Although not yet a tradition, in recent years, it has become customary, to implement revolutionary tax changes as soon as the New Year’s celebratory fireworks have died down. Despite the limitations the pandemic has created, 2020/21 is no different from the last several years.
Most of us are well aware that limited partnerships fall under corporate income tax rules. By the end of the year many have had to deal with this matter in practice and make key business decisions.
In the below article we would like to discuss a solution to this problem. This solution came into force at the same time as the tax on limited partnerships. How does it work and will CIT in Poland really become more ‘Estonian’? Notwithstanding the answer to the latter question, how do you use it? To find out, we encourage you to read further.
‘Estonian’ CIT … what does it mean?
The Ministry of Finance had been working on the new rules for a very long time, nevertheless the legislation was introduced quite hastily at one of the last sessions of Parliament in November (the end of November is the cut-off date for making tax changes for the following year). The flat rate corporate income tax, otherwise known as ‘Estonian’ CIT, is being touted as a means to stimulate investments in Polish small and medium enterprises. Importantly a solution potentially allowing these companies to relieve their tax burden has also been implemented alongside a tax on limited partnerships, the latter of which will mainly impact small and medium enterprises.
The main objective of this solution, long-touted by ministers, is to stimulate investments in small and medium enterprises. The idea was modelled on a solution applied in Estonia, the premise of which is that corporations do not pay income tax until profits are distributed to shareholders. Paying out profits is not an obligation, but rather a right; therefore, until the company exercises its right, it will not have to pay income tax.
As a result, the company will retain more cash on account at the end of the tax year. In other words, cash can be reinvested instead of it being spent on tax. In Estonia, this is the default solution, i.e. each CIT payer falls under those rules.
What about the ‘Polish’ CIT?
As stated above, new regulations modelled on the Estonian rules came into force in Poland with the new year. However, emphasis must be applied on the term ‘modelled’, as it is by no means the same legislation as in Estonia.
The general assumptions are the same: a company should not have to pay income tax until it distributes its profits to its shareholders. However, the solution introduced in Poland is subject to a number of conditions the taxpayer must meet in order to be able to benefit from it.
Firstly, only limited liability companies and public liability companies can benefit from the new legislation, this means that newly taxed limited partnerships will not be able to take advantage of the flat-rate tax system. Furthermore, these taxpayers cannot generate income in excess of PLN 100,000,000 in the prior tax year.
Secondly, at most 50% of their taxable income may come from passive sources. For the purpose of the legislation, the following are to be considered passive income sources: debt; interest on loans and leases; warranties and guaranties; copyrights or industrial property rights; transfer and execution of financial instruments; transactions with affiliated parties (in the absence of or negligible added value in transactions with affiliated parties).
Additionally, a taxpayer who wishes to benefit from a tax deferral must meet the following conditions:
- it must formally employ at least three staff members (employees) who are not also shareholders in the company;
- the total remuneration of those employees must be in excess of at least three times the average salary in the private sector;
- its shareholders must be natural persons (i.e. no other legal entities, including partnerships, foundations and others, and they may not hold shares);
- it may not hold shares, rights, etc. in any other entity (including investment funds, companies, corporations, partnerships);
- it may not prepare financial statements on the basis of IAS;
- it may not be a financial business or a lender;
- it cannot generate income from SEZ;
- it cannot be subject to bankruptcy or liquidation proceedings;
- it may not be formed as a result of a merger, a split, or through the receipt of assets obtained from the liquidation of other companies, or a business or part thereof (not necessarily the so-called structural part of an enterprise, but the assets themselves) the value of which exceeded EUR 10,000;
- it cannot bring in a business or its part (assets) worth in excess of EUR 10,000 to another entity;
- it may not bring in any assets received as a result of the liquidation of another company.
Moreover, in order to benefit from the tax deferral, while meeting all the conditions set out above, it is necessary for the taxpayer to bear the capital expenditure in relation to the past tax year, following which the period of two or four years of use of the flat-rate began:
- capital expenditure higher by 15% but not less than PLN 20,000 over two consecutive tax years;
- capital expenditure of 33% but not less than PLN 50,000 over four consecutive tax years.
In this context capital expenditure is understood as the acquisition of factory new fixed assets or the production of fixed assets and lease payments within the meaning of the Accounting Act (but excluding operating leases).
What comes out of this?
Firstly, and most importantly, it is clear from the legislation that the new regime, although seemingly very beneficial, is not for everyone. Quite the opposite in fact, many taxpayers will not be able to benefit from it, even though they do not fall into the general category of foreign corporations that divert income from Poland abroad without incurring taxes. This is the main difference, which makes the Polish approach markedly different from the Estonian version.
Importantly, this option is taken away not only from taxpayers exceeding the relevant income cap, but also those who exist in any holding company structure (i.e. have shares in other companies or have shareholders – companies). Such practice is common in business, even companies that operate on a relatively small scale often have different entities within their structures, including other companies. More often than not it is a sign of a pragmatic business and a practical need to separate different types of activities. In this situation, a holding company structure will automatically be excluded from these opportunities, even if each company within it would separately meet all the criteria and carry out regular production activities (the only company in such a structure that meets the share requirement is the holding company directly controlled by natural persons), as it will not meet the other criteria.
Additionally, it should be pointed out that the regulations disqualify many a start-up. Very often, start-ups have strategic investors who put capital into starting the business. In this case, investors most often enter the company through a specific investment entity or vehicle, not as natural persons. Although such activities and the creation of the structure are in no way dictated by tax optimisation, the participation of a strategic investor in a start-up is likely to make it impossible for those companies to benefit from the new regulations. Such entities may also ‘fall by the wayside’ of this legislation due to the requirement to increase capital expenditure. It is worth noting that capital expenditure arises when fixed assets are either acquired or produced (and then used in return for consideration). No other type of investment has been included in the legislation. One such example are IT companies. More often than not, investments in this industry do not mean creating or acquiring fixed assets. Equally, it is impossible to deny the huge levels of capital expenditure incurred in this sector. Within this context, the cost of acquiring new technology, know-how or licence which are the most common examples of capital expenditure in the IT industry demonstrates the issue at hand. Unfortunately, this type of capital expenditure will not allow IT companies to benefit economically from the new legislation. It is only an investment in fixed assets, of which IT companies have little, that allows this condition to be fulfilled. Naturally, there is a way to increase fixed asset capital expenditure, even if those are not needed to carry out the taxpayer’s activities, but the business sense of this approach is debatable.
Another business industry, that will be unlikely to take advantage of the new regulations due to its inherent restrictions are developers and other player in this sector. Those companies produce very valuable fixed assets (as well as non-fixed assets) which are then let, leased or sold. Capital expenditure is incurred before any income is made. Therefore, at the point where return on investment is achieved, the investment is no more. Whereas, at the time when the investment is made more often than not there is no income. In summary, those types of companies will not be able to benefit from the new rules, even if their businesses are innovative and include high investment.
There are many example, but only by applying the rules in practice will we find out how large (or small) a group of taxpayers can take advantage of the new regulations. Nevertheless, the deferral of tax ought to be considered, especially in these difficult times. This unlocked cash could be used to increase the competitiveness of a business and speed up its post-crisis recovery. It is worth bearing in mind that the use of preferential arrangement has been curtailed. To that end, the Ministry of Finance has announced it will issue explainers and information on how to adapt market practice in line with the new restrictions. It is worth keeping an eye on this, as is looking into whether the new rules can be applied immediately. If yes, then no doubt they will be very useful for our business.