Avoiding double taxation of affiliates

Transactions between affiliates attract particular interest from the tax authorities, which are entitled to verify the declared income and assess adjustments of income. Audits of non-market transactions are expect to become more common.

The increasing interest in transfer pricing is a part of international policy. In July 2013, in its BEPS Action Plan, the OECD published a list of measures it intends to take to combat tax base erosion and profit shifting. Amendments are expected to made in the OECD Transfer Pricing Guidelines and the OECD Model Tax Convention concerning intangibles, capital and high-risk transactions.

In May 2013, at an EU summit devoted to issues including combating tax avoidance and tax fraud, the European Commission announced that it would propose regulations concerning shifting of profit between parents and subsidiaries as well as “aggressive” tax planning.

Poland is joining these initiatives, and work has been underway accordingly on amending the Tax Ordinance for several months. The changes would seek to tighten up the tax system, including through a clause addressing circumvention of tax law. More numerous and frequent audits of transactions between affiliates are also expected.

Assessment of income by the tax authorities (primary adjustment) may result in double taxation in an economic sense. In order to eliminate this, the other party to the transaction would have to adjust its own income (corresponding adjustment). The practice of Polish and foreign tax authorities indicates, however, that corresponding adjustments are made rarely and grudgingly. In Poland there are no reports on such adjustments.

During the February 2014 conference of the International Fiscal Association in Prague, Michal Roháček from the General Directorate of the Czech Ministry of Finance admitted that one of the reasons for the unpopularity of correspondence adjustments on the part of the tax authorities is that they reduce the state’s revenues. Offsetting the primary adjustment, they involve a reduction in taxable income and a reduction in income of the state budget.

It is possible to encourage countries to allow corresponding adjustments. Taxpayers may rely on international instruments or national regulations. Polish taxpayers may resort to arbitration under Convention 90/436/EEC on the elimination of double taxation in connection with the adjustment of profits of associated enterprises (known as the Arbitration Convention). Another option is the mutual agreement procedure for avoiding double taxation, or MAP, provided in tax treaties based on the OECD Model Convention.

Poland has introduced provisions governing corresponding transfer pricing adjustments in its income tax laws. There are also executive regulations issued by the Minister of Finance from September 2009 (Dz.U.2009.160.1267 and 1268) which include rules in Chapter 7 for eliminating double taxation in the case of adjustment of profit on transactions between affiliates. These regulations contain formal requirements related to filing and consideration of applications and the procedure and time limits for resolving cases by agreement between the taxpayer and the Ministry of Finance and the relevant foreign tax authorities. The regulations also provide for the possibility of making a general adjustment of tax obligations in order to eliminate double taxation of related entities.

Cezary Krysiak, director of the Tax Policy Department at the Polish Ministry of Finance, who also participated in the conference in Prague, said that one of the advantages of the international procedures is that they make it possible to commence a proceeding and reach an agreement at an early stage. Moreover, depending on the statute of limitations on the tax obligations, the ministry is required to implement the resolution reached through arbitration or MAP if the tax treaty in force between Poland and the other country includes the relevant clause (as is the case in many of Poland’s tax treaties, particularly those recently renegotiated). Thus, even more than 5 years after the end of the tax year in which the tax obligation arose (the general limitation period), the taxpayer may be able to correct its tax declaration and claim a refund based on the international resolution.

The effectiveness of cross-border procedures may be limited, however. For example, MAP does not require the parties to agree on a position or impose any time restriction, which in effect may mean that no agreement, even a partial agreement, is ever reached. In turn, the possibilities for using the procedures provided for in the Arbitration Convention are limited among other things by regulations concerning “severe penalties.” These allow the Polish authorities to refuse to commence MAP or arbitration if in a pending national judicial proceeding one of the interested entities is threatened with at least a fine. The situation of a Polish taxpayer may also be affected by the reservations to the Arbitration Convention or the Model Convention asserted by Poland or other countries if a party to the disputed transaction is a tax resident of that country. Poland did not assert reservations with respect to Art. 9 of the Model Convention governing taxation of affiliated enterprises, but it did reserve its own position on application of tax relief and refunds as a result of amicable agreements, which should be bound by the strict time limits provided in national legislation. As mentioned, however, many Polish tax treaties govern this issue in a manner requiring the Polish tax authorities to respect an agreement reached through MAP even though the limitations period has expired.

One shortcoming of the international solutions is that they cannot be used to eliminate double taxation of transactions between domestic entities. Here I should mention an instrument enabling entities to avoid double taxation in advance in the area of transfer pricing on both domestic and cross-border transactions, that is, an advance pricing agreement. If an APA is reached, the tax authorities will not be entitled to dispute the agreed transfer pricing.

Joanna Prokurat, Tax Practice, Wardyński & Partners