|Innovative aspects to tax reform|
Motives behind protective tax policy
Since 2016, the Polish government's tax policy has been increasingly aimed at closing loopholes in the tax law and changing it to prevent base erosion and profit shifting, aggressive tax optimisation, indirect tax fraud and tax leakage caused by all the above. This is, however, not only about tax compliance and sealing the tax system. It also seems to some extent to be about the Polish government's disagreement with the position of HQs of multinational enterprises (MNE), ie that their local operations do not contribute much to the global value chains (GVCs) they operate in. The Polish tax authorities have expressed the view that the Polish subsidiaries are underpaid and/or overcharged and the HQs functions and central intangibles overvalued through transfer pricing policy. These two perspectives (of MNEs' HQs and local tax authorities) look set to clash more often during transfer pricing audits. Who is right is not a simple black and white issue. This is about the global economics and bargaining power of a single country like Poland on the one hand and changing the local consumer markets landscape on the other, which is enough to trigger a rethink and an update of global transfer pricing policy, including redefining the value drivers in GVCs. The Polish government believes in the country's strengths even though local entrepreneurship is not growing particularly fast; Polish entrepreneurs are increasingly successful and expansive but still, in relative terms, this is a micro scale which makes the Polish economy rely significantly on foreign capital to drive exports and investments, bring innovation, and increase employment and salaries. This should not be surprising as Polish private businesses are not sufficiently capitalised, and benefit significantly less from global supply chains than do companies with foreign capital.
Conversely, one possible local perspective is that Poland is a large consumer market, which makes global MNEs interested in selling their products in the country through their subsidiaries and marketing companies. The high potential of the still quite cost-competitive and well-educated workforce continues to attract elements of GVCs to the country such as production, processing and services, to benefit from cost savings. Based on economic theory, the most value added in the economic process is created where concepts and design or R&D are done, as well as where marketing and distribution concepts are created. The least value is created where simple processing and assembly is conducted. The global view is that Polish subsidiaries are low value added manufacturing, service, or selling entities, though ever more substance in Poland is centred around global business R&D works, sales and marketing, or manufacturing efficiencies.
Consequently, the local perspective is that factories, shared service centres and distributors located in Poland contribute scale, efficiency and cost benefits to GVC, and thus should be better remunerated. In practice, intense transfer pricing audits are carried out aimed at challenging, primarily, any loss makers operating in profitable supply chains, but also focusing on low margin operators. The tax law is being amended to equip the tax authorities with tools allowing them locally to validate global transfer pricing models. It seems that mere global documentation files with general descriptions and global benchmarks will not be sufficient to defend TP arrangements locally. Much more transparency, reference to real economic analysis of the supply chain and more GVCs' financials will have to be part of the discussion with the Polish tax authorities on local subsidiaries' shares in supply chain profits. The protective tax law will increasingly shift the burden of proof from local tax auditors to taxpayers and will move the discussion more to an Advance Pricing Agreement (APA) or Mutual Agreement Procedures (MAP) platform. The recently published tax law changes also indicate higher scrutiny on related party transactions, and not only from an income tax perspective; withholding tax will be subject to more thorough validation in terms of beneficial owner or business substance tests if the proposed law is implemented. Increased penalties for outstanding tax liabilities caused through transfer pricing arrangements or withholding tax irregularities have also been proposed. Furthermore, local management teams may expect to bear more personal responsibility for tax issues. The overall rationale behind the reforms coming from the Polish government is simple: tax prevention.
Carrot-and-stick approach to tax law changes
Cost of intercompany services and intangibles subject to limits
The Polish government decided last year to implement a restrictive solution in 2018 to prevent HQs' service and intangible charges and intercompany financing from adversely impacting local subsidiaries' incomes. Thus, the tax authorities put in place a solution aimed at shifting the burden of proof regarding arm's length and benefit tests to businesses. In January 2018, a limit of 5% on the value of EBITDA was implemented into the tax law. If a subsidiary plans to deduct more of an HQ's activity costs and intangible royalty type costs, it is allowed to do so only if it holds an APA confirming the whole amount of the deduction is arm's-length. This limitation appears aggressive, especially given that no explanation was offered on how the government estimated the 5% threshold and how this estimation fits into the transfer pricing standard. However, the authorities are encouraging APAs to have a transparent and business-focused discussion on the transfer pricing models used to establish these charges.
