Draft tax guidelines: Rules for collection of withholding tax
The Ministry of Finance has published a draft of the long-awaited clarifications of the rules for collection of withholding tax and the obligations of tax remitters. The document is intended to resolve taxpayers’ doubts arising after amendment of income tax acts.
Amendments to the Corporate Income Tax Act and the Personal Income Tax Act entered into force at the beginning of 2019, modifying the mechanism for collection of withholding tax by tax remitters, introducing a new definition of “beneficial owner,” and changing the specific tax-avoidance clause in the CIT Act.
Initially, application of the new regulations governing the mechanism for collection of the tax was suspended through 30 June 2019 to allow taxpayers to prepare for application of the new regulations. Subsequently, the suspension under the CIT Act has been extended through 31 December 2019.
The discussion below primarily refers to the CIT Act.
Regulations in force from 1 January 2019
The new definition of “beneficial owner” (literally “true owner”) effectively expands the list of requirements that must be met for a remitter to exercise the right to apply a non-statutory rate of tax, a tax exemption, or conditions for non-collection of tax arising under special regulations or tax treaties.
Under the definition, a “beneficial owner” is an entity meeting all of the following conditions:
- It receives amounts due for his own benefit, including deciding for itself on the use of the receipts, and bears the economic risk connected with loss of all or part of the income
- It is not an intermediary, representative, trustee or other entity legally or factually required to transfer all of part of the income to another entity, and
- It conducts actual economic activity in the country where it has its registered office, if the income is connected with economic activity conducted by the owner.
The regulations require verification of fulfilment of the last of these criteria via the characteristics used to examine whether a foreign controlled entity conducts economic activity (Art. 24a(18) in connection with Art. 4a(29) of the CIT Act).
The remitter must apply due diligence in verifying these conditions. The nature and scale of the activity conducted by the remitter are considered in assessing whether the remitter has applied due diligence.
Regulations in force after 31 December 2019
After 31 December 2019, the new mechanism will apply in full for collection of withholding tax which entities paying amounts described in Art. 21(1) and 22(1) of the CIT Act, including dividends, as well as interest, licence fees and fees for selected intangible services, paid to non-residents, are required to apply.
In simple terms, under the CIT Act, the new mechanism means that the remitter will collect withholding tax on payments made at the statutory rate with respect to amounts in excess of PLN 2 million, and then the relevant entity (taxpayer or remitter, if it has borne the economic burden of the tax) will apply to the tax authority for refund of the tax.
Alternatively, the remitter may elect not to collect the tax, and submit to the tax authority:
- A statement that it holds documents required by provisions of tax law for application of a tax rate or exemption or non-collection of the tax, arising under special regulations or tax treaties, and
- A statement that the remitter lacks knowledge of circumstances excluding application of more favourable conditions for taxation or non-taxation.
The exemption referred to in Art. 21(3) or Art. 22(4) of the CIT Act may also be exercised if the relevant entity (taxpayer or remitter, if it has borne the economic burden of the tax) has obtained an opinion from the tax authority recognising the remitter’s exemption from collection of flat-rate income tax on amounts paid to the taxpayer.
Criminal liability—crowning achievement of the regulation
Some zest is added to the situation by the fact that filing of the aforementioned statements carries the risk of criminal liability. This applies to all three procedures:
- Statement submitted to the tax office with the aim of direct application of more advantageous conditions for taxation or non-taxation
- Application for a tax refund referred to in chapter 6a of the CIT Act
- Application for an opinion on use of the exemption referred to in Art. 26b(1) of the CIT Act.
In the case of the application route, under penalty of criminal liability under Art. 56d §1(2) of the Fiscal Penal Code, a statement must be submitted attesting to the truthfulness of the facts presented and the authenticity of the copies of documentation enclosed with the applications.
That offence is punishable by a fine or imprisonment or fine and imprisonment jointly, or in instances of lesser gravity, a fine for petty fiscal offences.
The essence of the problem
The catalogue of payments affected by the new regulations is extensive, including for example payment of dividends, but also payment of interest, royalties, and fees for various types of services. In effect, the group of entities touched by the new regulation and subjected to the new obligations is broad.
