Be careful to prepare and not get 'done' on transfer pricing
It's the first column of the year, and time to think the unthinkable and speak the unspeakable. Has the cut in corporate income tax rate to 30% and promised further reductions to 22% meant that Poland is suddenly becoming a tax haven?
Let's consider the evidence in favor. Most countries in Europe and elsewhere in the OECD now have rates equal to or higher than Poland, particularly the major trading partners and countries where holding companies for companies in Poland are traditionally based. Therefore if you're stripping income out of Poland into another jurisdiction, then you're moving it from being taxed at 30%, to being taxed at a higher rate. You don't need me to tell you that this is not good tax planning.
Let's think also about one of our favorite old tax-planning ideas, the idea of financing the company with an intercompany loan rather than equity. Up until the end of 1998 this was great because you could delay payment of interest, and take the tax deduction, until you had sufficient profit to offset the interest with. This became a bit more complicated with the "thin capitalization" rules that came in Jan. 1, 1999, which limited your interest deductibility if your debt exceeded a multiple of three times equity, meaning that multimillion dollar companies ended up needing more than zl. 4,000 of equity for the first time. This was still useful, as effectively you have the chance to manage your tax profit if you have the accrued interest capacity.
But combine this with the lower tax rate, and you are now taking a deduction in a lower tax country in favor of recognizing income in a higher tax country, with the possible risk of withholding tax on the interest payment (depending on the country that you're paying to). Also, many countries recognize the interest receipt on an accrual basis, meaning that you pickup interest income now, and get the deduction later. Suddenly, the dynamics have changed, and we can expect to see a lot less of this financing in the future, particularly if you're not expecting to be so profitable as you originally hoped.
What was once a great planning idea is now a recipe for getting murdered twice if you're not careful (although your tax position in the other country means that you may not be being murdered there, but that's another column worth of material). Then again, you still get the benefit of being able to repay a foreign currency amount to the lender rather than have them suffer devaluation on their equity investment, so involvement of your tax adviser here is, as always, crucial!
As a result of the increased interest of the tax authorities on transfer pricing over the last few years, we have been devoting much time and effort into ensuring that Polish affiliates of international companies can withstand the scrutiny of a transfer pricing audit, if the tax controllers come in and examine the intercompany prices. That way, we can maximize the chances of the tax authorities accepting that the prices have been set based on economic reality, and not solely for nefarious purposes. (For those of you new to the subject, transfer pricing is the setting of prices between related parties to have profit recognized in one jurisdiction rather than another, usually but not always to take advantage of a lower tax rate).
From now on, as the rate continues its fall from 30% to 22%, it will seem strange to have to try and argue with the tax man that your profit in Poland is actually not high enough, and that you have set your price to maximize your profit here. This goes against all they have been taught about the evil practice of unscrupulous multinationals who try and take profit out of Poland where they should be taxed, and spirit them away to someplace else for evasion purposes.
But this is what we will find ourselves arguing. You can imagine the conversations:
Tax inspector: "Your prices are wrong and you should make more of your profit here so that we can tax it."
Taxpayer: "O.K. then."
Of course it is more complicated than that, as suddenly the country on the other side of the transaction will be starting to argue for a higher share of the income. Hopefully, if this is a country that has more experience in applying transfer pricing legislation, they will better understand the idea of a corresponding adjustment, whereby an adjustment in price made by one country gives an equal and opposite adjustment in the other. Or recognize the idea of "competent authority" arguments (which is roughly tax-speak for telling the tax officials of the two countries to fight it out themselves and come back to you with an answer).
Unfortunately, it's not likely to be as simple as that. Part of being able to justify any transfer price is having documented proof that the price charged is one that would be charged in a transaction between unrelated parties. It is a sad fact that, worldwide, and not just in Poland, most companies that get "done" on transfer pricing get done not for complicated tax reasons, but for documentation reasons. The price may be "arm's length," but if you can't prove it, then it is difficult to support a full deduction, and if you don't have the documentation proving the price is legitimate, claiming a corresponding adjustment in the other country is likely to prove difficult.
Peter Ferrigno is a tax manager in the Warsaw office of Arthur Andersen.
