TOPICS OF THE MONTH Ministry of Finance in the fight against VAT fraud. Clearing House IT System (STIR). Taxation of oxygen for VAT purposes. Automatic exchange of information on tax interpretations within the EU. Principal amount of the loan determines the documentation obligation. Liquidation not being a settlement of a liability. Transfer pricing audit: "routine" examination of group support. When interest is not a tax expense. Can expenses for financing another entity be tax deductible? What is the cost of disposing of assets received in liquidation? Refund of part of contribution is not a revenue for equity partners. 1
MINISTRY OF FINANCE IN THE FIGHT AGAINST VAT FRAUD. CLEARING HOUSE IT SYSTEM (STIR) On 20 March 2017 the Minister of Finance and Development presented a draft law introducing a new risk analysis system for the use of banking systems (as well as cooperative savings and credit unions) for the purposes related to tax frauds against tax obligations. The core element of the proposed regulation is to create STIR system run by the clearing house (most likely Krajowa Izba Rozliczeniowa S.A.), the essence of which will be to process information on entrepreneurs, regardless of the form of their business activity, as well as on individuals acting on their behalf and the actual beneficiaries. The operations of STIR will result in a percentage risk of using the bank activities and activities of cooperative savings and credit unions for purposes related to fiscal frauds by account(s) holder, which will be automatically transferred to the Central Data Tax Register (Centralny Rejestr Danych Podatkowych). The following criteria should be decisive: economic (assessment of transactions made by an entrepreneur from the perspective of its business goals), geographic (transactions with countries where there is a high risk of fiscal frauds), subject (conducting activity prone to occurrence of fiscal frauds), behavioural (atypical behaviour of an entrepreneur) and connections (occurrence of connections indicating risk of participation in or risk of organisation fiscal frauds activities). Significantly, with the launch of STIR the Head of the National Tax Administration (KAS) is authorized to request a blockade of entrepreneur's account for a period of no longer than 72 hours from receipt of this request by a bank or cooperative savings and credit union. The basis for issuing such request is the suspicion that the account in question may be used for a purpose related to fiscal fraud. The assessment of this fraud risk belongs exclusively to the Head of National Tax Administration. According to the current wording of the draft law, the request for account blockade may be based on the results of risk analysis and other circumstances known to the KAS bodies, e.g. through tax information or field operations. The draft also stipulates that the Head of KAS may issue a decision to extend the blockade for a definite period of no longer than 3 months if they reasonably fear that an entrepreneur does not settle the current or future tax liability or third party liability. The described solutions proposed by the Minister of Finance and Development even though it is expected that they will facilitate the fight against VAT fraud they also seem to grant too broad powers to tax authorities to intervene in the business activities of entrepreneurs. Essential doubts may be raised by numerous imprecise criteria of assessment whether the request to block the account should be issued by the Head of KAS. The legislator justifies them with dynamically changing schemes of action of dishonest taxpayers, but there is also a risk that they will adversely affect honest taxpayers. The proposed regulations creates a new section of the Tax Ordinance Act. According to the assumptions, first results of the risk analysis will be transmitted through the STIR within 60 days since the amending Act comes into force (i.e. 7 days from the date of its publication). 2
TAXATION OF OXYGEN FOR VAT PURPOSES At the beginning of March 2017 the Court of Justice of the European Union issued another judgment (C-573/15) on the possibility of applying different VAT rates to substitute goods, which are almost identical from the consumer's point of view. Earlier, the CJEU spoke on e-books, which had been considered as similar goods for which different taxation would violate the principle of fiscal neutrality. The case concerned the taxation on sales of oxygen in a particular form used for medical purposes. In Belgium, oxygen is distributed in three forms that are mutually substitutable: concentrators of oxygen, cylinders with medical oxygen, liquid oxygen medical systems. Only for oxygen cylinders there was a possibility of applying a reduced VAT rate. The Belgian court had doubts whether such variation in VAT rates is a violation of the principle of fiscal neutrality. The Court agreed with the need to respect the principle of fiscal neutrality. The CJEU added, however, that this principle does not allow for an extension of a reduced rate applicability in the absence of a clear regulation. As a result, the CJEU pointed out that the provisions of the VAT Directive do not require the Member States to extend a reduced VAT rate to all modes of delivery of oxygen, even