On 24 August 2018, the Ministry of Finance published a draft act amending the Personal Income Tax Act, the Corporate Income Tax Act, the Tax Ordinance Act and certain other acts (hereinafter referred to as the “Draft Amendment”). In the present article, we will focus on the most important planned changes in the Corporate Income Tax Act (hereinafter referred to as the CIT Act), as they can be approached from two perspectives. On the one hand, the Draft provides for considerably simplified procedures and introduces new tax incentives, and on the other hand, it introduces significant restrictions and difficulties for Polish entrepreneurs while boosting tax revenues in an effort to make the tax system more efficient.
Notional Interest Deduction
The first important change for the taxpayers is the introduction of the Notional Interest Deduction (hereinafter: NID) mechanism which allows hypothetical costs of acquiring external capital as tax deductible costs to be recognised despite the fact that these cost are not actually incurred. However, there is a precondition: it is essential that the company’s sources of funding are either additional payments made by partners or retained profits. According to the Statement of Reasons for the draft, the underlying goal of the amendment is to make equity financing more attractive in terms of taxation.
According to the Draft Amendment, the annual cost limit shall amount to PLN 250 thousand. The cost shall be recognised in the year in which the additional payment is made and in the two subsequent years. The NID mechanism shall apply if the additional payment refund or profit division and payment take place not earlier than after 3 years after the end of the tax year in which the additional payment was credited to the company’s payment account or a resolution was adopted to keep the profit in the company. If the additional payment or its part is refunded before the set deadline in a tax year in which the refund was made, the income shall be the value of hypothetical interest that was earlier recognised as tax deductible costs. Any mergers, divisions or transformations into a company that is not a legal entity before the expiry of a 3-year deadline shall have similar consequences.
The new solution is supposed to apply as of 2020; however, it will apply to profit retained in 2019, as well.
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Another important tax incentive and one of the most essential planned changes of the CIT Act is the introduction of a preferential 5% tax rate (instead of the standard 19%) on income from the commercialisation of the intellectual property right following the research and development works, i.e. income derived from an innovative and patented solution that has been created, developed or improved by the entrepreneur.
The scope of the IP Box shall include the following: a patent, additional rights of protection for an invention or a patent for a medicinal product, or a plant protection product, the right of protection for a utility model, the registration right of an industrial design or an integrated circuit topography, or an authorised medicinal and veterinary product, or new plant and animal varieties, as well as the right to a computer programme. A prerequisite for this tax relief is that the research and development activity must be directly related to creating, commercialising, developing or improving an intellectual property right. It should be emphasized that research and development works can be outsourced, both to related and unrelated entities. All taxpayers using the Innovation Box shall be entitled to this tax relief until a given right expires.
The goal behind introducing the IP Box to the Polish tax system is to make it more attractive for national and foreign entities to pursue the research and development activity in Poland, to change the economic model to a knowledge-based economy and to raise awareness of intellectual property rights as potential sources of income, and therefore it is supposed to generate greater interest in conducting research and development works in Poland. What should be pointed out, however, is that the rules and principles of recognising the income subject to a reduced tax rate are complex and complicated; thus, their introduction may require specialist tax expertise.
Reduced CIT rate for small taxpayers
The draft provides for introducing a new reduced tax rate at the level of 9% (instead of the 15% rate) for small taxpayers, i.e. entities whose revenues generated in a tax year do not exceed the PLN equivalent of EUR 1,200,000, and whose share of income in revenues in the previous tax year did not exceed 33%.
This tax relief shall not apply to taxpayers starting their business operations. The reduced tax rate cannot be applied by those taxpayers who perform restructuring activities set forth in the act.
What should be considered the pivotal change introduced by the draft and at the same time a measure that opens up a catalogue of changes aimed at making the tax system more effective is the exit tax, a tax on unrealised capital gains, addressed in a separate Tax Alert due to its importance.
