The Supreme Court has recently ruled contrary to previous rulings, thus changing the treatment of late-payment interest paid in refunds of undue income for Income Tax (“IRPF”) purposes.

In this new sentence, it establishes that late-payment interest paid by the Tax Agency is subject to IRPF, since it is considered a capital gain that must be included in the general income.

The High Court understands that IRPF is the tax levied on all global income accumulated by the taxpayer. For this reason, the total income, capital gains and losses and the imputations of income must be grouped in the aforementioned tax.

However, although the general rule is the tax on all the income that affects the taxpayer, the exemption of some of them in the tax is allowed as an exception. To this end, the cases in which the taxable event is not understood as having occurred and the cases of exemption must be specified, being able to exempt on specific occasions the duty to contribute despite the fact that the taxable event has occurred.

In relation to the interests that the Tax Agency pays as compensation for economic damages caused to taxpayers, as is the case of late interest in a return of undue income after a court sentence, this is considered as compensation for the economic rights affected. The Tribunal considers that this situation is similar to other cases in which interest is received, such as for example a result of the delay in the payment of an expropriation.

Although the Tax Administration is responsible for causing the infringement of the economic rights of the taxpayer by making an income that is later determined to be improper by a court sentence, it is understood by the court that the solution should not be different.

For the purposes of classifying this income, the judicial decision applies the IRPF rule that establishes that when the change in the value of the assets comes from the addition of assets or rights that do not derive from a transfer, the income disclosed will be included in the taxpayer’s general tax base, which means that, as a general rule, this income will be subject to higher rates than if it is included in the savings tax base.

It is important to appreciate that the sentence had two dissenting votes and consider that late interest in the return of undue income should not be subject to IRPF.

The main argument of these dissenting votes is that, as referred to in the previous sentence, when the taxpayer is reimbursed for the interest that he has unduly borne, a capital gain is not generated, but rather a capital rebalancing occurs.

The returned money does not increase the taxpayer’s wealth, but simply goes back to where it illegally left. The taxpayer’s legal and economic position does not improve upon receiving the refunded amount, since the purpose of this return is to restore the situation prior to the illegal act, as required by law.

On the other hand, it is stated that it does not make sense to deny the deductible nature of the interest that the taxpayer bears and to consider the interest associated with the return of undue income subject to tax.

In conclusion, with this sentence, the Supreme Court has established that late-payment interest paid by the Tax Agency when returning undue income is subject to IRPF, considering it a capital gain that must be included in general income.

This change supposes a modification in the previous jurisprudence and has generated controversy, as evidenced by the two individual votes that disagree with the majority decision.

We understand that it is especially burdensome for the taxpayer and that it causes an unfair enrichment for the Administration the fact that stands out in the individual votes, that is, that looking at the taxpayer’s situation as a whole, there is not a capital gain but a patrimonial rebalancing, because the income obtained has not increased as a whole the patrimony of the taxpayer, but it returns to the patrimonial situation that was unduly injured.

Despite this, the sentence is based on the interpretation of tax regulations, which establishes that IRPF is levied on all global income accumulated by the taxpayer, and on the consideration of interest on late payment as compensation for damages to economic rights

In any case, this decision of the Supreme Court will have a significant impact on the taxation of refunds of improper income and on the treatment of default interest in general, which shows the importance of the interpretation and application of tax regulations in our legal system.

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