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Tax deductibility of interest on loans from individuals

Interest is often a common component of most taxpayers' profit or loss. However, assessing their tax deductibility is usually very complicated. In order for the interest to be treated as a tax-deductible expense, it is not sufficient that it has been accounted for in accordance with the accounting rules in terms of the substance and timing principle, but it is also necessary that the interest expense in question meets all the relevant tests set out in the Income Taxes Act.

Where the creditor is an individual who is not an accounting unit, the Income Taxes Act allows tax deductibility not in the period in which the interest expense is booked but in the period in which it is paid.

The assessment of whether and to what extent the interest on loans and borrowings granted by an individual is tax deductible can be very complicated in situations where such interest is subject to, for example, a thin capitalisation test or other limitations on tax deductibility and the payment occurs in a different period than the period in which the interest was booked.

First, it is necessary to assess for each year whether the interest in question meets all the conditions for tax deductibility and only then can the payment be tested. We would like to briefly explain the rules using the following example:

• In 2020, a company has accounted for interest of 100 on a loan from an individual partner. The company did not pay this interest and treated it as tax non-deductible due to non-payment. In addition, the company had negative equity in that year and, as the loan was from a related party, the company did not meet the thin capitalisation rules. 
• The company paid this interest in 2022. Although the company met the payment condition in 2022, the interest cannot be considered tax deductible in that year either, given that the company did not meet the thin capitalisation rules in the year of its recognition.

Finally, we would like to add that the above brief commentary cannot substitute for a detailed tax assessment of a particular tax situation.

If you have any questions, please contact the authors of this article or the EY tax team you regularly work with.

Authors:

Ladislava Zamazalová

Karolína Mikešová