if they are perceived by consumers as similar to those products with a reduced rate. In other words, the CJEU has recognised national regulations as complying with the VAT Directive. The judgment concerning Belgian issue indicates that the concept of similar goods and the violation of the principle of fiscal neutrality through the application of different VAT rates is constantly evolving. In the Polish judgment on e- books, the CJEU considered that the violation of the principle of fiscal neutrality could be justified by other values that the EU legislator underlined when differentiating the tax rules. In the case at hand, the principle of fiscal neutrality was unsuccessful with the absence of a clear rule permitting lower rates for certain goods. It clearly demonstrates that the planned reform of the VAT rate system is much needed. AUTOMATIC EXCHANGE OF INFORMATION ON TAX INTERPRETATIONS WITHIN THE EU On 4 April 2017, the Act on the exchange of tax information among EU countries came into force. The Act is an implementation of EU Directive 2011/16/EU and amending directives. The new law regulates the exchange of information on tax interpretations (tax rulings), which rule in some way on transactions or structures with foreign entities. The new regulations exclude exchanging information on tax ruling of natural persons tax cases. In practice, this means that the Polish and EU tax authorities will now have the full knowledge of tax rulings requested by Polish or foreign entities. This information exchange is to enable tax authorities to effectively combat the international aggressive tax optimization and tax frauds. 3
Information on tax rulings will be exchanged by other countries by the Head of the National Tax Administration (KAS) twice a year. The Head of KAS will also exchange information on tax rulings "with foreign element" issued over the last 5 years. Exchange of information takes place automatically - without any request from competent authorities of other Member States. Shared data will include: an applicant's identification data, a summary of the ruling, and an indication of the parties involved that are located in other Member States. Will this new regulation facilitate the fight against the abuse of tax law? - time will tell. Certainly, when applying for a tax ruling from now on, it should be remembered that information presented therein will be available to tax authorities throughout the whole EU. PRINCIPAL AMOUNT OF THE LOAN DETERMINES THE DOCUMENTATION OBLIGATION The latest judgment of Provincial Administrative Court (WSA) in Warsaw gives guidelines on how to determine the value of a transaction for TP documentation preparation purposes in the case of a loan agreement. In the judgment of WSA in Warsaw (of April 5 2017, III SA/Wa 1142/16) it is said that the taxpayer challenged the tax ruling in which the Director of the Tax Chamber considered the taxpayer's position incorrect. The taxpayer claimed that for the purposes of determining the obligation to prepare a TP documentation, only the interest should be taken into account (and not the principal amount). The Director of the Tax Chamber did not agree with the taxpayer's arguments showing the similarity between a loan agreement and a lease agreement. In the opinion of the taxpayer in the case of lease agreements we are dealing with other types of assets, but nature of these transactions from an economic point of view is similar the nature is to make certain types of assets available for a certain period of time and for an agreed remuneration (respectively: in the form of rent or interest). The Director of the Tax Chamber concluded that "preparing and examining the documentation for the transaction (in this case, the interest-bearing loan) by the tax authorities cannot be limited only to the examination of the price (if any), because the documentation should also allow to analyse market conditions of the loan such as: value, loan period, repayment guarantees or risk calculation". According to the Director of the Tax Chamber, a full picture of the economic nature of a transaction is necessary to correctly determine whether a given transaction is arm s length. Having recognised the complaint on the above interpretation, WSA in Warsaw agreed with the Director of the Tax Chamber and rejected the taxpayer's complaint. The court found that "in case of a loan agreement, both the value of the loan and the amount of interest should be taken into account as the value of the transaction for transfer pricing documentation purposes." The court pointed out that the nature of the transaction lies in the amount of the loan granted, not in the interest itself, which is a secondary value dependent on the principal amount of the loan. The above judgement is a confirmation that the threshold determining the TP documentation obligation in case of loan agreements, both the principle amount and the interest are included. It also points out that, in order to correctly assess the arm's length nature of financial transactions between parties, the examination of the TP documentation cannot be limited to price analysis but should cover the entirety of the transaction (including the loan amount in the analysed case). The Polish TP documentation regulations (Art. 9a of the CIT Act) do not refer to pricing only, but also 4
