Taxation of interest awarded against the State Treasury
Damages won from the State Treasury are exempt from personal income tax. Does this exemption also apply to statutory interest awarded in a legally final judgment?
Art. 21(1)(3) of Poland’s Personal Income Tax Act exempts damages (material damages [odszkodowanie] or moral damages [zadośćuczynienie]) from income tax if the amount or rules for determining the damages arise directly from separate statutes or executive regulations issued under such statutes. Meanwhile, Art. 21(1)(3b) of the PIT Act exempts from taxation damages received pursuant to a judgment or judicial settlement, up to the amount specified in the judgment or settlement, except for damages:
- Obtained in connection with the conduct of business activity
- Concerning benefits which the taxpayer could have obtained if not for the injury.
In cases concerning taxation of damages received from the State Treasury (e.g. for losses caused by the inability to recover land from the State Treasury taken under the Warsaw Decree of 1945), there is a major doubt whether the PIT exemption indicated in Art. 21(1)(3b) of the PIT Act also applies to statutory interest awarded in a legally final judgment of a state court. This is important, if for no other reason, because with the passage of time in Warsaw Decree cases, the amount of interest awarded sometimes exceeds the principal amount of the damages.
Under Art. 160 §1 of the Administrative Procedure Code, in proceedings for damages for Warsaw Decree properties, damages are generally awarded pursuant to Art. 417 and Art. 361 §1 of the Civil Code. These provisions do not specify the rules for determining damages in an arithmetical sense (e.g. the amount of the damages or the method for calculating them), but instead regulate the scope of liability in damages. This means that the court will award damages taking into consideration all of the circumstances of the case in which the loss occurred. According to Art. 160 §1 of the Administrative Procedure Code, a party which has suffered a loss as a result of issuance of a decision in violation of Art. 156 of the code or the invalidation of such a decision is entitled to damages for the actual loss suffered. The amount of the damages is set by the court with consideration for, among other factors, the value of the property and the length of time the State Treasury unlawfully held the land over the years from the original filing of the previous owner’s application to establish the right of temporary ownership.
Following an amendment to the PIT Act in 2003 affecting the wording of Art. 21(1)(3b), the view was developed in the case law of the administrative courts (in line with the position of the tax authorities) that while damages awarded in the judgment by the court enjoy a tax exemption (if they are damages for actual loss rather than lost benefits—lucrum cessans), the same exemption does not cover statutory interest awarded in the judgment, which is thus subject to PIT. This view was taken for example by the Province Administrative Court in Warsaw in its judgment of 12 November 2015 (Case III Sa/Wa 4022/14—not legally final).
This ruling, and the many others like it, is surprising because statutory interest is calculated on the damages awarded and constitutes an integral part of the compensation adjudged against the State Treasury. The interest would not arise if not for the right to damages, and the claim for interest is therefore in a legal sense inherently connected with the same set of facts, the suffering of the same loss, although the substantive legal basis for calculation of the interest is different (Civil Code Art. 481). In other words, the interest which is auxiliary to the principal damages should enjoy a PIT exemption if the damages on which the interest is calculated are exempt from PIT.
However, in the judgment from last November cited above, the Province Administrative Court in Warsaw made a different interpretation of Art. 21(1)(3b) of the PIT Act. Citing the Supreme Administrative Court’s judgment of 24 January 2008 (Case II FSK 1629/06), the province court held that there is no basis for interpreting the concept of “lost benefits,” which has a fixed meaning in legal terminology, differently in tax cases. The interest payable in the event of a debtor’s failure to make timely performance of a monetary obligation (Civil Code Art. 481 §1) should be treated as compensation for the extended and unlawful use of the creditor’s capital. Looking at it in another way, it is damages for depriving the creditor of the possibility of deploying the capital, and thus depriving the creditor of the anticipated benefit of the capital (e.g. through profitable investment). Consequently, interest is compensation for the fact that the creditor could not use the money earlier. This leads to the conclusion that interest received on the basis of a judgment for the debtor’s delay in performing a monetary obligation (Civil Code Art. 481 §1) constitutes damages concerning benefits which the taxpayer could have received if the loss had not been suffered.
The issue of interest received on the basis of a judgment for the debtor’s delay in performing a monetary obligation was also the subject of analysis by the Supreme Administrative Court in its judgment of 26 August 2009 (Case II FSK 588/2008). In that judgment as well, the court took the view that interest received on the basis of a judgment for the debtor’s delay in performance of a monetary obligation (Civil Code Art. 481 §1) constitutes damages for benefits which the taxpayer could have obtained if the loss had not been suffered, and as such is not exempt from personal income tax, because Art. 21(1)(3b)(b) of the PIT Act excludes such damages from the tax exemption.
As the Supreme Administrative Court indicated in its judgment of 20 December 2012 (Case II FSK 1009/11), in the case of actual loss (damnum emergens) the damages function as restitution, intended to restore the balance of the claimant’s asset position upset by the injury. From the point of view of the injured party’s assets, no surplus is created; only the detriment to the assets caused by the injury is made up. It is obvious that the accrual to the injured party on this basis is not taxable. The situation is different in the event of lost benefits. If the taxpayer had achieved the benefits, they generally would have been taxable. Extending the tax exemption to damages received for lucrum cessans would result in privileging of taxpayers obtaining income in this form over other taxpayers, and thus would conflict with the constitutional principle of universality and equality of taxation.
In summary, there is currently a substantial risk of a finding by the tax authorities, as well as the administrative courts, that even though under the civil law interest on damages depends on the grounds for the principal claim, it nonetheless constitutes a separate subject of taxation under the Personal Income Tax Act. This means that so long as interest is not expressly mentioned in Art. 21 of the PIT Act as a category of income enjoying a tax exemption, it may not be found to be tax-exempt, even if the principal amount is tax-exempt.
This tax issue affects not only interest on damages awarded in reprivatisation cases, but is of vital importance in other matters, such as expropriation.
Aldona Leszczyńska-Mikulska, Private Client Practice, Wardyński & Partners