The recently published draft law provides for an increase in the deduction limit from 5% to 10% of EBITDA starting from 2019. This higher limit will help some companies to avoid the limitation, while some already started changing their TP designs, some will pay tax and try to get it back from another jurisdiction, and some will have to apply for an APA in order to avoid double taxation. Comparatively few companies will opt not to observe the limit and risk controversy. The fiscal personal responsibility of the local management makes this option even less viable.
Limit on deducting intercompany debt costs
Another solution, but based more on a BEPS recommendation, has also been implemented since January 2018. This is to limit any deduction of intercompany debt costs to 30% of EBIDTA.
Tax reform going even further
The recently published tax law changes (dated July and August 2018) indicate that the Polish government is planning to go even further with its carrot and stick approach. On the one hand, the proposals seek to reduce the administrative burden; on the other, they provide for more restrictions on withholding tax and penalties for unpaid taxes.
The following are examples of positive changes aimed at reducing regarding the administrative burdens:
Decreased documentation requirements
The draft rules provide for some value threshold changes, which should reduce the number of related party transactions to be described and properly defended through benchmarking studies in the transfer pricing documentation.
Furthermore, the local transactions will probably be excluded from the TP documentation obligation, which should mainly help local groups, but will to some extent also reduce the problem for MNAs of having separate documentation files for local transactions not covered by central reports.
Polish documentation rules today require more details than global reports based on exact BEPS wording. This results from the local implementation of the BEPS rules. The scope of information to be presented in future local files will be adjusted to better reflect the scope of BEPS Action 13.
A highly positive development is that the stringent deadline for having the transfer pricing documentation in place will be extended from three to nine months after the tax year ends, with 12 months in effect for master files. In line with the new law, master files can be provided in English (which should help save on sometimes-significant translation costs).
Safe harbours for services and interest
It is positive that a safe harbour provision has been proposed for margins on low value added services and interest rates on lowl value intercompany loans. There will be no requirement to prepare a benchmarking study to prove arm's length for margins on low value added services (the draft law regards administration services as low value added), provided they are 5% or less when charged in Poland and 5% or more when outbound. Similarly, interest rates for total debts amounting to no more than PLN 20 million, incurred for up to five years, will be safe for transfer pricing audits on the condition they are based on rates published by the tax authorities.
The draft law also provides for a notional interest deduction.
A positive proposal in the draft legislation is the Innovation Box Regime (IBR), which is aimed at incentivising innovative research and development (R&D) activities. Poland already offers an R&D incentive, but it refers to the cost side of a taxpayer's activities, while the proposed IBR will apply to incomes earned from the qualifying IP developed as a result of the taxpayer's R&D activities, and will implement a preferential 5% tax rate on qualifying income. The nexus approach is used, which intends to link the relief to the proportion of R&D in Poland, meaning the 5% will apply to qualified income obtained from the qualifying IP created, developed or improved by a taxpayer as part of their R&D activity in Poland. As many MNEs have their R&D centres in Poland, it seems like a good opportunity to take this allowance into consideration and potentially redesign some of the typical transfer pricing set-ups for intangibles and R&D. Royalty or intangible sale types of income can qualify for the reduced tax rate, as can the part of goods sales attributable to the qualified intangible asset.
The proposed reforms also have other angles. There are some proposals which can be viewed as strict but which are consistent with the approach of putting in place more tools to validate the correctness of arrangements between related parties.
Non-recognition or re-characterization of related party arrangements
When auditing taxpayers, the Polish tax authorities use the general transfer pricing rule to validate and challenge related party arrangements. The government has opted to grant even broader powers to the tax auditors to judge the merits of related party arrangements through the non-recognition or re-characterisation rule. As part of the transfer pricing regulation, this rule will give tax inspectors the right not only to validate whether or not the terms and pricing of a specific arrangement were agreed at arm's length, but will also allow them to deny the arrangement or require that third parties not enter into a different one. The rule is reflected in the OECD BEPS reports, and the Polish tax authorities simply seem to be following the recommendation in this respect; however, it makes a difference whether a particular rule is included in the OECD report or whether it is part of the local law. In order to make judgements on business rationale and evaluate business arrangements correctly, one needs very strong business and economic expertise and acumen. Thus, in the hands of the Polish tax administration, where auditors with adequate business knowledge are still in short supply, these tools seem to be extremely dangerous. If implemented, the new law would make companies change their approach to transfer pricing documentation. Accordingly, instead of merely presenting the methods and benchmarks, much more attention will have to be paid to the business rationale behind related party arrangements.