to the situation or economic behaviour of related parties, atypical from the point of view of business environment. In the case of intra-group lending transactions, it should be assessed whether the borrower's financial situation, taking into account other conditions of the transaction, such as collateral, loan period or deferral of interest payments, would allow a borrower to get the same amount of financing from an unrelated party. LIQUIDATION IS NOT A SETTLEMENT OF A LIABILITY Once again the provincial administrative court confirmes that disposal of assets in the context of the liquidation of a capital company is not a taxable revenue for this company. All the confusion is brought about by article 14a of the CIT Act added in 2015. According to this provision, if a company disposes of its assets (in a tangible form) in order to settle a liability from a loan (bank loan), dividends, redemption or divestiture for the purpose of redemption of shares in kind, the company is taxed accordingly. Although the regulation does not explicitly refer to the liquidation of a company, it has been already mentioned before in the justification for the implementation of this new provision. This regulatory change caused a lot of doubts and triggered a stream of tax rulings with which taxpayers disagreed. In turn, the administrative courts decide on the matter non-unanimously. In the recent judgement, administrative court in Warsaw decided that since the regulation does not directly refer to the liquidation, it cannot be interpreted as such. At the same time it is difficult to recognise that liquidation is a form of settlement of liabilities within the meaning of the civil law. Awaiting a decision of the Superior Administrative Court. Source: III SA / Wa 377/16, Judgment of the Provincial Administrative Court in Warsaw. TRANSFER PRICING AUDIT: "ROUTINE" EXAMINATION OF GROUP SUPPORT Intra-group services received in return for a fee commonly referred to as a management fee is a widely used concept among capital groups. A few aspects of the tax audits resulting from obtaining intra-group support, including: how to communicate with tax inspectors, and what is the significance of the "routine" nature of these charges in this context, are presented below. Routine audit Certain transactions between related parties have become a "routine" element of transfer pricing audit. This results not only from the commonness of intra-group services noticed not only by the tax authorities but also by the OECD (see Section 7.2 of the Guidelines). The fact that tax inspectors gain experience in transfer pricing should be perceived positively, as it may influence the better understanding of transfer pricing concept by the tax authorities, so that the dialogue with the tax authorities is conducted on a common ground. Unfortunately, in the case of management fee, "routine" tax audit is unfavourable to a taxpayer. 5
Firstly, when analysing the management fees tax inspectors demand proof of receipt of each title / type of support, using an analogy to verifying service costs of from unrelated parties. Secondly, by verifying the cost of the management fee in a "routine" way, inspectors seek to apply the same approach they already know (from previous tax audits). To put it more bluntly, based on previous experiences, inspectors expect the taxpayers to present exactly the same type of documents as evidence of their group charges, or they expect that the level of service charges (including the margin / mark-up applied) and the allocations keys will be similar to those known from other audits. How tax inspectors formulate their charges Basically, the tax authorities question the tax deductibility of management service fees based on: lack of documents confirming the service cost is incurred, questioning the link between the service cost of a given support area and the taxpayer s revenue, treating part of management support as a shareholder activity from which the service recipient does not have any benefit, verification of the mark-up / margin and the allocation key and challenging them as non-arm s length. How to communicate with tax inspectors Certainly, the automatic delivery of further evidence of intra-group services to the tax inspectors may turn into a never ending story titled "evidence - never enough". Therefore, in the course of tax audit, we encourage taxpayers to address queries to the inspectors based on Section 7.4 and 7.24 of the OECD Guidelines, according to which "activity of intragroup services may seriously differ from one multinational group to another," and the commonly used method of indirect charge applies (...) "where the proportion of the value of services provided to different entities can be calculated only on the basis of estimation or approximation method. (...) invoicing can be made on the basis of split of costs between potential recipients of costs, which costs cannot be charged directly, which means they are not to be allocated to actual recipients of the service. In conclusion, we emphasize that in order to achieve a desired level of communication with tax inspectors, the emphasis should be put on the benefits from the management services and, above all, on