Amendment of the small clause against tax avoidance
Under the Draft Amendment, the existing prerequisite excluding the withholding tax exemption, i.e. concluding a contract or performing other legal acts or many related legal acts, shall be replaced by a wider catalogue of events allowing to assess the context of the existing structure along with the actual and legal dependencies of the taxpayer who wishes to enjoy a tax exemption, i.e. the performance of a transaction or another action or many transactions or other actions. The tax authorities shall continue to be responsible for proving that a given transaction is artificial in nature, namely that a reasonable taxpayer observing the law would not rely on such a method of operation, primarily for justified economic reasons. However, we suggest reviewing the solutions used in capital groups in the light of potential risk of being qualified under the new clause.
Changes in withholding tax
Currently, if a taxpayer wishes to benefit from a reduced tax rate or be exempt from the withholding tax, all he has to do is meet the prerequisites stipulated in a double tax treaty. The Draft Amendment provides for many changes here, and they are going to involve some difficulties for taxpayers. In the proposed form, the new regulations introduce additional obligations for entrepreneurs, namely a check of payments of receivables to foreign business partners, which in turn would result in an increased burden on businesses, with the lack of any relevant tools for performing the said check being introduced by the draft.
The most crucial changes shall also pertain to tax remitters paying amounts exceeding PLN 2 million per year to a single taxpayer. Once the aforementioned threshold is exceeded, the taxpayer shall be obliged to submit an additional declaration to notify the tax authorities that he holds all the required documents authorising him to apply this tax rate or exemption or ‘no tax’ option, and that the business partner has been verified and there are no circumstances that would exclude the application of a tax rate or exemption or ‘no tax’ option. There is also an option of applying a preferential tax treatment on the basis of an opinion from a tax authority approving the exemption.
Should the taxpayer fail to meet the new obligations, they will not be allowed to apply preferential tax rates and exemptions. In such a case, the remitter will have to collect the tax according to rates set forth in national income tax regulations, and in order to obtain a tax refund the taxpayer will first have to apply to the tax authorities to have the overpayment recognised.
Income taxation of a controlled foreign corporation (CFC)
At first sight, the amendment concerning the CFC is about making the provisions more precise. However, the basic terms are modified, namely definitions of a “foreign entity” and a ”controlled foreign corporation”, and it is going to affect the entire CFC regulation. The idea is to extend the scope of the CFC regulation to include foreign foundations, trusts and similar entities that are not taxable in the opinion of the draft authors and as such contribute to the tax base erosion.
Elimination of the 50% penalty rate for transfer pricing
The changes concern a penalty rate imposed for the failure to submit transfer pricing documentation despite a taxpayer’s obligation to do so. The draft act introduces two rates instead of the 50% rate currently in place. If a decision on additional tax liabilities is issued, as referred to in Article 58a of the Tax Ordinance, this liability shall amount to 40% of the amount of the tax benefit. However, if the issued decision concerns the corporate income tax, and income is the tax base, the additional tax liability shall be determined at the level of 10%. In reference to tax documentation, the aforementioned rates may be doubled or even tripled! It should be noted here that if submitting incomplete documentation is followed by submitting this documentation in its entire scope and within a defined deadline as indicated in the request from a tax authority, it shall not have any negative consequences.
Summing up: despite the fact that the proposed tax incentives are definitely very welcome, the entry into force of the amendment may have a negative impact on Polish entrepreneurs. The number of taxpayers burdened with greater registration, documentation and inspection requirements will be in fact higher than the number of entrepreneurs entitled to the proposed preferential tax treatment. What is more, the quality of the regulations leaves much to be desired, as they are unclear, incoherent and bound to raise many doubts. This state of affairs is a concern, because with numerous amendments being introduced, individual interpretations that used to offer protection in such situations will not protect the taxpayer’s interest as effectively as they did in the past.
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If you have any questions or need to discuss the topic, you are strongly encouraged to contact our expert, Piotr LISS:
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