Investment-related interest expenses and the interest deduction limitation in corporate income tax

In the case of significant investments financed through borrowings, the related interest expenses are typically capitalized as part of the acquisition cost of the investment in accordance with the applicable accounting rules. As a result, these costs do not affect profit or loss when incurred, but only after the relevant assets are capitalized, through depreciation charges.

Under the current interest limitation rules, the portion of net borrowing costs that exceeds the higher of (i) 30% of the taxpayer’s tax EBITDA (adjusted earnings before interest, taxes, depreciation and amortization) for the tax year or (ii) HUF 939,810,000 is not deductible for corporate income tax purposes and must therefore be treated as a non-deductible expense. Net borrowing costs include interest expenses, costs and expenses that are economically equivalent to interest, costs incurred in connection with obtaining financing, as well as interest capitalized as part of the acquisition cost of assets.

However, the relevant legislation does not clearly specify in which tax year interest capitalized as part of an asset’s acquisition cost should be taken into account for purposes of the interest limitation rules. It is unclear whether such interest should be considered:

• during the investment phase, before the asset is capitalized, in the tax year in which the interest economically arises, regardless of the fact that it does not yet affect the accounting profit or loss;
• upon capitalization of the investment, when the asset is brought into use, in a single amount; or
• over time, when depreciation is recognized, as the capitalized interest becomes part of the accounting profit or loss through the depreciation expense of the asset.

This uncertainty regarding timing may be particularly significant in the case of large-scale, debt-financed investments with substantial borrowing requirements and extended implementation periods.

The differences between the above approaches are not merely technical. They may materially affect the amount of deductible interest expense in a given year, the extent of any positive tax base adjustment, as well as the utilization of interest deduction capacity available in future periods.

The interpretation issue outlined above may be especially relevant where a major investment is financed predominantly through external funding, involves significant debt, and the taxpayer’s EBITDA during the investment period is limited or fluctuating. In such cases, it may be advisable to assess the potential interpretations and their tax implications in advance and establish a practice that is supportable and acceptable from a tax authority perspective.

Deloitte’s tax specialists can assist in evaluating the available interpretation options, quantifying the related tax impacts, identifying associated tax risks, and developing an appropriate and robust tax treatment.