On September 28 2023, the Polish Ministry of Finance published the long-awaited draft of official guidelines on withholding tax (the Draft). The Draft relates to a major criterion of withholding tax exemptions and many lower treaty rates – the premise of ‘beneficial ownership’, which, under Polish law, includes the test of genuine business activity, commonly called ‘substance’.
Summary of the Draft
The Draft, if applied in its existing wording, would require the application of standard rates of withholding tax (19 or 20%) to many types of payments from Poland that are currently exempt or taxed at lower rates. This is mainly due to a very broad, although not defined, understanding of the terms, such as ‘beneficial owner’ and ‘genuine business activity/substance’.
The Draft lists multiple requirements for beneficial ownership status; for example, regarding the management of the company receiving the payment and its office, personnel, costs incurred, and balance sheet structure. However, there is a lack of precise – or, at least, banded – expectations in the Draft regarding, for example, the number of employees and their remuneration, office space and costs, the proportion of passive income to operating income, and transactions between related and unrelated parties.
The Draft contains many conclusions that will lead to withholding tax discrimination of certain categories of entities or even entire industries. Negative circumstances in the context of beneficial owner status would be indicated by the following, among others:
Receiving a majority of revenues from cross-border financial payments from related entities;
The entity is located in a jurisdiction with an extensive network of double taxation treaties;
The entity is located in a country which is highly ranked on the list of direct investments to Poland mainly due to cross-border financial payments rather than commercial or production activities;
The entity realises a small margin on the payments made;
The sole activity of the entity is obtaining and forwarding financials;
Received amounts are transferred to other entities within a short time or on a regular basis;
The entity does not reinvest the received funds;
Significant items on the entity's balance sheet are related to foreign group entities;
Received payments are paid to another entity which would not benefit from withholding tax exemptions or treaty rates;
There is no effective taxation of payments in the recipient’s country of residence;
The entity is part of a non-transparent structure where the various shareholders are other intermediary companies; and
There is a timing link between the establishment of the entity and the change in tax regulations giving tax preferences in that country.
Potential impact of the guidelines
The Draft points out that the look-through concept is not entrenched in Polish tax law. What is puzzling is that, despite the declared lack of legal basis, the authors of the Draft nevertheless see the possibility of applying the look-through approach in one exceptional situation. Thus, on the one hand, the Draft justifies its position with the principle of legalism, while a sentence later it derives a special principle, without any legal basis for it.
There is also a change of approach towards a positive direction. The Draft seems to confirm (although without detailed explanation) what for years was certain but deviated from in recent practices, that, in the case of dividends, the exemption of distributed profits from income tax in the country of tax residency of the dividends’ recipient is not a reason to deny the right to a withholding tax exemption, provided that the recipient is subject to tax on its worldwide income in the country of tax residency.
The Draft excludes, however, all payments of a passive nature from income from own business activity (a ‘good’ type of income, according to the tax authorities). This conclusion may lead to the exclusion from reduced rates or withholding tax exemptions of holding platforms whose economic purpose and business sense of existence is precisely to generate passive income and conduct financial transactions within the holding group.
The Draft states that the criteria concerning a beneficial owner must be met even if an applicable tax treaty does not require it.
Furthermore, the Draft goes in the direction of an extremely extensive tax remitter obligation to obtain information about a taxpayer (the entity receiving the payment). The numerous items of data and circumstances that the withholding tax collector will have to obtain to apply the exemption or lower treaty rate will require a large amount of resources, workforce, and cooperation from foreign recipients, which is often difficult in practice.
Final thoughts
Summing up, the Polish tax authorities present a very strict interpretation of beneficial ownership. Many holding platforms may find it difficult to meet the beneficial ownership conditions even if they would like to follow the guidelines. Polish withholding tax will remain a priority for investors and international businesses in the coming months.
The Draft in its current version enumerates many requirements but does not improve the position of withholding tax collectors and taxpayers in terms of what should be checked or done to apply withholding tax preferences. Numerous linguistic errors and confusion of terminology suggest that the Draft was published in a preliminary version that needs to be improved. We can only trust that more detailed and rational solutions will be worked out in the consultation, which will last until October 24 2023.