These regulations stirred well-founded controversy particularly among entities using holding companies in their corporate structures. Given the broad spectrum of the new regulations, their use of numerous general clauses, and imposition of severe sanctions for noncompliance, taxpayers and remitters have taken a number of measures aimed at gathering an extensive portfolio of information about counterparties and group entities, conducting audits, and in some instances restructuring their operations.
Considering the guidelines that have been published, these actions taken by taxpayers and remitters seem entirely justified.
Draft guidelines—problems discussed
The draft guidelines touch on selected issues connected with application of the new rules on collection of withholding tax, such as:
- Explaining why lawmakers decided to introduce a “beneficial owner” standard
- Supplementary remarks on the statutory definition of “beneficial owner”
- Comments on the peculiarities of holding companies
- Description of obligations connected with applying due diligence
- Description of conditions for seeking a tax refund
- Rules for determining whether the threshold of PLN 2 million has been passed.
In practice, the greatest doubt was raised by the standard of due diligence, and the relation between the business of holding companies and the definition of the beneficial owner including the requirement to conduct economic activity.
Operation of holding companies disfavoured, but it could have been worse
Let’s begin with the positives. The guidelines indicate that in practice, the conditions for conducting actual economic activity will differ for manufacturing, trading and service companies, and companies involved in financial activity, such as investments and corporate holdings. From this I conclude that the Ministry of Finance is signalling that it will recognise the activity of holding companies as economic activity. To find otherwise would not be rational, and would also conflict with European law, but nonetheless I feel it was necessary for the Ministry of Finance to state that conclusion.
Unfortunately, the section of the draft concerning the nature of holding entities focuses on the idea that it will be difficult for them to meet the definition of a beneficial owner. All of the remarks in this section point to instances where there is an abuse of law or an attempt to apply the regulations contrary to their purpose. Conclusions may be drawn from the document on what circumstances demonstrate a lack of true economic activity (e.g. a lack of adequate substance) or the existence of an artificial construction (e.g. the existence of contracts aimed at shifting income away from operating companies in order to reduce tax burdens). Positive determinations, or a clear pattern for how taxpayers should proceed, can be obtained mainly through an interpretation a contrario.
This construction of the guidelines seems to me only moderately helpful, as it will be hard for a taxpayer to comply with guidelines lacking a positive model for behaviour.
Nonetheless, the guidelines signal (a contrario) that it is possible for a holding entity to be regarded as a beneficial owner if it:
- Was not established with the aim of obtaining a tax advantage
- Does not limit its activity to receiving interest or dividends and passing them on to another entity
- Has its own human resources essential to conducting holding activity
- Has physical premises, furnishings and programming, and
- Is not a party to a contractual or de facto relationship resulting in reduction of tax burdens.
Awaiting the final version
The appearance of guidelines undoubtedly has helped clarify the position of the Ministry of Finance in many areas. But the draft still fails to answer several fundamental questions based on European law, the OECD Model Tax Convention on Income and on Capital, and Polish law.
In particular, the draft lacks references to the latest European case law under the tax directives insofar as the standards adopted there may conflict with the requirements of Polish law. The document cites models based on that case law a few times, but several aspects require further exploration.
Taxpayers would also be interested in comments on the possibility of benefitting from tax treaties in a situation where both the holding company that is not a beneficial owner and the company above it that is the beneficial owner are both based in the same country. The draft merely points to the example where a custodian of securities will not be treated as a beneficial owner of amounts paid out on that basis. Using this example, tax-treaty benefits would be available to the entity for which the custodian acts, upon fulfilment of the conditions provided by law. In my own view, it would be worthwhile to expand the catalogue of examples set forth in the guidelines issued by the Ministry of Finance.
In terms of the certainty of tax law, it would also be helpful to hold up a positive model for the operation of holding companies, or provide a more holistic regulation of this issue, so that the law corresponds more closely to market realities.
Wojciech Marszałkowski, adwokat, Tax practice, Wardyński & Partners