New law could be the PITs for management contracts

This week's column is by special reader request and relates to the recent discussions, both formal and legislative as well as in the press, of one of the proposed changes to the Personal Income Tax Law for 2003 - specifically, the changes relating to the treatment of income received under a so-called "management contract." As you may recall from earlier columns, there is technically no such thing as a "management contract." This is an institution that formally exists only within the personal income tax (PIT) law - and only there since its introduction as an additional source of income in 2001. The term has no formal definition in any legislative act. Let us go back and trace the history of this creature. From where? Historically it was recognized that certain key individuals within an organization who did not qualify, for whatever reason, for appointment to the board of directors should be singled out not only financially but visibly. Most commonly, such individuals were engaged under (in real terms) a personal service contract (umowa zlecenia), which was colloquially named a "management contract." In due course the new name stuck, and so it was included within the PIT law.

Treatment over the years Until Dec. 31, 2000, the situation was fairly straightforward with individuals subject to unlimited liability to Polish tax (most Polish nationals) taking a statutory 20% flat rate cost of earnings deduction (or actual documented costs if higher). These individuals obtained a cash flow benefit by paying monthly tax advances during the course of the year at the 20% rate, only making up tax to the full appropriate rate at annual reconciliation by April 30 of the following year. On the other hand individuals with limited liability to Polish tax (most expatriate individuals) had no costs deduction but benefited from a preferential final flat rate of taxation of 20%. From Jan. 1-Dec. 31, 2001, the situation changed drastically. Although the "management contract" was introduced as an additional source of income it was nowhere formally defined. As a practical rule it was accepted that this referred to those contracts described above and, in a worst-case scenario, to any form of contract that specified duties of a managerial nature. This created confusion. Worse than this, however, was the omission of any reference to this form of income in subsequent articles of the PIT law. In short, as a consequence of the wording of the 2001 PIT law, all individuals, whether subject to limited or unlimited liability to Polish tax, had their management contract income subjected to tax on the same basis.

Although this income remained subject to monthly tax advances at the 20% rate throughout the year, for expatriate individuals the story no longer ended here. For the first time they were forced (as Polish nationals) to pay at annual reconciliation, by April 30 of the following year, up to the full rate in the appropriate tax bracket. To add insult to injury, there was no possibility of utilizing the previously available 20% statutory cost of earnings deduction and, only by analogy, was it possible to deduct actual documented costs. Everything hinged on whether the contract in hand, whatever it was called, was in fact a simple personal service contract (umowa zlecenia) or a contract for managerial services (management contract).

Year by year Since Jan. 1, 2002, the position has been further refined in relation to individuals with limited liability to Polish tax (expatriates largely) who are once again able to benefit from the preferential final 20% flat rate of taxation with no further reconciliation necessary at year-end. Individuals with unlimited liability to Polish tax see no difference in tax treatment. For both groups the costs treatment remains unchanged from what it was in 2001; that is, by analogy only actual documented costs are capable of deduction. Potentially from Jan. 1, 2003, the status quo could change once again. The proposal under consideration is to bring back a fixed statutory costs deduction. Before you all start cheering, the fixed costs deduction is to be at the same level as that applied to ordinary employment contract income, that is 0.25% monthly of the sum being the first limit of the first tax bracket. In layman's terms, a grand total of zł. 92.56 per month and a maximum of zł. 1,110.72 per annum. (These are proposed figures for 2003, still to be confirmed.) Compared to the original scenario, zł. 1,110.72 is a million miles away from the 20% fixed costs deduction for those with unlimited liability to Polish tax. For those with limited liability it's an improvement as historically these individuals were not able to benefit from the fixed-rate costs deduction. Compared from 2001 until now, the change will affect different managers in different ways - everything hinges on whether you incur business costs directly or whether these are borne by the company.

Cheering Poland Clearly for those individuals who bear business costs directly this will be a major blow as they will only be permitted to deduct the very minimal statutory costs proposed and not actual documented costs, as they previously have. For those whose business costs are borne by the company rather than individually, then this provision should make little or no difference in practical terms UNLESS one of the other proposed changes to the PIT law for 2003 remains unchanged (see "Pay your taxes today, prepare to pay more tomorrow," WBJ, April 15-21). I refer to the proposal that any reimbursement of costs made by an employer should be considered as additional income and therefore taxed as such ... that is, double taxation because having used your own after-tax income to pay a business expense in the first instance, on receipt of reimbursement of the sum expended by you from your employer, you will be taxed on the amount reimbursed. As I said in an previous column, I have a strong suspicion that the wording of this article, if approved at all, will be somewhat changed in the final version. I do not believe the above scenario was the real intention of the legislator. The proposed changes to the whole packet of tax laws was given a very speedy review by the Sejm in just two and a half hours, and in time to allow them to cheer Poland on in its World Cup match on June 4! The proposals were next up for review by the Sejm last week, after which they will still need to be considered by the Senate - so watch this space.

Anna Szymańska is a tax senior manager in the Warsaw office of Andersen.