The resolution of 7 judges of the Supreme Administrative Court, adopted on 25 June 2012 (case reference number II FPS 2/12) resulted in solutions beneficial for those tenants who carried out arrangement and finishing works at their own costs, adapting the premises to their needs. Those tenants will be able to include the loss corresponding to the undepreciated value of the investment in external fixed asset in their tax deductible costs.
In which situation is the resultion of SAC applicable?
The resolution of Supreme Administrative court is applicable in a situation when a tenant carries out arrangement (adaptation) of lease spaces according to his business needs.
From the tax point of view, tentants can consider the expenditure (improvements) incurred for adaptaion of leased premises as investments in external fixed assets and they can book write-offs for them. The minimal period of depreciation of such investment is 10 years, so if the lease agreement lasts 10 years or longer, the costs can be depreciated. However, if the agreement is shorter or if it is terminated prematurely, a part of the adaptation costs might be excluded from a tenant's financial result.
In such cases it often happens that lease agreements do not include the possibility of costs return for the expenditure incurred by the tenant for improvement of premises and equipment. Such provisions of lease contracts result from the fact that improvements and equipment are in line with specific premises, and dismantled elements of the arrangment usually cannot be used again or sold. The Polish Civil Code regulations place the issue of accounting for such costs at the parties' disposal, who can act freely in this matter (the Code only points to a specific model of accounting for the expenditure incurred by the tenant, which is applicale provided the parties do not agree otherwise).
What has been the stance of tax authorities so far?
So far there have been discrepancies in the judical decisions of administrative courts and tax authorities actually all claimed that a tenant cannot expense the loss corresponding to the undepreciated value of an investment in external fixed asset in their tax deductible expenses. Article 16 (1) (6) of the Corporate Income Tax Act ( hereinafter referred to as: CIT Act) is the basis for such stance. According to CIT Act, losses resulting from disposal of fixed assets which were not fully depreciated are not considered tax deductible if these fixed assets lost their economic use due to a change in the scope of the enterprise.
Tax authorities pointed out that termination or expiry of a lease agreement does not mean that a disposal of a fixed asset took place, in the meaning of the asset being destroyed or exhausted. Therefore, not using an efficient fixed asset in relation to lease termnation or expiry is not identical to the disposal of such fixed asset. A fixed asset is not, then, held for disposal but there is simply no more any causation between the costs incurred for the adaptaion of a fixed asset and income of the tenant. According to this stance, undepreciated expenditure cannot be considered tax deductible, as provided for in Article 15 (1) of the CIT Act (tax deductible shall refer to expenditure incurred for generating income or for retaining the source of income or for the protection of it, except for expenditure listed in Article 16 (1) ).
How has the situation changed thanks to the resolution of SAC?
The key here is the interpretation of the term "disposal". According to the Supreme Administrative Court, a narrow definition of the term "disposal", which covers only the physical destruction of a fixed asset, would make Article 16 (1) of the CIT Act senseless. In the opinion of SAC, there are no reasons to accept that, in case of lease termination or expiry, a physical destruction of an investment (incurred expenditure) should be the only deciding factor in expensing an investment which has not been fully depreciated in tax deductible. In practice, a physical destruction of an investment would mean dismantling or destruction of the improvements. Disposal should be considered from the point of view of the tax payer and it should be interpreted as retirement of a fixed asset (or, in this case, of an investment in an external fixed asset), for example by leaving the incurred expenditure to the lessor.
Of course, a loss in fixed assets, just as any other item to be included in tax deductible, should be subject to verification, as provided for in Article 15 (1) of the CIT Act, as to whether there is causation with income generated by the tax payer or in order to retain and/ or protect the source of income. Therefore, not every loss corresponding to the undepreciated value of an investment in an external fixed asset can be included in tax deductible. A loss resulting from the retirement of an investment which has not been fully depreciated (other than due to change in the type of business) can constitute an expense if it took place due economically justified activities, which were aimed at retaining or protection of the source of income.
Such activities include e.g.: cancellation of the lease agreement by the tenant, if business run in the leased premises generate a loss. If the tax payer did not undertake such activities, his source of income would be endangered.
SAC underlines therefore that a loss coressponding to undepreciated initial value of an investment in an external fixed asset, which does nto meet the prerequisites of Article 16 (1) (6) of the CIT Act, can be included in tax deductible if it resultd from activities of the tax payer undertaken to fulfil the aim specified in Article 15 (1) of that Act (that is to say generate income and/or to retain or protect the source of income). A physical destruction of this investment is not necessary - it is enough to retire the investment. Lack of the possibility to include expenditure incurred for an investment in an external fixed asset in tax deductible in a situation when this investment is no longer useful for the tax payer (tenant) for legitimate reasons would result in inadequate tax charges being imposed on him. The said resolution of SAC constitutes a solution which is beneficial for the tenants. It is bounding for all administrative courts in Poland and I hope that it will provide a new direction in tax authorities' intepretations.