No income recognised on in-kind contribution to partnership

In-kind contribution of a sole proprietorship to a partnership does not constitute the sale of the business, and thus the partner is not deemed to have income on the transaction.

In a case before the Province Administrative Court in Wrocław (judgment dated 11 May 2010, Case No. I SA/Wr 153/10), an individual doing business as a sole trader sought an interpretation of the tax consequences of an in-kind contribution of his business to a limited partnership. The taxpayer took the position that the in-kind contribution had no tax consequences under the Personal Income Tax Act.

The Minister of Finance, acting through the local tax authorities, issued an interpretation rejecting the taxpayer’s position. The tax authorities took the view that the transfer of assets used for business activity generated business revenue for purposes of Art. 14 of the PIT Act, in an amount corresponding to the value of the in-kind contribution set forth in the partnership agreement. They also found that in this case PIT Act Art. 21(1)(109) (an exemption for the par value of shares taken up in exchange for in-kind contribution of an enterprise or organised part of an enterprise) and Art. 17(1)(9) (treating shares taken up in exchange for an in-kind contribution as capital gains) were not applicable in this case because they do not apply to contributions to a personal company (such as a partnership).

The taxpayer successfully challenged the ruling before the province administrative court.

In the court’s view, the ruling by the tax authorities was incorrect, because the in-kind contribution of assets used by the taxpayer for operating his sole proprietorship could be deemed to be business revenue only if it were considered to be a transaction for payment. The court found that in-kind contribution to a personal company is not made for payment, as the assets are merely converted into a partnership contribution.

The tax law does not contain provisions governing in-kind contributions to personal companies, and thus the issue is the subject of much debate. Recently the tax authorities have taken the position that such transaction constitutes a form of sale and thus should be taxable. Even if the in-kind contribution were regarded as a form of sale, it would be difficult to say that it involved payment. In exchange for the in-kind contribution, the partner does not receive money or in-kind consideration; rather, as the Wrocław court found, the partner’s assets are converted into a partnership contribution.