In thejudgment of August 19, 2015 (case file no. II FSK 1747/13) the Supreme Administrative Court ruled, consistently with its previous rulings, that in the case of a transfer of shares for redemption at a remuneration lower than their market value, the tax authorities do not have the discretion to prepare their own assessment of the income generated by the shareholder as a result of the transfer. In accordance with tax regulations, income on account of a paid transfer of assets or property rights is generally assessed on the basis of their contractual price. However, if the remuneration is substantially different from the market value of the assets or rights so transferred without any apparent reason, the tax authority has the discretion, under Art. 14 Sec. 1 of the CIT Act, to assess this income at the level of the market value.
The case resolved by the Supreme Administrative Court (NSA) concerned a Polish joint stock company which held 100% shares in a Polish limited liability company, and intended to transfer some of these shares to that limited liability subsidiary for redemption. The shares had been originally subscribed for and acquired in return for an in-kind contribution not constituting an enterprise or an organized part of the enterprise. The shareholder and the subsidiary intended to specify remuneration for the aforesaid share transfer at the nominal value of the shares which was likely to be lower than their market value. In the transaction at issue, the acquisition cost of the shares transferred was almost identical to their nominal value, thereby practically eliminating any CIT liabilities on the account of the transaction.
In connection with the planned transaction, the shareholder applied for a tax ruling to confirm that the aforesaid Art. 14 Sec. 1 of the CIT Act would not apply to the transaction, meaning that the tax authorities will have no right to assess income generated as a result of the share transfer for redemption at a value higher than that agreed by the parties, based on the market value of the shares. The Director of the Tax Chamber in Łódź issued a negative tax ruling, which was subsequently upheld by the Provincial Administrative Court in Łódź pursuant to an appeal filed by the shareholder. The tax authority and the Provincial Administrative Court pointed out that starting from January 1, 2011, income on account of share transfers for the purpose of redemption has been subject to the general provisions of the CIT Act (formerly, they had been classified as distributions of corporate profits and therefore subject to special regulations). As a result of the legislative change, the aforesaid income was made subject to general regulations regarding taxable income provided in Art. 12 Sec. 1 of the CIT Act. Notably, this provision contains an explicit reference to Art. 14 of the CIT Act, which suggests the possibility of tax authorities verifying the fair market value of the remuneration received in connection with a transfer of shares for voluntary redemption on the basis of this regulation.
Notwithstanding the above, in considering the last resort appeal, the Supreme Administrative Court agreed with the argumentation presented by the taxpayer, referring primarily to the literal interpretation of Art. 14 Sec. 1 of the CIT Act. The Supreme Administrative Court ruled that the transfer of shares for redemption is a special legal transaction which cannot be classified as a paid transfer of assets or rights. Additionally, Art. 14 Sec. 1 of the CIT Act uses the notion of “price”, whereas in the case of a transfer of shares for redemption we are dealing merely with “remuneration”. Moreover, the Court noted that the commercial law expressly permitted share transfers for redemption without any remuneration being offered, in which case no additional income could be assessed for the shareholder in connection with a transfer transaction. After all, in the present transaction, certain remuneration (if lower than the share market value) has been agreed. The Supreme Administrative Court also found several arguments supporting the above view by applying an internal systemic interpretation, namely identifying a number of CIT Act provisions determining the rules for assessing income on account of acquisition or transfer of shares, which only proves that the general income assessment regulations cannot apply to transactions involving a transfer of shares for redemption. Additionally, based on the external systemic interpretation, the Supreme Administrative Court pointed out that in the case of other taxes, such as tax on civil law transactions (PCC), share transfers for the purpose of redemption are also treated as a special legal transaction different to a share transfer pursuant to a standard share purchase agreement and for this reason they should not be assessed in accordance with the general rules applicable to the given tax.
The Supreme Administrative Court judgment may raise certain doubts as to the formal correctness of the argumentation used in the judgment. That said, it is another consistent judgment regarding the application of Art. 14 Sec. 1 of the CIT Act to voluntary share redemptions (cf. Supreme Administrative Court judgment of February 19, 2015, case file no. II FSK 399/13 and previous NSA judgments handed down in 2013 – 2014, referred to in the judgment). Interestingly, tax authorities have recently tended to take a more favorable approach in similar cases, adding that the transfer pricing regulations did not apply to this types of transactions either (e.g. tax ruling issued by the Director of Tax Chamber in Katowice, dated July 2, 2015, case file no. IBPB-1-3/4510-98/15/AW). At this point it needs to be noted that for some time now the tax authorities have in their practice supported the view that Art. 14 Sec. 1 of the CIT Act and the transfer pricing regulations are also inapplicable in case of the share transfers for the purpose of redemption if no remuneration is paid (e.g. tax ruling issued by the Director of Tax Chamber in Katowice, dated July 14, 2014, case file no. IBPBI/2/423-438/14/PC). This transaction is also commonly deemed exempt from tax on civil law transactions (PCC), regardless of whether or not any remuneration is paid.
The above line of jurisprudence adds to the attractiveness of share redemption as a tax-optimization tool in restructuring the capital structure of companies, including in the case of partial withdrawal of an investment by a shareholder without realizing capital gains or in the case of the intention of taking over attractive tangible assets owned by the subsidiary. A share transfer for redemption may be effected without remuneration or with remuneration fixed below the cost of generating revenue in connection with the shares. However, in the light of the Supreme Administrative Court judgment, this transaction is unlikely to involve the risk of the tax authorities assessing the value of income generated by the shareholder at the level of the market value of the shares so transferred. A share redemption may therefore be an interesting solution for a number of corporate restructurings targeted at multiple business objectives. That said, before implementing this solution, further development of case law needs to be monitored and the risk of a potential dispute with tax authorities also must be factored in, although considering the above judgments, a hypothetical lawsuit is likely to be successful.