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Unfavourable Trend for Taxpayers is Consequence of Court Rulings

26 Jul 2010

The restrictive approach taken in recent rulings of the Polish tax administration, as well as Polish administrative courts, shows there is a tendency towards vague and unclear interpretations of the tax regulations against the in dubio pro tributario principle. Unfortunately, this trend can also be seen in the recent judgments of the Polish Supreme Administrative Court ("SAC") - the highest judicial authority in tax matters. Be it the aftermath of the financial crisis or not, this trend should be carefully monitored by taxpayers.

Verdicts of the SAC do not, as a rule, have binding precedents. However, the exception to this rule is resolutions - they have a higher rank, as they are legally binding. Any position established by the SAC, even if not assuming the form of a resolution, has a major impact on tax practice.

Taxand Poland illustrates the above point, by way of examples presenting three tax controversies tackling important CIT and PIT issues, which were resolved unfavourably for taxpayers in recent rulings by the SAC.

Expenditures related to increases and decreases in capital
It is now the established position of the SAC, confirmed in a number of rulings that expenses related to a capital increase of a company (capital duty, lawyers' fees etc.) cannot be regarded as tax deductible costs. The main principle invoked in favour of this position is that expenditures corresponding to income that is exempt from taxation cannot be classified as a tax-deductible cost. Since corresponding revenues received by a company in return for the newly issued shares are not treated as taxable revenues, expenses in question are not CIT deductible.

This standpoint seems to be based on an erroneous reading of the relevant provisions of tax law disregarding economic substance of income tax. The costs in question have an obvious link with the taxable revenues generated by assets received by the company as a result of the capital increase. On that ground they should be treated as tax deductible.

Unfortunately, a similar position by the SAC and the opposing considerations apply also to expenses relating to the decrease of capital (redemption of share capital) - in particular, interest on loans drawn to finance the payout of the redemption proceeds.

Personal income tax on medical packages
It is common practice for employers to purchase additional health care bonuses for their employees, as fringe benefits in addition to their regular salaries ('medical packages'). The bonus consists in making health services available to employees based on a general service agreement concluded by the employer with a private provider.

The Polish PIT Law does not give a precise answer to the question whether such benefits should be taxable (and how their value should be calculated for that purpose). Consequently, this issue was subject to the long-lasting controversy, including inconsistent rulings by administrative courts. The SACs resolution on 24 May 2010 brought this controversy to an end. The SAC ruled that employees receiving medical packages from their employers receive in fact free-of-charge benefits (regardless of whether they actually used health care services or not) which should be subject to PIT taxation.

The negative resolution by the SAC in this respect is not only PIT taxpayers' concern. It means that their employers are now obliged to calculate and collect personal income tax (as well as social security contributions) taking into account the value of health services bonuses. In practice, interest for outstanding liabilities may be a significant issue for them. What makes things worse is calculating the value of the free-of-charge benefit for a particular employee which could prove to be technically difficult.

Taxation of management contracts
Under the Polish PIT Law, revenues from management contracts are treated as stemming from 'activities carried out personally' are not eligible for the flat rate which may be applied to business income (19%), but are subject to the standard tax scale (18% and 32%). However, entrepreneurs conducting their business activity in the form of partnership may opt for the flat rate. These principles seem to be in conflict with each other. Individuals acting as managers on a personal level are subject to the standard tax scale. Yet partners running a business activity through a partnership potentially benefit from the 19% flat rate.

On 26 April 2010 the SAC ruled that revenues of such managers should be taxed according to the general rules (for which flat taxation of 19% is not available). Regardless of whether management contracts are concluded within a business activity or outside it, the income from their performance will be accounted for as income from activities performed personally.

Taxand's Take

The above examples are significant and warrant specific consideration.

Entrepreneurs should analyse the unfavourable rulings by the SAC on the current basis in order to be fully aware of their own tax position and - where needed - to decide what steps need to be taken. This analysis should take into particular consideration the legal status of the ruling, likelihood of the courts' standpoint changing in the future, facts of the case decided by the court as compared to those applicable to the taxpayer's own case, argumentation examined by the court -vs- other reasons which potentially might be put forward to defend the position of the taxpayer, practical and legal implications of correcting taxpayer's settlements (for the past as well as for the future), and a number of other factors. Obviously, understanding these considerations will not be an easy task.

Moreover, taxpayers already in a dispute with the tax authorities should seek specialist tax advice to ensure their case is presented comprehensively to the tax administrative court. Doing this is even more prudent today when a tax administrative court is not necessarily a taxpayers' friend.

Your Taxand contact for further queries is:
Hanna Filipczyk
T. +48 22 324 59 40

Taxand's Take Author