- Interest on loans between companies is classified as financial income and expenses, unless it is considered as a return on equity in business groups.
- The deductibility of financial expenses in Corporate Income Tax is limited to 30% of operating profit, with a minimum of 1 million euros always deductible.
- Related-party transactions require the application of market interest rates and may generate tax adjustments for both companies and individual partners.
- Interest-free loans, participating loans and intragroup financing require special attention to their documentation, valuation and treatment in IRPF, IS and AJD.
Understanding how loan interest ( real interest rate ) is classified and taxed in Corporate Income Tax can seem like a real labyrinth: participating loans, related-party transactions, deductibility limits, withholdings… If we also mix in business groups, individual partners and interest-free loans, the technical cocktail is significant.
This article provides a comprehensive and structured explanation of all the key elements affecting the taxation of interest under Corporate Income Tax (and its connection to Personal Income Tax and Stamp Duty where applicable), based on the criteria of the Directorate General of Taxes, the annual tax control plan , the Corporate Income Tax Law (LIS), and the standard practices of advisors and companies. The aim is to provide you with a solid understanding, although it is always advisable to consult a professional regarding your specific situation.
1. Participating loan between unrelated companies: classification and tax effects
The Directorate General of Taxes has specifically analyzed the tax treatment of interest on a participating loan between unrelated companies , for the purposes of Corporate Income Tax. The analysis is based on a case in which entity X owns 10% of the capital of entity Y and grants it a participating loan to finance a real estate transaction.
The unique aspect of this contract is that the loan repayment is not based on a traditional fixed interest rate , but rather on a specific percentage (for example, 25%) of the profits Y obtains from selling certain plots of land. In other words, the interest is variable and linked to future results, introducing a highly significant contingent component from both an accounting and tax perspective.
This approach leads the Treasury to rule on the classification of said interest as financial income and expenses , its time of imputation following the accrual principle and the possibilities of deductibility of the expense in the borrowing company, subject to the limit of financial expenses provided for in article 16 of the LIS.
2. Accounting and tax treatment in the lending company
From the perspective of entity X, which acts as the lender, the participating loan is analyzed as a financial asset held at cost , since it is an investment in a debt instrument whose return depends largely on the borrower's profits.
In accounting, the loan is initially recorded at the amount disbursed and is generally maintained at amortized cost. Subsequently, its value will be adjusted for the results derived from the participation in the profits or losses of entity Y, as the variable interest linked to the profits of the real estate transaction accrues.
Interest linked to results (Y's profits) is classified as financial income in X's profit and loss account, and is recognized applying the accrual criterion: it is recorded as it is generated, not only when it is actually collected, following the provisions of articles 10.3 and 11 of the LIS.
If, in addition to the variable remuneration, a fixed interest component had been agreed , this would be recorded separately, also as periodic financial income, allocating each year the corresponding part according to the agreed financial calendar.
3. Accounting and tax treatment in the borrowing company
In entity Y, which receives the financing, the participating loan is classified from the outset as a financial liability , as it represents an obligation to repay a principal and satisfy a return linked to the profit.
Variable interest expenses that depend on the performance of business unit Y are recorded as financial expenses in the profit and loss account , also following the accrual basis of accounting. That is, they are recognized when they are generated by the business's performance, not only when they are paid, which can lead to temporary differences if the actual cash flow is delayed.
The valuation of the liability is updated based on the results attributable to the lender and profit expectations. If the forecasts for the results of the real estate transaction change, the amount payable for interest linked to profits is revised, adjusting the debt and the corresponding financial expense.
Transaction costs associated with the loan (commissions, legal advice, notary fees, etc.) are not charged to results all at once , but are systematically allocated throughout the life of the loan, following the rules of the General Accounting Plan, usually by calculating the effective interest rate.
4. Tax treatment of interest: financial expense or return on equity?
The classification of interest for corporate income tax purposes depends largely on whether or not the companies belong to the same corporate group, as defined in Article 42 of the Commercial Code. This distinction is crucial both for the nature of the payment and its deductibility.
When X and Y are not part of the same corporate group , the interest derived from the participating loan is not considered a return on equity. Consequently, for tax purposes, the remuneration is classified as financial income for X and financial expense for Y, following the standard accounting treatment for loans and credits.
If, on the other hand, the companies are part of a corporate group, certain participating loans may be classified as a return on equity . In such cases, the consideration is not treated as a deductible financial expense for the borrowing entity, but as a distribution of profits, with significant implications for the corporate income tax base.
