost is the moment when the supplementary capital is actually increased, rather than the year in which the profit allocated to that capital was generated. Consequently, the fact that the profit was generated in 2023 and 2024 does not deprive the Company of the right to benefit from this preferential treatment if the resolution to transfer it to the supplementary capital is passed in 2026.
We have confirmed that, should a resolution be passed in 2026 to transfer the profits for 2023 and 2024 to the reserve fund, the Company will be able to recognise the cost of hypothetical interest in 2026, 2027 and 2028.
What this means
Thanks to the analysis carried out, the client received confirmation that the possibility of claiming the preferential treatment regarding the cost of hypothetical interest does not depend on the year in which the profit was generated, but on the date on which it was transferred to the reserve fund.