The Polish government recently published proposed amendments to the corporate income tax (CIT) aimed at increasing tax fairness by curtailing certain tax planning devices that have been in use for a number of years. The changes, which are to be effective as of January 1, 2013, are unprecedentedly wide-ranging, and are intended to overrule a series of tax cases that have upheld taxpayers’ positions that were contrary to the government’s interpretation of the law.
Limited Joint Stock Partnerships (SKAs)
The taxation of limited partners in limited joint stock partnerships (SKAs) has been the subject of much controversy for some time. Although SKAs are technically tax transparent, and thus are not themselves subject to tax, limited partners have been taking the position that they should not be taxed on their share of an SKA’s income until the income is actually distributed to them. In January of this year, the Supreme Administrative Court sustained this position, resulting in a situation where neither the entity nor the limited partners would be subject to tax until the SKA actually makes a distribution (i.e., the profits could be reinvested indefinitely without current taxation). General partners have been taxed on a current basis, but the SKAs generally have been structured so that the interests of the general partners are small.
The CIT amendments would treat SKAs the same as regular business corporations, thus subjecting their income to CIT on a current basis. This would make SKAs less favorable vehicles for investment than limited partnerships or general partnerships. Therefore, it is likely that a number of structures that were designed to take advantage of the tax transparent treatment of SKAs, including many fund structures, will have to be transformed in order to preserve their tax results.
As a side effect of the government’s attack on the SKA structure, the CIT amendments make profit splits between partners in all types of partnerships, including joint-ventures, subject to transfer pricing principles. Historically, in many structures based on an SKA, the limited partners/shareholders have been assigned most of the partnership's profits, thus deferring taxation on the bulk of the income.
It appears that the transfer pricing regulations are intended to preclude taxpayers from allocating business profits to partnerships to which they are “related” on other than arm’s length terms and without a business rationale in order to take advantage of such deferral. The transfer pricing regulations would require profit sharing arrangements between a partnership and its related partners to be comparable to such arrangements between partnerships and unrelated partners. However the proposals relating to profit splits among partners are written in very vague language which may result in significant discrepancies in their interpretation by tax authorities in practice. Therefore, it may be advisable to restructure sharing ratios in advance of the amendments becoming effective on January 1.
According to the proposed changes, the transfer pricing regulations would also be applied to foreign permanent establishments of Polish tax residents and permanent establishments of non-residents established in Poland.
New Thin Capitalization Rules
Currently, the thin capitalization rules, which limit the deductibility of interest if the debt-to-equity ratio of a corporation exceeds 3 to 1, do not cover loans from indirect shareholders and horizontally related parties, which has made it fairly easy to avoid the limitations. The proposed amendment will apply the thin capitalization to a much broader range of related entities.
Elimination of Double Non-Taxation of Profits with Use of Cross-Border Structures
In addition to amendments to some of its tax treaties, where the main effect has been the elimination of savings resulting from so-called tax sparing provisions (e.g., in the treaties with Cyprus or Luxemburg), the Polish government now proposes further elimination of such savings by disallowing a participation exemption for dividends paid out of profits of a foreign payer that were treated as tax-deductible to the distributing entity (i.e., a profit participating loan).
Treatment of in Kind Payments
Currently, no tax arises on dividends and remuneration due on the redemption of shares paid to shareholders in-kind. Moreover, the party receiving assets as an in-kind payment is entitled to assess the value of the assets received at their market value, which results in a step-up in the value of the assets. Under the proposed changes, such payments in kind would be treated as taxable at the level of the company making the payment. The same treatment would apply to in-kind repayments of loans.
Treatment of in Kind Contributions
A non-cash contribution of assets, other than assets constituting a business enterprise, to a company will be taxable to the shareholder at their fair market value if no shares are issued to the shareholder in exchange for such contribution.
Taxation of Undistributed Profits of a Corporation Transformed into a Partnership
The proposed amendments would make undistributed profits (including profits contributed to company capital, other than the share capital) taxable in the hands of shareholders who become partners when the company is transformed into a partnership. Currently some of the profits escape taxation due to the courts disagreeing with the “all to be taxed” approach of the tax authorities.
Taxation of Partner Leaving a Partnership
For several years the tax regulations have specified the amount of taxable income of a partner in a partnership when the partner departs from the partnership. Following court judgments in 2011, a regulation was introduced aimed at the elimination of double taxation on the same profits of such partners, which due to different methods of computing tax profit than accounting profit. The result of the regulations was that a portion of income of a departing partner was never subject to tax. The proposed amendment is intended to eliminate the situations in which a portion of income of a departing partner is never subject to tax. The proposed change is, however, written in such a manner that the idea behind it may not be in line with its purpose. Therefore, the final outcome of this proposal, if the language stays as is, is not predictable.
Taxation of Disposal of Assets Used in Business Activity by Individuals or Partnerships
Income tax regulations for individuals distinguish business profits from various categories of private profits. This has been the basis of numerous tax controversies between taxpayers and the tax authorities, especially since the introduction of a flat rate of taxation of business profits, ultimately leading to inconsistent interpretations by the Polish courts. The proposed amendment widens the scope of assets owned by individuals and used for business which would be subject to tax on business profits when disposed of.
Tax Deductibility of Interest on Partner’s Capital
The proposed amendment would eliminate the tax deduction for interest on capital brought by partners to the partnerships.
The Government’s proposal sets out, in a very complex way, to eliminate many tax optimization opportunities that have been used in recent years. Due to the deficiency of transition regulations, most of the changes do not allow taxpayers to adjust to the new position over time. There are only a few grandfathering solutions proposed. Notwithstanding the fact that the proposals are not yet binding laws, and are still subject to public consultations, it would be prudent to analyze at this stage if and how “I am going to be affected” and whether there is any remedy, particularly before the proposal is formally introduced into Polish tax laws. An obvious technique would be to use the grandfathering provisions regarding existing debt to related parties that are currently not covered under thin capitalization limits but will likely be so from as early as the beginning of 2013.