Tax treatment of interest, fines and penalties
This article will introduce you to the way various tax laws regulate the income and expenses on interest, fines and penalties of legal entities, sole proprietors and natural persons. In this regard, the following statutes will be examined in turn: Corporate Income Tax Act (CITA), the Value Added Tax Act (VATA) and the Income Taxes on Natural Persons Act (ITNPA).
Interest according to § 1, item 7 of the SP of ITNPA is the income originating from any type of receivables for a debt, regardless to whether the debt is secured by way of a mortgage or by way of a clause providing for participation in the debtor’s profit, including the interest on bank deposits and the income (bonuses) from bonds and debentures. The definition of interest in § 1, item 7 of CITA is similar, but is supplemented by stating that for the purposes of Part Three of this Act income in the form of dividends, penal interest on late payments and penalties are not considered interest.
The penalty is a monetary amount that can be negotiated in favour of one or both of the parties. The penalty cannot be compared with the penal interest on late payments.
Tax treatment under CITA
The following accounting expenses are not recognized for tax purposes: fines, confiscations, including under Art. 307a of the Penal Code (PC), and other sanctions imposed in connection with violation of statutory instruments, and interest on delayed payments for public liabilities or municipal ones - Art. 26, item 6 CITA.
Penalties can be imposed by administrative, criminal or tax statutes. The penalties are often personal (i.e. are imposed on the natural persons, representing businesses).
Interest is charged under the Interest on Taxes, Charges and other such State Claims Act (Art. 1 ITCSCA).
The interest expenses to the amount determined by the formulas contained in the respective provisions are not recognized for tax purposes in the year in which they are accounted for (Art. 43 (1) CITA) or during the following 5 years until the full amount thereof has been recognized (Art. 43 (2) CITA).
Interest expenses do not include the expenses of:
- interest under financial leasing or bank credit, except where the parties to the transaction are related parties, or the leasing, and the credit, respectively, has been guaranteed or secured or extended by order of a related party;
- penal interest on delayed payments and indemnities;
- interest that is unrecognized for tax purposes on any other legal grounds (due to tax evasion, for example);
- interest and other borrowing costs, which according to the accountancy legislation have been capitalized as a part of an asset value.
Interest including those originating from instalments under a finance lease charged in favor of foreign legal entities are taxed at the source with a 10% tax, and the tax is final - Art. 12 (5), item 1 CITA. This only applies to interest which has not been realized through a place of business within the territory of Bulgaria - Art. 195 CITA.
This provision also applies where, through a business activity establishment within the country, the foreign person assesses the said income to other parts of his establishment which are located outside the country, with the exception of those cases in which the accounting expenses are not recognized for tax purposes, or accounting expenses or assets accounted for at the amount of the expenses actually incurred (the cost value) are recognized for tax purposes in the business activity establishment.
Tax treatment under VATA
Interest and penalties are calculated based on outstanding, partially implemented or fully implemented, but different from the agreed actions.
Under VATA, the definition of the basis of taxation expressly states that any payment of damages and interest of compensatory nature is not considered a consideration for a supply - Art. 26 (2) VATA;
Tax is charged neither on interest and penalties received from the supplier, nor on exempt supplies. Exempt supplies are, for example, financial services. It should be noted that Art. 46 (2) VATA enables the supplier to choose the service of granting a loan under a finance lease under Art. 46 (1), item 1 VATA to be a taxable supply.
Tax treatment under ITNPA
In principle, income originating from interest, including interest on leases of taxable persons under ITNPA are taxable under this Act - Art. 8 (6), item 4 ITNPA. Interest on bank accounts are taxable with regard to interest on deposit accounts in commercial banks and branches of foreign banks established in a Member State of the European Union or in another state party to the EEA Agreement; interest and discounts from Bulgarian governmental, municipal and corporate bonds and similar bonds issued under the laws of another Member State of the European Union or a state party to the EEA Agreement; interest on receivables established through the courts, these receivables not being subject to taxation, and the adjudged compensation for court costs.
As of 1.01.2013, interest rates on deposits in commercial banks have been subject to a rate of 8%.
The interest, fines and penalties paid by sole proprietors are treated in tax terms the same as interest, fines and penalties paid by legal entities, as under Art. 26 ITNPA the said sole proprietors form taxable income under the procedure established by CITA.
A final tax of 10% is levied on the gross amount of income acquired by local natural persons from interest on bank accounts - Art. 38 (13) ITNPA.
Under Art. 8 (11) ITNPA, penalties and compensations of any kind, except for insurance reimbursements accrued from local legal persons, local sole entrepreneurs or foreign legal persons and sole entrepreneurs through a place of economic activity or certain base in the country in favour of foreign natural persons established in jurisdictions of preferential tax regimes, shall be income from a source in the country.