WHT reform, more penalties and exit tax to come
It was expected that at some stage of the reform, the Polish tax authorities would decide to focus more on WHT issues. The proposed changes will reshape the existing standard of applying WHT exemptions and treaty-based rates for dividends, interest rates and royalties, and will follow a similar logic as the deduction limit on service and intangible charges, ie 'pay tax first and ask for a refund only later, explaining why you should get it'. Businesses will be given a choice: either (i) take the abovementioned route; or (ii) apply preferential rates and submit a statement to the tax office in which the business confirms that it is in possession of the documentation required under the tax law for the WHT exemption or application of a lower WHT rate and that, having verified with due diligence that the conditions to apply a treaty rate or exemption have been met, it is not aware of any circumstances that would preclude application of the lower WHT rates or exemption. Confirmation of beneficial ownership and real economic activity will be part of this validation. As the statement should be signed by the head of the tax remitting entity with possible stringent personal sanctions, and statements will be audited for factual compliance, it is anyone's guess whether or not this will be the preferred option for local companies.
The above changes may also be followed with implementation of an additional penalty tax of 40% (10% in case of total income adjustment) for outstanding tax liabilities resulting from a tax benefit achieved mainly through transfer pricing or aggressive tax planning or WHT irregularities. On top of this, exit tax, ie a tax of 19% on the transfer of assets and changes of tax residence, has also been proposed in the draft law.
It is not yet fully clear whether the government is determined to implement all the restrictive changes next year. In view of the proposals, the government's policy of preventing tax leakage seems to clash with assurances given to businesses to reduce the administrative burdens. Which of the two will gain higher priority in the current round of tax amendments should become clearer in the coming weeks.
Partner, transfer pricing & operating model effectiveness
With more than 21 years in business and 19 years in transfer pricing advisory services, Aneta is highly experienced in all aspects of the transfer pricing advisory, compliance and controversy business. She has been dealing with APAs since the beginning of 2006, and has personally led 15 APA projects thus far. She won the first ever successful Polish APA concerning IP cross-border licensing, under which the profit split methodology was one of the methods discussed with the Finance Ministry's APA team. In 2016 Aneta won the best tax advisor award in the field of transfer pricing in the 11th ranking of the Best Tax Advisory Companies and Tax Advisors by Dziennik Gazeta Prawna. In 2016, her transfer pricing team was recognised as one of the most innovative TP teams in Poland for developing the TP Documentation Scanner, an online tool designed to identify gaps and missing information in transfer pricing documentation in the light of the new reporting rules in Poland.
EY Transfer Pricing Team – the most innovative TP Team on the market
One of the biggest challenges for the administrative office and advisory companies in current times are also the changes of tax regulations aimed at preventing the transfer of profits abroad. New regulations coming into force in 2017 are considered to cause a revolution in the process of preparation of TP documentation. Among others, the changes will significantly affect the content and the scope of the documentation. Simultaneously, the tax authorities have already increased the tax audits in this area in 2016. In response to this trend the jury has awarded EY in the category of innovative solutions for its TP documentation scanner.
This original and first online tool in the market was created from scratch by consultants of EY Transfer Pricing Team. The tool enables the fast identification of potential risk connected with the documentation of transactions between related parties – confirms Aneta Błażejewska-Gaczyńska, the Partner and the leader of EY Transfer Pricing Team.
Rzeczpospolita, 21 June 2016
Aneta has broad practical experience in business restructuring projects, including those involving valuation of exit charges and the design of post-restructuring transfer pricing flows. She places significant practical emphasis on tax valuation of intangibles and intercompany debt arrangements, as well as arm's length valuation. Since 1999, she has been developing EY's practical transfer pricing knowhow and expertise, and has been leading the company's transfer pricing business since 2009, coaching numerous experts in the field and providing support and advice to hundreds of companies. With her broad practical transfer pricing experience and expertise, she has a clear understanding of global supply chains and how global multinational companies operate.
Manager, transfer pricing
Aneta is a manager on EY's transfer pricing team. She is a Polish-licensed tax advisor and attorney.
Aneta focuses on transfer pricing advisory for multinational enterprises. She specialises in negotiating unilateral and bilateral advance pricing agreements and MAP procedures, and actively supports client during tax audits. She has gained experience through engagement and management of developing transfer pricing models, business restructuring and developing post-restructuring models. She advises on setting transfer pricing policies for capital groups for settlement of goods, services, intangible assets and financial intercompany transactions.
Aneta has authored articles published in the press and on the internet. She has also presented events and training on transfer pricing.
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