Polish Deal introduces further domestic measures to limit profit shifting 

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

Newly proposed amendments to the corporate income tax law set out in the “Polish Deal,” signed into law by Poland’s President on November 15, introduce several domestic measures that impact intragroup transactions beyond transfer pricing regulations. The provisions will generally enter into force in 2022, although some controversial provisions will not enter into force until 2023.

According to the government, the new provisions should help in creating a level playing field for Polish corporations. While there are a couple taxpayer-friendly amendments, other provisions make clear that the Polish government is very suspicious of intragroup transactions and aims at limiting shifting of income before tax by utilizing different measures.

Minimum corporate income tax

The scope of this measure covers all corporate income tax taxpayers that demonstrate in their tax return tax losses or very low income from operational activity (less than a 1% return).

Under such conditions, the minimum corporate income tax should be calculated as 10% of the sum of the following components: 4% of return from operational activity, surplus over 30% of tax EBITDA of debt-financing costs among associated companies, deferred tax due to intellectual property exposure in accounting books (leading to increase in gross profit or decreasing gross losses), and the cost of some intangible services or royalties paid to associated companies.

The minimum tax paid for a fiscal year can be credited against corporate income tax based on general rules for three subsequent consecutive years.

An exclusion from the new regime covers, among others, companies with a sudden decrease of returns (at least 30%) and start-up companies (for the first three years).

The minimum tax waives the other controversial provision – already existing in the tax law – limiting the deductibility of costs incurred for some intangible services or royalties. Taxpayers were allowed to deduct such costs to a limit of EUR 670,000 (approximately USD 755,000) plus 5% of tax EBITDA (earnings before interest, taxes, depreciation, and amortization). Under the Polish Deal, such costs are planned to be part of the tax base for the minimum tax.

Hidden dividends

Regardless of transfer pricing provisions, the bill introduces further limitations to the deductibility of passive intragroup transfers amongst associated companies. The bill includes so-called “hidden dividend” provisions, and, due to wide controversies, it was decided to postpone these provisions until 2023.

The limitation on deductibility concerns all sorts of services provided by associated companies only if the cost of such services can be determined to be a “hidden dividend”. The costs can be considered as a “hidden dividend” if the level of the cost depends on the taxpayer’s profit or if a rationally acting taxpayer would not incur such costs or would incur such costs in lower amounts. A “hidden dividend” would also include a payment for the right to use of any kind of assets owned by an associated company before the establishment of the taxpayer. The safe harbor exclusions can be utilized when the sum of “irrational taxpayer” costs and asset payments is lower than accounting gross profit. 

Disqualification from deductibility of some debt-financing costs

The Polish Deal introduces a separate provision disallowing deductibility of debt-financing costs arising from intragroup financing, incurred to finance capital deals, such as (corporate and incorporate) share acquisition, increase in the share capital or re-purchase and redemption of its own shares. The regulation is a next step in systematic limitation of debt-financing benefits following thin cap and other earning stripping rules, such as two baskets of income disallowing blending of financial costs from capital gains basket with operational income basket (from 2018) or restrictions of debt-push-down benefits (from 2018).

Tax for profits shifted

Associated companies that are tax residents in Poland will additionally be taxed on deemed shifting of profits. Profits are deemed to be shifted if direct or indirect specific costs incurred by a Polish taxpayer for the benefit of an associated company represent 50% of tax revenue (or accounting revenue) of the benefiting associated company and tax actually paid by this company is at least 25% lower than the tax that would be due when imposing Polish tax at a rate of 19%. These conditions also include profit allocation to a permanent establishment.

The direct and indirect special costs should be tax-deductible in Poland and include costs of intangible services, royalties, debt-financing costs, transfer pricing remuneration for restructuring, and amortization.

The exclusion from deemed profit shifting tax covers situations where a beneficiary associated company has its tax residency in the EU or European Economic Area and has real activity in this country.

Clarification of thin cap rules

The new bill clarifies existing thin cap rules limiting the deductibility of debt-financing costs. The provision determines two alternative limitations of deductibility, which are, one, 30% of EBITDA and, two, the amount of EUR 670,000 (as a safe harbour rule). The limitations cover financing both from controlled and uncontrolled companies. Additionally, the new bill provides a new algorithm for calculating EBITDA.

Conclusions

These provisions affecting associated companies mostly target passive income. However, some of the provisions – like on hidden dividends – might affect other sorts of intragroup transactions if the level of tax costs depends on profit.

Despite growing compliance burdens for transfer pricing purposes (including documentation, risk assessment reporting, mandatory disclosure of vast transfer pricing transactions, and others), tax authorities have not been successful in auditing transfer pricing cases. The majority of tax audits focus on the formal side of documenting the intragroup transactions, specifically intragroup services. Primary adjustments are infrequent and concern selection and application of transfer pricing method. The cases concerning accurate delineation and recognition of a transaction are very rare, and these cases mostly end up in tax court, where the tax authority losses the majority of its cases.

Such inefficiency is probably the main reason for implementing strict rules for shifting passive income between associated companies. From 2022, the state of play will be changed as new legal tools will be introduced. Some transfers will be penalized per law if they result in low tax income or tax losses due to intragroup transactions.