This reclassification may entail additional restrictions on deductibility and even changes in the treatment of income obtained by the lending entity (for example, the possibility of applying exemption on dividends or limitations when there is debt to acquire shares).
5. Limits on the deductibility of financial expenses in Corporation Tax
Leaving aside the assumptions of return on equity, the general rule of Corporate Income Tax establishes that interest and other financial expenses associated with business debt are deductible up to a quantitative limit.
The Spanish Corporate Income Tax Law (LIS) considers net financial expenses to be the excess of financial expenses over financial income for the year derived from the transfer of equity to third parties and other financial transactions. These net financial expenses are deductible up to a limit of 30% of the entity's operating profit.
Furthermore, there is a very important minimum: at least €1 million of net financial expenses are always deductible, even if 30% of operating profit is less than that amount. This minimum acts as a safeguard for businesses with relatively moderate debt.
When the net deductible financial expense for the year does not consume the entire limit of 30% of operating profit, the unused portion of the limit is carried forward to the following five years, increasing the deduction cap available in those periods, always above 30% of annual operating profit.
6. What is considered financial expense and income for these purposes
To correctly calculate the deductibility limit, it is essential to identify which items are defined as financial expenses and income following accounting regulations and the specifications of the LIS.
Financial expenses include, among others, those recorded in accounting accounts related to debts and financial instruments: interest on bonds and debentures, interest on loans and credits, dividends from instruments classified as financial liabilities , as well as implicit interest associated with financing operations and fees linked to indebtedness.
Financial expenses also include negative results corresponding to non-managing participants in joint venture agreements , provided that they reflect the remuneration of the capital contributed to the business project and not of a different nature.
Financial expenses for the purposes of the limit in Article 16 of the Spanish Corporate Income Tax Law (LIS) do not include those that are incorporated into the cost of an asset (capitalization of financial expenses), those related to updating provisions, or those that are already non-deductible under other specific rules (for example, expenses related to exempt activities or to borrowing to acquire certain shares).
On the financial income side, the following are mainly included: those recorded in the interest accounts of loans and securities , uncollected interest on loans impaired by insolvency , positive results of non-managing participants in joint venture accounts and certain dividends or financing income from holding companies, even when accounting includes them in the operating result.
7. Calculation of operating profit and management of excess or insufficient deductions
The operating profit used as the basis for applying the 30% limit is calculated by starting with the operating profit and adjusting it for certain items. Generally, depreciation of fixed assets, allocation of subsidies, impairments, and gains on the sale of fixed assets are subtracted.
On the other hand, certain dividends or profit shares from entities in which there is a minimum percentage of participation (or a high acquisition value) are added, unless the rule expressly provides for their non-inclusion because they are specific situations of indebtedness to acquire those shares.
If, when applying these rules, financial expenses exceed financial income , the difference will be the net financial expense subject to the limit of 30% of operating profit or, failing that, to the absolute minimum of 1 million euros deductible in all cases.
When the net financial expense for the year is higher than the maximum deductible amount, the excess is not lost : it can be deducted in future years, without time limit, provided that in those years there is a margin within 30% of the operating profit, applying a criterion that prioritizes first the expenses of the current year and then those of previous years.
Conversely, if the net financial expense for the year is less than 30% of operating profit, the unused difference can be used during the following five years to increase the deduction limit for those years. However, the portion between the deductible expense and the unused one million euros is not carried forward to subsequent years.
8. Loans within business groups and non-deductibility of interest
When loans are granted between entities that are part of the same business group in accordance with Article 42 of the Commercial Code , the specific rule of Article 15.a) of the LIS comes into play, which determines the non-deductibility of certain interest.
Interest (both fixed and variable) derived from loans granted between group entities may, in general, not be tax-deductible in the borrowing entity when the rule classifies them as remuneration of own funds, even though they are recorded in the accounts as a financial expense in the profit and loss account.
This limitation does not affect intragroup loans granted before June 20, 2014. For those transactions prior to the reform, interest continues to be considered deductible under the terms established by the regulations in force at that time, unless other restrictions apply.
If the lender is a non-resident and the borrower is resident in Spain, the income paid by the latter may be classified as a return on equity, which prevents its tax deductibility in Spanish Corporate Income Tax, with the consequent obligation to make positive adjustments to the accounting result.
