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Positive Supreme Administrative Court Ruling Regarding Investment in Polish Closed-End Investments Funds
Recently the Polish Supreme Administrative Court ("SAC"), the highest judicial authority in tax matters, issued a breakthrough ruling regarding the taxation of investments in Polish closed-end investment funds ("CEIF"). The approach taken by the Minister of Finance in his interpretations and administrative courts in their rulings through an 18 month period has been unfavourable for taxpayers. This negatively influenced the willingness of the investors to apply CEIF as an investment tool. Taxand Poland describes the conclusions by the Supreme Administrative Court on the ruling regarding investment in Polish closed-end investment funds.
CEIFs are specific entities operating under the Polish Investment Funds Act, benefitting from exemption from Polish CIT on their income.
The process of investing in CEIF may be divided into two stages:
- Firstly, the investor obtains investment certificates (having no fixed / face value) in exchange for payment in cash or for certain assets - such as securities - contributed to CEIF. In the event of payment in securities - as was the case subject to SAC's verdict - the stage includes two distinguishable events, not necessarily performed at the same time:
(i) contribution of securities subject to valuation
(ii) allocation of investment certificates.
- Secondly, the investor obtains the final income resulting from the investment process. This may be achieved by:
(i) sale of investment certificates
(ii) redemption of the certificates
(iii) quasi-dividend payment performed by CEIF (without redemption of investment
Previously, tax authorities changed their approach as regards treatment of the operations at hand. Initially, the favoured trend was reversed when the Minister of Finance issued series of negative tax interpretations (without any amendment to tax regulations coming into law). Since then, tax authorities have constantly assumed an unfavourable stance - ie, that in the event of securities contribution into a CEIF, taxable revenue should be recognised already at the first stage of the investment process. Such a position was subsequently confirmed by the administrative courts (among others the SAC) in their rulings.
However, this standpoint has just been rebutted by SAC in the recent ruling. The Court found that payment in securities for investment certificates at the first stage is not a taxable event for the investor. Instead, for tax purposes, taxable revenue shall be recognised only at the second stage, when the investor obtains final income resulting from the investment process.
To support this conclusion the following arguments may be raised.
- Firstly, the investor receives investment certificates which do not have any fixed value, but which only represent the right to future revenues (from sale, redemption or quasi dividend from the fund). Therefore, contribution of securities at the first stage shall not be viewed as creating taxable revenue on the part of the investor.
- The valuation of securities contributed may differ from the valuation of investment certificates allocated. This results in uncertainty as to which value should be taken as the basis for determining the revenue.
- Were the revenue to be recognised for tax purposes at the first stage, the investor would find no precise provision in the current CIT regulations to determine tax deductible cost at the second stage. This in turn may lead to double taxation of the same income. This would be against the fundamental principles of income tax.
To conclude - the tax authorities' standpoint conflicts with the inherent structure of income tax regulations.
As a structuring tool, CEIFs are exempt from income tax and allow free of tax assets management. The recent ruling - if it initiates a favourable trend in the administrative courts' and tax authorities approach - may extend the possibilities of favourable structuring of investments for entities from various branches, mostly for the financial and real estate sector. Taking all that into account, potential investors may wish to revisit CEIF as an attractive investment instrument.
Also, the case shows that complex instruments such as CEIF are not always fully understood by tax authorities. This in turn can lead to possibly subjecting them to tax treatment contradicting the basic principles of income tax. In this context, before implementing a structure involving CEIF (or other instruments similar as to their complexity), to secure the taxpayer's position, it is strongly recommended to consider applying for a tax ruling (binding interpretation). The ruling should be applied for before performing a transaction as only in such case the taxpayer may benefit from full protection available under Polish tax regulations.
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