the specific nature of the group and its business activity, as well as on the uniqueness of the intra-group service support model. This is aimed at discouraging the tax inspectors from comparing different capital groups and seeking for comparisons among their service charges by conducting only superficial analyses and by simplifying the nature of management service charges. WHEN INTEREST IS NOT A TAX EXPENSE According to the judgment of the Provincial Administrative Court (WSA) in Warsaw of 11 April 2017, calculation method of interest on bonds determines whether or not they will be a tax expense for the company obtaining financing - in this case an issuer of corporate bonds. And while the Civil Code allows liberty in formulating a remuneration for financing, the tax laws is not that flexible. Statement of facts: The taxpayer who wanted to issue bonds considered introducing an interest rate mechanism defined as a sum of two elements: fixed (expressed as annual interest rate) and variable. The variable element would be based on one of the following mechanisms: i) observation of the growth of commercial real estate value in the Warsaw market, ii) calculation of the bond issuer's profit from the given business venture (calculated according to IFRS 6
or as EBITDA), iii) calculation of the discounted value of future revenues from the lease of acquired commercial real estate properties. Such flexibility in determining interest rate for bonds is permitted by the amended Bond Act of 2015. Therefore the taxpayer applied for a tax ruling asking whether interest rate calculated in such a way would constitute a tax expense. Regulations of the Corporate Income Tax Act do not give direct guidelines on the methodology used to determine the remuneration for a particular transaction. What s more the tax regulations do not restrict recognizing bond interest as tax-deductible expenses depending on the manner in which the interest rate is determined. Shall the parties to the financing agreement freely determine how to calculate the remuneration? Unfortunately, the taxpayer received a negative tax ruling, which he contested before WSA. Sentence: the Tax Chamber, when issuing the negative ruling, concluded that the CIT Act does not define the concept of interest, but in the judicial decisions and in the literature the definition of interest has been quite well determined as "interest is a remuneration for the use of others' money or its equivalents, payable [ ] in proportion to the lent amount and its term of use". Interest must be calculated as an interest rate on capital. The administrative court in Warsaw agreed with the Tax Chamber stating that since the interest is not a proportion of the principal amount of the bonds issued or an interest rate, it does not meet the definition of the concept of interest. The expenses incurred by the taxpayer are a different form of remuneration for the bond issue, established by the parties on the basis of the freedom of contract resulting from Article 353 (1) of the Civil Code. The expenses are incurred for obtaining financing rather than obtaining specific revenues by the taxpayer. Conclusions: Unfortunately, this judgment, like the judgment of the Supreme Administrative Court (NSA) of 2015 and the judgment of the WSA in Poznań (signature No. I SA / Po 406/16), uphold a negative interpretation line, which severely restricts the freedom of taxpayers in shaping the manner of determining remuneration on the financing. If a taxpayer wants to include the cost of debt as a tax expense, the only way acceptable by the tax authorities is to calculate interest rate as a percentage of the financing principal amount. Any other form of determining the cost of debt, e.g. based on the efficiency or profitability of a taxpayer, which actually shows that the borrowed funds were utilized to generate revenues (and income) does not allow to recognize the interest cost as tax-deductible. CAN EXPENSES FOR FINANCING ANOTHER ENTITY BE TAX DEDUCTIBLE? Where rationality, economic nature of the business and objective business reasons are in favour, insolvency cost of the supplier of components may constitute a tax deductible expense, as the Supreme Administrative Court (NSA) stated in its judgment of 5 April 2017 (II FSK 567/15). The judgement was issued in a ruling proceeding in which the taxpayer wanted to include insolvency cost of its German component supplier as tax deductible cost. The taxpayer, along with other customers of the collapsing supplier, decided to support the supplier in the short term in order to maintain its production process until the insolvency proceedings began. At the same time, the Polish taxpayer pointed out that it operates in a "just in time" system and has limited stock of components as well as its industry regulations require to certify new subcontractors by clients, which is time consuming. As a result, by incurring expenses to temporary finance an insolvent subcontractor allowed the taxpayer to maintain the continuity of production and sales. Incidentally, it is worth mentioning that negotiations with a collapsing supplier were carried out by a company related to the Polish taxpayer on behalf of the entire capital group. The insolvency cost was included in the invoices for the company's management services. Each of the 7
