TAX DEDUCTIBILITY OF PENALTIES AND SURCHARGES

What would you do if one day a government body issued a ruling that set aside a guideline you were required to comply with, and another day it issued another ruling requiring you to do a different thing, potentially exposing you to wrongdoing? Unfortunately, that day appears to have arrived in the case of the Board of Taxation, a panel drawn from various respected government agencies, appointed and empowered under the Revenue Code to provide interpretations on tax matters.

Interpretations by the Board of Taxation generally are far more in-depth than normal Revenue Department rulings. As a result, taxpayers regard them in the same way that they regard rulings by the Council of State. Although a ruling by the board is legally binding on the department, a dissenting view could still claim that it applies only to the taxpayer specifically addressed in the ruling.

The case we’re looking at today relates to the scope of Section 65 ter (6) of the Revenue Code, which prohibits the deduction of “tax penalties and/or surcharges, criminal fines and income tax payable by a company or juristic partnership” as a tax expense.

A very long time ago, the Revenue Department asked the Board of Taxation to interpret whether this provision encompasses “tax penalties and/or surcharges, criminal fines” imposed under other laws, as well as those imposed under the Revenue Code.

The Ruling of the Board of Taxation No.10/2528 (1985) stated that “since the prohibition to deduct such items as tax expenses is a deprivation of taxpayer’s rights, the term ‘tax penalties and/or surcharges and criminal fines’ must be interpreted narrowly. In other words, it must be limited to tax penalties and/or surcharges and criminal fines under the Revenue Code only”.

Ever since then, all taxpayers have followed this guideline and Ruling No.10/2528 is part of the law.

A few years ago, however, a case arose in which the Customs Department determined that a company had underdeclared the import prices of goods. It assessed the company more than 600 million baht, comprising import duty, criminal fines on defaulted import duty, customs surcharges, excise tax, interior tax, penalties for interior tax, value-added tax, VAT penalties and VAT surcharges. The company eventually agreed to pay the required amount to end the dispute, and deducted it as a tax expense.

The Revenue Department in 2005 disallowed the deduction. A court ruling was subsequently sought on whether the fines on defaulted import duty, customs surcharges and penalties on defaulted interior tax were tax-deductible, since they were levied by the Customs Department and not governed by the Revenue Code.

The Central Tax Court in 2011 ruled in favour of the Revenue Department and explained that, even though the Ruling of the Board of Taxation No.10/2528 was issued under the authority of the Revenue Code and was considered final, “it could still be changed by the court’s decision”. Last year, the Supreme Court upheld the Central Tax Court decision and stated the following:

“While fines on defaulted import duty, customs surcharges and penalties on defaulted interior tax were not imposed under the Revenue Code, they reflected the punishment against a violator of such laws. Thus, if the Revenue Code were interpreted to allow the offender to deduct them as tax expenses, there would be no real punishment, which is against the spirit of the laws.”

The Supreme Court went on to explain that “since the fines on defaulted import duty, customs surcharges and penalties on defaulted interior tax were liabilities that the company was required to pay due to its offence against the law, they were not qualified as expenses that were spent exclusively for profit-seeking or for business purposes under Section 65er (13) of the Revenue Code”.

This case raised a number of questions about which direction taxpayers as well as tax officials should follow. The Revenue Department thus decided to ask the Board of Taxation to confirm its position one more time. The result was Ruling No.40/2560 (2017), issued on Feb 27 this year:

(i) Since tax penalties and surcharges and criminal fines are imposed as punishment of an offender, if they were allowed to be tax-deductible, they would encourage the offender to violate the laws.

(ii) Thus, the term “tax penalties and/ or surcharges, criminal fines” under Section 65 ter (6) must encompass tax penalties and/or surcharges, including criminal fines under all types of “tax legislation”, and not limited only to those of the Revenue Code.

(iii) The Ruling of the Board of Taxation No. 10/2528 (1985) was, therefore, repealed.

The most worrying part of this development is not really the wording of the new board decision, but the fact that the Supreme Court also applied the prohibition rule of Section 65 ter (13) by stating that the penalties, surcharges and fines charged against the wrongdoers were not spent “exclusively for profit-seeking or for business purposes”.

This raises a question about tax deductibility of a number of related expenses incurred by a taxpayer in defending a case such as lawyers’ fees, court fees, litigation costs and interest. Will they also be prohibited under Section 65 ter (13)?

We appear to be entering a new era of tax compliance in which taxpayers cannot easily trust the view of government agencies anymore, as different interpretations could create equal amounts of trouble.