Draft withholding tax clarification submitted for public consultation
On 28 September, the Ministry of Finance presented a draft clarification on withholding tax for public consultation. The draft has been eagerly awaited by entrepreneurs and tax advisers for a very long time, as the practice of applying withholding tax rules in Poland has raised many tax managers’ or CFOs’ eyebrows high with astonishment.
Importantly, however, the draft clarifications only address issues relating to the so-called Beneficial owner (hereinafter BO). The due diligence of the tax remitter, for example, therefore remains outside the clarification.
The Draft clarification on withholding tax (Draft) therefore address the issues of:
a) having the status of the beneficial owner by the entity receiving the receivables,
b) applying the so-called look-through approach,
c) applying the principle of effective taxation of payments for the application of the exemption from the Parent-Subsidiary Directive (PS Directive) and the Interest-Royalty Directive (IR Directive) (EU Directives).
Status of beneficial owner of payment vs. receipt of payment for own benefit and intermediary
The Project, starting from the definitions of BO contained in the CIT Act (Article 4a point 29) and the PIT Act (Article 5a point 33d), indicates that the premise of receiving payments for one's own benefit and not being an intermediary should be analysed jointly. In this set-up, the Draft indicates that the notion of BO excludes entities whose status may be described as an administrator of income.
Although the Draft indicates that it is not possible to exhaustively define the prerequisites that will characterise a Revenue Administrator, aspects of an economic nature related to an entity's function within a group, as well as "factors of an external nature", may indicate that an entity has such a status (and consequently is not a BO). The aspects of an economic nature that the Project mentions in this respect are:
- the intermediary entity realises a small margin on the payments transferred,
- at the level of the intermediary entity, there is no actual taxation of the revenue from the receivables received,
- the sole object of the entity is to receive receivables and pass them on,
- receivables are transferred to another entity at short intervals,
- payments of receivables occur cyclically at regular intervals,
- the entity does not reinvest funds received in connection with receivables received,
- the majority of the entity's revenue comes from cross-border financial payments made by related parties,
- there are significant items on the company's balance sheet in relation to foreign related entities,
- there is a multi-level non-transparent structure with other intermediary companies as subsequent shareholders,
- the receivable is passed on to an entity that would not benefit from the preferential taxation provided for in the PSA or EU directives,
- there is a temporal link between the establishment of the entity and a change in the tax legislation guaranteeing tax privileges in another country.
Interestingly, in addition to circumstances strictly related to the subject entity itself or the payment received, circumstances that are related to the country of residence of such an entity may also indicate that the beneficial owner premise is not met. The draft indicates that the status of income administrator may be determined by the fact that the entity in question is resident in a jurisdiction with an extensive network of double taxation treaties, in a jurisdiction that offers preferential tax treatment to passive income or in a jurisdiction with no or limited withholding tax.
Status of beneficial owner of payments vs. actual economic activity
Another element of the definition of BO, analysed by the Project, is the definition of actual economic activity. Historically, this element of the premise made reference to the actual economic activity requirements that exist under the foreign controlled companies legislation (CFC regime). Currently, the construction of the premise speaks only generally of actual economic activity and indicates that the nature and scale of the activity carried out by the entity in respect of the receivable received is taken into account in determining the premise.
The draft indicates that the benefits of double taxation treaties (DTAs) or EU Directives may be granted to those entities that have a 'substrate of assets and persons' in the country in question, but should not be granted to entities established solely to achieve the benefits granted by DTAs or EU Directives.
Under the Draft, both wholly artificial arrangement and artificial arrangement in part tax structures will fail to meet the premise of actual economic activity.
Going further, citing CJEU case law, the Draft indicates that for the purposes of the asset-personality substrate analysis, the specific characteristics of the activity in question must be taken into account, in particular:
- the way the company is managed,
- the company's accounting balance sheet,
- the structure of costs and actual expenditure incurred,
- the number of staff employed and their qualifications, and
- the range of premises and equipment available to the company.
The draft indicates that the physical presence (or perhaps they meant registration?) of an entity in a given country is not sufficient. At the same time, it is indicated that in the analysis of the criterion of actual economic activity, the organisational, economic or other relevant features of groups of companies and the structure and strategy of a given group should also be taken into account. The fact that in the analysis of actual economic activity one should also look at the characteristics of groups of companies or the strategy of a given group seems at first sight rather positive. The draft seems to omit the aspect of the so-called consolidated asset-personality substrate in the analysis of actual business operations.
