Introduction of taxation of income of controlled foreign corporations (CFC) and modification of the rules governing thin capitalization
On 16 September 2014, the Polish President signed the Act of 29 August 2014 amending the Corporate Income Tax Act, the Personal Income Tax Act and certain other laws (Amendment). The planned date on which the Amendment would come into force, subject to certain transitional provisions, is 1 January 2015 (the exact date of entry into force of a part of the Amendment depends on the date of its publication in the Journal of Laws).
The most important areas in which the proposed amendments are to be made are:
- Introduction of taxation of the income of controlled foreign corporations (CFC)
The Amendment proposes to impose on Polish residents (both individuals and legal persons) the obligation to report the CFC-derived income in a separate tax return and tax that income at the rate of 19%. The CFC income will be liable to CIT or PIT, depending on whether the shareholder of the foreign corporation is a legal person or an individual.
A CFC is defined by reference to the following criteria relating to: (i) the level of control (interest of a minimum of 25% directly or indirectly in the capital, or in the voting rights or in the profit), (ii) the nature of the revenues generated by the foreign corporation (at least 50% of the revenues of a “passive” nature), and (iii) the location of the controlled foreign corporation in a state with low tax rates (less than 14.25%) or in a state where the revenues of that corporation are exempt from taxation or in a state applying harmful tax competition.
Revenues of a passive nature shall include dividend and other revenues on participation in the profits of legal persons, revenues on the transfer of shares, receivables, interest and benefits on any type of loans, sureties and guarantees, as well as revenues on copyrights and industrial property rights – including those on the transfer of the said rights, and revenues on the transfer and realization of rights under financial instruments.
The said provisions will not apply to taxpayers controlling companies located in an EU member state or a state that belongs to the European Economic Area, provided that the foreign company carries on “genuine economic activity” there. This term has been defined in the provisions of the Amendment by indication of the sample criteria for carrying on “genuine economic activity”.
- Significant modification of the rules governing thin capitalization
The rules governing thin capitalization limit the tax deductibility of interest for companies excessively using debt instruments. The amendment amounts to: (i) the inclusion of loans granted by companies also holding an indirect shareholding in the debtor’s capital (under the current thin capitalization regime); and (ii) the introduction of the possibility of selecting a new alternative thin capitalization regime based on the value of the debtor’s assets.
Please note that the existing debt to share capital ratio of 3:1 was replaced by the rigidly regulated debt to equity ratio of 1:1. Moreover, under the new alternative thin capitalization system, the limit of interest included under tax deductible costs will be based on the product of NBP reference rate plus 1.25 percentage points and the tax value of assets and will be limited to 50% of operating profit. Additionally, it would be possible to opt for a new alternative thin capitalization regime also with respect to loans executed before 1 January 2015 (the general rule is that loans paid out prior to 1 January 2015 are subject to the current regime in the version in force prior to the Amendment).
- Other amendments
- taxation of certain income paid out in a non-monetary form (the so-called in-kind hand-overs), such as in-kind dividend or in-kind remuneration for the redemption of shares.
- amendments to the provisions relating to transfer pricing and tax documentation, including the introduction of regulations on related party partnership agreements, joint ventures, and others of a similar nature, the regulation on transactions between a taxpayer and its permanent establishment and the regulation enabling domestic adjustments to be made also if tax settlements are adjusted individually by a taxpayer in connection with a tax audit;
- an amendment of the provisions on the exchange of shares, including the possibility of applying the preferential share conversion regime to several separate transactions involving shares’ contributions carried out within a period of no more than 6 months;
- the exclusion of tax exemptions on dividend and other income (revenues) from participation in the profits of legal persons which are tax deductible at the paying out company (the so-called profit participating loan);
- an amendment to the provisions on taxing retained earnings in connection with company transformations (to tax each profit actually not distributed to partners and transferred to other capitals);
- the introduction of rules governing the determination of the initial value of the fixed assets in a European Company, European co-operative and in a foreign enterprise located in Poland (i.e. including the rule of continuation of valuation of the said fixed assets);
- fine-tuning the algorithm used in connection with a partner exiting a partnership (by way of imposing the obligation to reduce the tax free income by non-deductible costs)
- the introduction of detailed rules governing tax residency certificates that do not specify a validity date (particularly, the validity of indefinite term certificates will be limited to 12 months from the date of their issuance);
- harmonizing the provisions of the PIT and CIT Acts in regard of remitters of the flat rate tax on interest, dividend and selected income from the profits of legal persons (the amendment is aimed at introducing the concept of remitter with respect to entities keeping securities accounts and omnibus accounts – the said entities would be authorized to collect tax on interest, dividend and selected income from the profits of legal persons, generated by securities registered in securities accounts and omnibus accounts kept by the said entities)
- fine-tuning the PIT Act’s provisions on determining revenues from the transfer of assets used in business operations (the proposed amendment includes, but is not limited to, the extension of the catalogue of revenues on business operations by adding to them the revenues from a transfer of assets subject to disclosure in the register of fixed assets and intangible assets but not entered in the said register).
- Penalization of a breach of the obligation to file financial statements.
The Amendment is important for all Polish tax residents who control, directly or indirectly, an entity that can be considered to be foreign controlled within the meaning of the above mentioned CFC regulations contained in the Amendment. Note, however, that in many situations it is possible to continue the use of foreign structures without additional tax burden in Poland.
In addition, the amendment will be of a great importance in terms of the finances of Polish CIT taxable companies. In light of the above, it will be even more important to plan tax-effective financing schemes for such entities.