Poland considers delayed introduction of ‘hidden divided’ non-deductibility concept

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

The Polish government plans to introduce a controversial amendment to regulations that would limit the deductibility of so-called “hidden dividend” payments as part of the “Polish Deal” tax bill that was accepted by the government on September 8. However, due to immense criticism of the new regulations, the Ministry of Finance announced on September 28 that the introduction might be postponed until 2023.

According to the government, the proposed amendments to the corporate income tax law in the Polish Deal should help in creating a level playing field for Polish corporations. While there are a couple of taxpayer-friendly amendments, the bill has raised plenty of critical opinions regarding both the manner in which the Ministry of Finance has advanced it as well with respect to certain controversial content, such as the hidden dividend provision. The postponement will allow for further public consultations and reshaping of the wording of the provision.

The bill has proceeded to Parliament for consideration.

‘Hidden dividend’ concept 

The tax bill proposes a new special measure that would limit the deductibility of some intra-group payments (beyond the regular transfer pricing rules). The proposal was planned to enter into force from 2022 if passed by Parliament. 

With some exemptions, the current wording of the new regime would allow no deduction for so-called “hidden dividend” pre-tax payments such as true-up costs, some royalty payments, some intra-group central charges (e.g., management fees, corporate/strategy management), and intra-group inflated costs.

One of the exemptions would apply when the sum of assets-sourced intra-group payments (royalty payments, leasing, rent, etc.) and other intra-group payments is lower than earnings before tax. When this condition is met, the indicated payments can be deducted. 

Due to unfortunate wording and vague justification of this provision, in fringe circumstances, multinational entities with activity in Poland might have difficulty deducting the cost of goods sold if the transfer price is set at a higher level than between third parties in comparable circumstances. 

Generally, the regime targets the intragroup costs that might be charged in reliance on profit level or that are deemed as “irrational payments” if a third party would not incur such payments or would incur them but in lower amounts. This also includes payments for the right to use the assets (intellectual property, real estate) owned historically by shareholders (or entities associated with shareholders). 

Conclusions

It is not clear how the non-deductibility regime would interact with the price-adjustment regime (i.e., the arm’s length principle) if the transfer price is lower than that set between independent parties in comparable circumstances. 

As the non-deductibility rules are of a general nature and transfer pricing rules serve as lex specialis for associated companies, in audit situations the arm’s length principle should be followed.  

However, the “hidden dividend” rules determine tax liability. The determination of whether and how income should be taxed in a particular jurisdiction is the exclusive right of such jurisdiction. In extreme situations, when tax auditors utilize non-deductibility rules, then the potential economic double taxation will be impossible to eliminate. According to a new draft commentary on article 9 of the OECD model convention, article 9 does not deal with the issue of whether expenses are deductible when computing the taxable income of enterprises. This position opens the door for many jurisdictions to introduce into tax laws special measures that omit application of the arm’s length standards in some circumstances.