companies belonging the group was charged with this fee in proportion to the supply volume from the collapsing supplier. In such a situation, NSA considered that insolvency costs, as a means of limiting the loss or the taxpayer's revenue decrease, should constitute a tax deductible cost for the taxpayer. Apart from this judgement, it should be kept in mind that in general it is not possible to recognize as tax deductible costs any expenses related to business activities of another entity. It is always necessary to carefully consider whether the expenditure actually meets the definition of a tax expense in a given situation. In similar cases it is also worth to help tax authorities fully understand taxpayer's situation and to provide a comprehensive, convincing description of the factual background (including transfer pricing documentation). In such complex cases, especially when there are related parties, a thorough understanding of facts, economic reasons and business environment perception are as important as the interpretation of tax regulations. WHAT IS THE COST OF DISPOSING OF ASSETS RECEIVED IN LIQUIDATION? When liquidating a company that is a CIT taxpayer, several issues need to be taken into consideration. Both on the side of the liquidated entity as well as its shareholders. We recently mentioned the question of taxation of a liquidated company in the case of disposing tangible assets. And while the opinions on the matter are divided, recent arguments are in favour of the neutrality of this event for the entity that is subject to liquidation. However, it is still necessary to take into account the tax position of a shareholder who takes over the assets of a liquidated company. As shows from the regulations, if you are a corporate shareholder for at least 2 years and have the minimum 10% shares, you should be exempt from CIT taxation. If, however, the shareholder receives a non-cash asset and wishes to liquidate it in the future, how should he determine the cost base for these assets? This issue was recently raised in the final judgment of the Supreme Administrative Court (II FSK 775/15) on taxation of the disposal of land / the right of perpetual usufruct of land acquired as part of the liquidation of a subsidiary. The court confirmed that the tax expense is the initial value of fixed assets and intangible assets, i.e. the value determined by the shareholder (of a liquidated company), which is not higher than the market value, reduced by depreciation/amortisation write offs. Meaning the market value of the assets received at the time of liquidation of the subsidiary. And while liquidation takes time (depending on the legal form of the company and its business relationships - it takes from a few to over a dozen of months) and it is not perhaps advantageous for the business partners of a company, in some cases, it can simply pay off. 8
REFUND OF PART OF CONTRIBUTION IS NOT A REVENUE FOR EQUITY PARTNERS The current income tax law does not contain provisions that directly regulate the taxation of partial withdrawal of a contribution from a partnership. What is more, the tax authorities and the administrative courts also show divergent approaches to whether or not an equity partner's revenue is generated at all, and if so, what is the source of such revenue (capital and property rights referred to in Article 10.1.7 of the PIT Act, or the business activity) and how to determine the costs of obtaining it. This topic has been recently raised by the Provincial Administrative Court (WSA) in Warsaw in the judgments of 21 April 2017 signature III Sa/Wa 2458/16 and signature III Sa/Wa 2459/16. The case concerned shareholders of the limited liability company, which was to be transformed into a partnership (limited partnership). Company's shareholders were about to become partners in a partnership. In addition, they would have received a partial refund of the contributions (after the transformation). Partial reimbursement of contributions depending on the financial liquidity of a limited partnership was to take place in the form of cash or noncash assets. In the partners view, return of some of the contributions from a limited partnership would be neutral for them, as this would be a partial reimbursement of the contributions made earlier. The Director of the Tax Chamber in Warsaw disagreed with the approach of the partners. According to the tax authorities, the partners would have earned revenue from property rights, whether or not a part of the contribution would have been made in cash or non-cash assets. WSA judged in favour of the partners. The court stated that receiving a partial refund of contributions from a limited partnership would be neutral for taxpayers. The court also recalled that there are divergent judicial decisions in this case, and that there is no overriding approach, but it ruled in favour to the taxpayers. 9
SHOULD YOU HAVE ANY ADDITIONAL QUESTIONS CONCERNING THE ABOVE ISSUE, PLEASE CONTACT: Andrzej Puncewicz Partner +48 22 324 59 49 andrzej.puncewicz@ Paweł Toński Partner +48 22 324 59 29 pawel.tonski@ Roman Namysłowski Partner +48 22 324 57 38 roman.namyslowski@ podatkiwbiznesie.pl kontrolapodatkowa. cenytransferowe. jpk. cfc. 10