The project also briefly addresses the actual economic activity in the context of the different types of business carried out.
With regard to holding companies, it has been pointed out that the fact that a holding company in the country of residence meets the conditions as to minimum personal and asset substrate does not automatically mean that the criterion of artificiality is not met (which is worth noting in the context of the planned ATAD 3 Directive). In particular, limited economic activity does not exclude artificiality of the structure. This may be indicated, inter alia, by the fact that:
- the entity may not be performing significant management functions in relation to its assets;
- the entity derives limited revenue from its own business activities;
- the entity does not meet the criterion of effective management, as only the place of day-to-day administration of affairs is located in the State of establishment;
- lacks sufficiently important economic or commercial considerations to justify the attribution of profits to the entity, which therefore does not reflect economic reality;
- the entity does not perform its basic economic functions independently and does not use its own resources.
The draft further indicates that when analysing the criteria of genuine economic activity in a loan transaction, it should be taken into account whether the entity:
- owns its own assets;
- has an office in the material sense;
- employs staff;
- pays bills related to day-to-day operations (including e.g. rent, utilities: electricity, telephones, etc.);
- employs (has) managers with sufficient experience and knowledge of financial transactions;
- whether loans received are not related to loans granted;
- has its own capital to finance its activities;
The draft further indicates that the mere exercise of genuine economic activity by such an entity is not a sufficient condition for it to be considered as the beneficial owner in relation to the payment in question.
Beneficial owner in the context of double taxation treaties and Directives
In addition to considerations aimed at clarifying the definition of beneficial owner, the Draft also addresses the relationship of this concept to double taxation treaties and Directives.
The draft indicates that the Polish national definition of beneficial owner should be applied for the purposes of applying the preferences under the double tax treaties. A similar approach should be adopted for the Directives. Additionally, the fulfilment of the beneficial owner condition for the use of preferences on the grounds of double tax treaties is necessary even in the case when such a condition is not explicitly provided for on the grounds of the double tax treaties. This affects the due diligence of the tax remitter - its level should therefore be the same both in the case of a double tax treaty in which the beneficial owner condition is expressly provided for and one in which there is no such condition.
The Project also confirms that in the case of dividend payments, Polish tax remitters are obliged to verify the status of the beneficial owner of the recipient of such dividends (please note that the beneficial owner condition for the application of EU based WHT preferences was explicitly provided for only with respect to interest and royalties, while it is literally absent with respect to dividends). The authors of the Proposal, citing the theses of the judgments of the CJEU, interpret such an obligation from the prohibition of abuse of EU directives (putting an equal sign between not having the status of a beneficial owner and abuse of the PS Directive).
Applying the "look through approach" (LTA) concept
With regard to the application of the LTA, the Project indicates that the application of the LTA is not justified either by the provisions of the CIT Act or the PIT Act, nor by the provisions of the Tax Ordinance, and that the tax authorities are - in principle - not obliged to apply this concept.
In doing so, the draft indicates that the use of LTAs is possible if the following conditions are jointly met:
- The use of an intermediary company between the country of the tax remitter and the country of the recipient who is the beneficial owner does not result in a reduction of the withholding tax levied in the tax remitter’s country;
- there is an identity of payment in terms of type between the tax remitter - the foreign intermediary company - the foreign recipient who is the beneficial owner;
- the entire structure or the payment in question is not artificial within the meaning of Article 22c of the CIT Act.
This is in some contradiction with the approach expressed by the MF within the previous draft of the 2019 withholding tax clarifications, where the MF seemed to implicitly accept the application of the LTA concept.
Effective taxation and the application of exemptions under the PS and IR Directives
According to the Proposal, effective taxation of dividends under the PS Directive should be understood as the absence of a subjective exemption on the part of the recipient of the payment. This is, however, not the case under the IR Directive, where effective taxation must take into account both the absence of an objective exemption and the taxation of the payment itself, taking into account the non-deduction of notional costs from the income received, as well as the impossibility to obtain a refund of tax withheld on the income or to set off tax against tax for other purposes.
The consultation on the Project, runs until 10 October and as Crido we will be participating. If you would like to make any comments, please do not hesitate to contact us.