When, on the contrary, the entities are not part of a business group but are related entities for the purposes of Article 18 of the LIS, the interest paid is, in principle, deductible, provided that the limits of Article 16 are respected and they are valued at market value.
9. Related party transactions: market value and interest on participating loans
In financing operations between related entities (for example, between a partner and a company, between companies in the same tax group or between companies with significant reciprocal shareholdings ), the LIS requires that market conditions be applied, including the interest rate.
Determining the market interest rate for a participating loan is not trivial: a significant portion of the remuneration is linked to the borrower's financial performance, which introduces uncertainty. To justify the agreed-upon rate, a comparative analysis is advisable, considering the sector, credit risk, term, type of instrument, and typical conditions for similar transactions between independent parties.
If the agreed interest rate deviates from what would be reasonable in the market, the Administration may recalculate the corresponding financial income and expenses , adjusting the taxable base for both the lending and borrowing entities, with the impact that this may have on withholdings, deductibility and penalties.
In loans between related entities but not belonging to the same business group, the limitation of deductibility of net financial expenses to 30% of operating profit also applies , with the minimum of one million euros always deductible, plus the rules for carrying forward excesses and additional limits in case of not consuming the 30% in a specific year.
In loans between totally independent (unrelated) companies, the general scheme is the same: the interest generates financial income for the lender and financial expenses for the borrower , subject to the deductibility limits of article 16 LIS, provided that the interest rates are reasonable and the transaction responds to a real economic need.
10. Interest-free loans: Stamp Duty, Personal Income Tax and Corporate Income Tax
Another common scenario in practice involves interest-free loans , especially in the areas of SMEs, family businesses, entrepreneurship, and intercompany financing for support purposes. Their tax treatment depends on whether the parties are related and whether they are individuals or legal entities.
From a formal perspective, the granting of an interest-free loan is usually documented in a public deed or private contract . Both may be subject to the Tax on Documented Legal Acts (AJD) when executed in a notarial document, although the taxable event and the amount depend on regional regulations and the specific characteristics of the act.
For personal income tax purposes, when the lender is an individual, the tax authorities may presume the existence of income from movable capital if it is not adequately justified that no interest is being charged, applying, where applicable, the legal interest rate to estimate the income. The borrower, also an individual, may not be able to deduct interest as an expense if it is not actually paid.
When an interest-free loan is made between related parties (e.g., partner and company), the rules for related-party transactions under Corporate Income Tax must be applied: the financing is considered to be valued at normal market value, so that the lack of interest may, for tax purposes, conceal a contribution to equity, a gift, or a disguised remuneration for another transaction.
In cases where there is no connection, an interest-free loan can be interpreted as a gift from the lender, so that the economic loss assumed by not charging interest is not deductible in Corporate Income Tax, as it lacks correlation with business income and is due to a reason unrelated to the activity.
11. Withholdings on interest and effects on the partner's personal income tax
When the payer of interest is a company or a sole proprietor in the scope of their economic activity, they are obliged to withhold income tax or corporate tax on the interest paid or due to partners, third parties or related entities.
The standard withholding tax rate is 19% on the interest amount. The obligation to pay these withholdings is fulfilled through periodic returns (form 123) and an annual summary (form 193), which detail the amount of interest paid and the withholdings applied to each recipient.
In the personal income tax (IRPF) of a partner who is an individual, the interest received is taxed as income from movable capital integrated into the savings base, except for the part that exceeds certain debt thresholds with respect to the company's own funds, in which case that portion may be taxed in the general base, with a higher progressive scale, so it is advisable to review common errors in the income declaration that usually generate discrepancies.
To determine what portion of the income goes into the savings tax base and what portion into the general tax base, the loan amount is compared to three times the entity's equity multiplied by the partner's percentage of ownership (or 25% if the relationship is not as a partner, but as an administrator or family member). The interest corresponding to the "normal" portion (up to that limit) goes into the savings tax base, and the excess is included in the general tax base.
In form 193, the paying entity must distinguish between income subject to the savings scale (code B) and income that is integrated into the general base when derived from excess own capital in related operations (code D), in order to avoid subsequent discrepancies between the information declared by the company and the self-assessment of the partner.
Overall, the taxation of interest on loans between companies, partners, and individuals combines accounting rules, quantitative limits, related-party rules, and withholding taxes that require proper documentation of transactions, application of market interest rates, and review each year of the impact of these expenses and income on the entity's tax result and on the declaration of those who receive the remuneration.
