CIT 2004 Law and EU accession
Donka Darpatova is a tax manager in the Warsaw office of Ernst & Young.
A month ago the European Court of Justice (ECJ) finally ruled on the Bosal case. Most of you probably let the news slip by without giving it much thought. I confess to filing away the print-out of the court justification in my "moderate priority" drawer. It found its way out of the binder constraints only the night before I attended an internal seminar on EU direct taxation.
What is the significance of the Bosal ruling to Polish businesses? I have tried to answer this question by discussing some of the proposed changes to the Polish Corporate Income Tax (CIT) Law in reference to the case itself.
Bosal Holding BV, a Dutch limited liability company, claimed a tax deduction for the financing costs made in relation to its subsidiaries located in other EU member states. The Dutch tax authorities refused to allow this deduction from the company's taxable profits. They said that, in accordance with Dutch law, financing costs can be deducted at the parent company only if considered "indirectly instrumental" in generating profits taxable in the Netherlands. In other words, the tax deduction was not allowed, as the costs were made in relation to subsidiaries which were taxable outside the Netherlands.
It took almost ten years of Dutch and European court proceedings for the ECJ (European Court of Justice) to rule at last that the Dutch law violates the freedom of establishment set out in the EC Treaty, in that its restrictive tax provisions deter expansion of business across the EU. Namely, the existing provisions effectively discourage Dutch parent companies from establishing subsidiaries in other EU countries for purely fiscal reasons. This is incompatible with the vision of moving towards a common tax system.
The Bosal case has brought us Europeans one step closer to the miracle of tax integration. The concept of fiscal sovereignty is gradually being reshaped by EU case law and subsequently fiscal borders are becoming less significant as an economic factor influencing business decisions. For fear of a reprimand from the Commission or failure to meet their fiscal budgets as a result of enforcement of ECJ rulings, finance ministers across the EU have expended considerable effort in bringing their countries' domestic legislation in line with latest practices.
Although the Polish legislators have made a plausible attempt at implementing the required body of law when incorporating the latest EU trends, the 2004 draft of the CIT Law leaves much to be desired.
For example, aiming to comply with the EEC Parent-Subsidiary Directive 435/90, the draft law introduces a number of provisions on the taxation of dividend distributions.
Outgoing dividends (paid from a Polish subsidiary to its EU parent company) are exempt from Polish tax if the parent is registered outside of Poland, does not have a place of management here, holds at least 25 percent of the subsidiary's capital for a minimum of two years counting back from the date of dividend receipt. The latter holding period requirement is more restrictive than the one found in the EEC Directive.
Unless they can take advantage of a double tax treaty, companies outside of the EU will be less fortunate and will thus receive dividends from their Polish subsidiaries net of the proposed 19 percent withholding tax, which will also apply to capital gains on the disposal of shares.
As a minor deviation from the main topic, it seems that someone high up has a special affinity for the number "19", which will also be the new corporate income tax rate from January 1, 2004, if all goes as planned.
Coming back to the subject of profit distributions, notable is a step towards liberalization of the regime for taxation of incoming dividends. Previously, Polish companies were allowed a tax credit for the underlying tax on foreign dividend income distributed by subsidiaries, where they held 75 percent of voting rights. The draft law reduces the qualifying threshold for EU companies to 25 percent.
With the dividend distributions in mind, the EEC Parent-Subsidiary Directive seeking to eliminate obstacles to the free movement of capital and the latest case enforcing this point, it is mind-boggling why Polish legislators chose not only to preserve the tax consolidation benefit for capital groups, but also reduced the qualifying group ratio to three percent. It is only a question of time before an angry EU taxpayer claims the existence of Polish legislation, which favors domestic companies forming a tax capital group, to be incompliant with EU law.
Transfer pricing is another area where the implementation of EU guidelines has been rather sloppy. The draft law still approaches transfer pricing matters from the narrow domestic perspective, rather than encompassing the whole of the EU, in line with the latest case law. For instance, companies are considered to be related parties under different conditions in domestic (at least five percent of voting rights) and in international (minimal shareholding) transactions.
Moreover, related parties engaged in domestic transactions will no longer be subject to the transfer pricing regulations, including the requirement to prepare transfer pricing documentation. This essentially implies that the tax authorities will not be equipped to adjust prices in domestic transactions, but will have the legal tools to do so where an EU company is involved. One does not have to be a genius to figure out that this rather conspicuous injustice should not be very difficult to argue against in court.
Passing through the phase of growing pains into adulthood will take the Polish tax system some time, but learning from the experiences of current EU members will hopefully facilitate the transition.
