Poland corporate tax bill clarifies definition of place of management

By Dr. Monika Laskowska, Center of Tax Analyses and Studies, Warsaw School of Economics

On 28 June, Poland’s Ministry of Finance launched a public consultation for a new tax bill called the “Polish Deal.” According to the Ministry, the proposed amendments to the corporate income tax law should help in creating a level playing field for Polish corporations.

With respect to transfer pricing regulations, there are a couple of taxpayer-friendly amendments to the transfer pricing documentation requirements. Most of these changes relate to regulations introduced in 2019 that have been the subject of criticism from practitioners.

However, there are other amendments to regulations of a general nature that might raise concerns amongst associated companies, such as the broadening of the definition of tax residency for corporations.

Tax residency in Poland

Under the current Polish tax law, the definition of tax residency for corporations is relatively narrow and imprecise. The corporation is defined to be a Polish tax resident (i.e., subject to tax on worldwide income in Poland) when it has a headquarters or place of management in Poland.

As there is no tax definition of “place of management,” the common interpretation, taken from court decisions, is that it is a place where significant decisions for a company are made and where day-to-day management takes place.

In the new tax bill, the Ministry proposes to clarify the notion of place of management. The amended rule covers two specific circumstances for non-residents. Under the amended rule, non-resident companies (without having headquarters in Poland) could still have a place of management in Poland when individuals or other persons perform functions in controlling, regulatory or managing bodies of such company and satisfy one of two conditions. One, such persons have domicile, a headquarters or place of management in Poland. Alternatively,  such persons, in actual manner, directly, or indirectly through conduit companies, perform current affairs of the company – on the basis of a founding contract, court decision or any other incorporation document, any power of attorney or actual association between individuals being tax residents in Poland or corporations being tax residents in Poland.

The new definition of place of management indicates these two conditions in a separate and disjunctive manner.

In a worst-case scenario, this means that – by domestic law – for example, only one member of a management body of a foreign company, just by having domicile in Poland, could make the company subject to tax on worldwide income in Poland, even if no economic activity was performed in Poland.

Generally, this provision implies that the burden to prove tax residency shifts to taxpayers. However, it does not include any domestic procedure for foreign companies to contest the presumption of tax residency in Poland.

Thus, due to the high potential for conflicts with respect to residency with other countries, the only accessible way to solve such cases will be through mutual agreement between the competent authorities of the two countries. Poland has a network of double tax treaties. However, according to OECD statistics, the average time needed to close MAP cases other than transfer pricing is around 20 months. Accordingly, the new provision creates a significant tax burden and uncertainty for foreign companies and entangles them in time-consuming international procedures due to single “cherry picking” factors like the domicile of board members.  

Mutual agreement procedures to set tax residency

Under the new rules, a dual residency issue could arise, for example, if the other jurisdiction attaches importance to the location of registration of the company. Then, in tax treaty circumstances the conflict test should be applied.

Poland agreed to replace in its 78 treaties the provisions on dual resident entities in accordance with article 4 paragraph 1 of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI). This means that residency conflicts should be determined through mutual agreement procedure (MAP), considering the place of effective management, the place where the company is incorporated or otherwise constituted and any other relevant factors.

As the new definition does not consider broad aspects of creating an effective place of management, in the majority of cases when MAP is commenced – based on the OECD model convention commentary – Poland would have to give up its newly created taxing rights based on domestic regulation.

However, one should expect a very long procedure in which the conflict might not be resolved between the two countries. The result is much worse in circumstances involving countries with which Poland does not have a tax treaty, like Liechtenstein, where no conflict tool can be implemented. 

 Associated companies

 It is not only individuals with Polish domicile that could create issues of double tax residency for foreign corporations.

The amended place of management rules would also impact companies, for example, that, according to Polish corporate law, concluded management agreements between a principal company and subsidiary. The new provisions would concern situations when a principal company is placed in Poland. In such circumstances, Poland would gain the right to tax worldwide income from the subsidiary.

Ministry’s explanation of the purposes for the change

The Ministry explained the change in the law by revealing examples of tax avoidance recognized in Poland. Firstly, it became common practice for Polish individuals to register companies in foreign jurisdictions while all the managing or controlling functions were performed in Poland by Polish residents.

Having this in mind, however, the Ministry should consider that there are many cases that individuals with Polish domicile frequently perform economically justified double-hut functions in board management in different countries, especially where a cluster/matrix structure of an organization is introduced. 

Secondly, according to the Ministry, the provision is supposed to act against the practice of setting up in a foreign country entities of a sham nature, such as a conduit company or letterbox company, without actual economic operations in that country.

If such practices are recognized by the Ministry as still occurring, then it would be reasonable for the Ministry to first reconsider the effectiveness of many other anti-avoidance regulations introduced to the law in previous years, such as the controlled foreign corporation (CFC) regulations, general anti-avoidance rule (GAAR), etc.

Commentary

In the author’s opinion, this is yet another example of the growing tendency of shifting the burden of proof to taxpayers. Moreover, taxpayers are forced to pursue inefficient and time-consuming procedures to secure tax certainty (like in the case of securing the tax deductibility of royalties and intangible services through the advance pricing arrangement program created for transfer pricing purposes). While tax auditors are losing their cases in court, the Ministry has shifted the burden of proof to taxpayers to avoid disproportionate taxation.

The Ministry should consider removing the condition of individual residents creating corporate residency per se and introduce the definition of effective management, focusing on complicated issues while not multiplying MAP cases.  Additionally, the new definition of effective management should indicate more senior-level executives. The proposed definition covers every actual management function, including a simple power of attorney, which by itself might create disputes that Poland would most probably lose in MAP cases.