Scope of permitted tax optimization is getting narrower
Which latest developments in the Polish tax law do you consider as the most important for international relations?
Firstly, on 18 March 2014, the Council of Ministers adopted a draft amendment to the Corporate Income Tax Act and the Personal Income Tax Act, which is to introduce Controlled Foreign Corporation (CFC) rules in Poland.
Secondly, on the same day the Council of Ministers adopted the guidelines for amending the Tax Code, of which the most important element are long-expected General Anti-Abuse Rule - GAAR.
How important are these amendments to the international tax optimization with the participation of Polish companies?
They significantly amend the existing rules of international tax planning in Poland, sharply restricting the existing options of reducing or avoiding taxation of certain categories of income, in particular that from dividends, interest, royalties and capital gains. In addition, the General Anti-Abuse Rule may give rise to a large uncertainty about the sustainability of the solutions adopted and their tax security for the participating entities.
What is the main feature of the CFC Rules?
The essence of these Rules is the taxation of virtual income, that is the income, which was generated by a controlled foreign company, but has not been - in any form - transferred from that company to the Polish parent company. The draft CFC rules provide for taxation at 19 percent on income of Polish companies having at least 25 percent of shares (in the share capital, voting rights or participation in profits) in foreign subsidiaries, which, in turn, generate a total of at least EUR 250 thousand of annual income and which receive at least 50 percent of such income by way of financial transfers, if in the country of the registered office of these companies such income is taxed at a rate lower than 75 percent of the Polish CIT rate, i.e. lower than 14.25 percent. The income exempt from tax under the EU directive on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, i.e. under the Parent-Subsidiary Directive will remain tax-exempt. In addition, the CFC rules are expected not to apply to taxpayers with foreign controlled companies located in the EU and the European Economic Area, if they conduct the so-called real economic activity.
What practical consequences for Polish taxpayers controlling foreign companies may arise from the introduction of the CFC rules?
The existing optimization schemes based, for example, firstly, on the transfer of intellectual property rights ( such as copyrights, licences, patents, trademarks) to foreign subsidiaries and, subsequently, on the provision thereof to Polish operating companies in exchange for license fees, may cease to be attractive for Polish entrepreneurs. It is worth reminding that in some jurisdictions, intellectual property management companies pay tax only on 20 percent of such type of income, which brings very large tax benefits within a group of related companies.
Similar negative consequences may affect optimization schemes covering a foreign holding company that obtains income on capital gains arising from the sale of shares in subsidiaries based in Poland to third parties. Very often, such schemes are currently used in the real estate transactions, which allows to avoid taxation in the country due to the direct sale of real estate. Instead, shares in real estate companies are sold, which finally makes it possible to obtain tax-free capital gain in the country of the holding company, for example, in Cyprus. Following the effective date of the new regulations, such income will be taxed in Poland at the rate of 19 percent.
And what is the objective of introducing the General Anti-Abuse Rule to the Polish tax law?
The primary objective is to provide the Minister of Finance with the right to effectively challenge the optimization scheme used by the taxpayer, if in the opinion of the Ministry such scheme is artificial, inconsistent with the actual economic objectives, and aimed only or primarily at reducing tax burden. This rule is to enable the Ministry to counteract the so-called artificial legal structures. The General Anti-Abuse Rule is applied in many other countries (according to the Ministry of Finance, there are 23 such jurisdictions ), and their introduction - although only in relation to income taxes - is recommended by the European Commission in the 2012 recommendations.
Such rule once existed in the Polish tax law; it was incorporated in former Article 24b of the Tax Code, which was repealed ten years ago by the Constitutional Tribunal on the grounds that it was inconsistent with the Polish Constitution.
What is the rule specifically aimed at?
In a nutshell, the general anti-abuse rule is a statutory provision which authorises the tax authorities, namely the Minister of Finance, to challenge and, thus, cancel the tax consequences of a transaction that, despite being consistent with the literal, formal wording of tax law, is structured in a way that enables the parties to the transaction to produce the effect other than that originally intended by the legislator. Generally speaking, to avoid or significantly reduce the tax burden related to transactions carried out without elements needless for the ultimate economic purpose of the transaction. The essence of the drafted rule is to infer tax effects from the economic events that actually occur rather than from the formal "externalized legal relation". The drafters stipulate that the reasons for the introduction of the rule, is to clarify tax law by "defining, through its content and application, the limits of permitted tax optimization" and to structure the relation between civil and tax law by "emphasizing the autonomy of tax law".
Do the proposed assumptions of the general anti-abuse rule include any safeguards for taxpayers against the subjective assessment of the transaction by the tax authorities?
Yes. The assumptions of the amended Tax Code provide for some types of safeguards such as reservation of the exclusive right by the Minister of Finance to apply the rule, the introduction of the the Council for Tax Avoidance in Poland as a type of authority to monitor the application of the general anti-abuse rule, the burden of proof imposed on the Minister of Finance in the given case, and, finally, the right of the taxpayers to obtain the protective, although quite costly opinions.
But this is theory and, as you know, the practice may differ and often differs from model theories. In my opinion, the ultimate effectiveness of these mechanisms and - more broadly - the 2014 general anti-abuse rule will be applied not earlier than after a year or even two pass from its effective date.