Latest amendments to the corporate profit tax legislation introduced at the end of 2013 extend the scope of thin capitalization rule (i.e. rule on deductibility of the interest on the shareholder’s loans) to the loans received from related persons.
What is thin capitalisation?
A company is typically financed (or capitalized) through a mixture of debt and equity. Thin capitalisation refers to the situation in which a company is financed through a relatively high level of debt compared to equity.
Why is thin capitalisation significant?
The way a company is capitalized will often have a significant impact on the amount of profit it reports for tax purposes. Croatian tax rules generally allow a tax deductibility of the interest, i.e. the higher the level of interest bearing debt in a company (i.e. interest paid), the lower will be its taxable profit. For this reason, tax administrations often introduce rules limiting the amount of tax recognized interest in order to prevent cross-border shifting of profit through excessive debt.
Why the review of the thin capitalization is important (Croatian perspective)?
Until latest changes of the Corporate Profit Tax Law, interest on loans that were received from foreign shareholders (that are not financial organizations), holding at least 25 % of the shares or equity capital in the company, have been tax deductible if the amount of loans did not exceed four times the shareholder’s share in capital or voting rights. The loans received from third parties, which were guaranteed by the shareholder, are considered shareholder’s loans for the tax purposes.
2013 amendments to the CPT Law extend this rule also to loans received from related persons. Persons are considered related if one person participates directly or indirectly in the management, control or capital of another person, or the same persons participate directly or indirectly in the management, control or capital of the company. In addition, the CPT Bylaw extends this definition to relatives and closely related persons.
Adding value to your business
Given the significantly increased activity of the Tax Administration in conducting tax inspection, we recommend performing an analysis of loans and accruing interest which your company received from related persons. Such analysis will enable you to properly manage risks identified and make necessary improvements that may result in profit tax savings. The thin capitalization compliance check should regularly include:
- Checking loan agreement;
- Checking ownership/legal structure of the company and identify relations;
- Identification and quantification of possible tax risks related to thin capitalization.