The court's decision is final sometimes
I haven't looked at any tax court decisions for a while, so I thought I'd turn this week's column to a few that have caught my eye. Needless to say, it's the usual mixture of cases that demonstrate the court's understanding of complicated tax issues, and those that leave me a little perplexed.
The first case is where a loan is granted and repaid in zlotys but denominated in a foreign currency. The question is whether the loss arising from the translation is deductible for tax purposes. The source of the controversy lies in the judgements of the Supreme Administrative Court (SAC), which contends that such losses do not represent a tax cost. Usually, exchange losses on repayment of foreign-currency loans are tax deductible.
However in the court's opinion, if a loan is drawn in zlotys, there is no change in the exchange rate of a foreign currency (in which the loan is denominated) against the zloty, so there are no grounds to say that any foreign exchange losses have occurred. The court went on to observe that the repayment of the principal denominated in a foreign currency does not represent a cost as it is tantamount to the repayment of a loan, and such repayment does not qualify as a tax-deductible expense.
It follows that the court understands the repayment as the repayment of the re-denominated amount (nominal value increased by the amount resulting from the translation).
In the judges' opinion all expenses relating to the repayment of a loan except for capitalized interest are classified as non-deductible.
A number of arguments might be put forth to challenge the validity of the above resolutions, but it is not unlikely that tax authorities will seek to question the tax deductibility of the amount resulting from the translation of a loan drawn in zlotys into another currency.
Economically, by denominating the loan in a foreign currency, the loss is effectively a quasi-interest payment, paid along with the repayment of the principal, as typically the interest rate on a foreign-currency loan will be lower than on a zloty loan. Accordingly, such a cost should be deducted in accordance with the Corporate Income Tax Act, which allows for interest accrued and paid to be deductible from taxable income.
So now we have a situation where two loans with the same economic characteristics may have different tax effects.
The second case is a bit more encouraging.
The case involved the cost of personnel training incurred and deducted for tax purposes by a company. The dispute arose because the trainees were employees of a subcontractor, and not of the company. The agreement between the company and subcontractor indicated the company was to transfer the technical knowledge to the subcontractor and organize training for employees of the latter, to enable them to carry out the job at hand.
The tax deduction of training expenses benefiting the cooperating firm's staff was questioned. In the tax inspector's opinion, the taxpayer is entitled to deduct training expenses for tax purposes only if the trainees are in his employ. This opinion was shared by the SAC, which argued that the training for the subcontractor's employees affected the revenues of the subcontractor only, and that there was no causal relationship between the expenses and the revenue generated by the company, which, as the SAC observed, was not involved in the production process.
The Supreme Court examined the case following an extraordinary appeal. As the court observed, the producer need not perform factual production operations because it may entrust them to specialized firms. The dispute over the causal relationship between revenues and expenses for the training of a cooperating firm's employees ultimately comes down to evaluating the factual circumstances. Therefore a re-examination of the facts (the Supreme Court referred the case back for reexamination) must invariably permit these expenses to be deducted because of the indirect link with the company's business.
The final case is a personal income tax case in the Supreme Court.
The dispute was over a prize won in a U.S. lottery, awarded to Polish spouses staying in the U.S. The lottery organizer is paying out the prize in yearly installments over a period of 10 years. The taxpayers paid income tax due on the prize to the Polish tax authorities in one tax year only. The tax office found that the taxpayers had the so-called unlimited tax obligation in Poland and issued a tax decision concerning the three subsequent tax years. The issue of primary importance was to establish that the couple's domicile was in Poland.
The circumstances the tax office considered in that respect included among others the taxpayers' registered address in Poland, ownership of real property, payment of road tax and real property tax, car insurance policies taken out in Poland, and even payment of telephone bills.
So it seems that the facts and circumstances of an individual's residency, in cases where they are dually resident, will be taken into account.
What makes this case more interesting is that the matter had previously been examined by the SAC, in whose opinion the case in question involved double taxation of income, and so the "treaty for avoidance of double taxation" should be considered. The court's interpretation of the treaty was that the fact alone of paying tax in the U.S. precluded taxation of the prize in Poland. This is favorable to the taxpayer and in direct contravention of internationally accepted interpretation of such treaty provisions.
The Supreme Court acceded to the extraordinary appeal of the tax office, and rejected the arguments advanced by the SAC. In the opinion of the Supreme Court (and your humble correspondent), the tax authorities correctly applied the provisions of the double tax treaty, allowing the taxpayer to apply the tax paid in the U.S. against the income tax payable in Poland, to ensure that the tax paid was a maximum of the higher of the two rates, but not to exempt this amount from tax just because it had been taxed before.
Peter Ferrigno is a partner in the Warsaw office of Arthur Andersen.
