Property law: Poland's thin capitalization rules

For anyone running a company in Poland, loan finance seems the most straightforward way to finance a business, especially in its early phase.

Like most other EU members, Poland has thin capitalization regulations which limit the tax deductibility of interest payments.

Thin capitalization rules were initially introduced in Western Europe to prevent foreign companies from making loans to subsidiaries and then reducing the corporate tax payments by charging interest on the loans. Unlike dividends, which are paid from post tax profits, interest expenses are generally tax deductible. Revenue authorities set a limit, based on a multiple of the paying company's share capital, above which interest would be disallowable when calculating corporate income tax liability.

Poland was a relative latecomer to these rules, introducing them into the Law on Corporate Income Tax of February 15, 1992 (the Law) on January 1, 1999. However, the tax authorities have proven themselves skilled at using these regulations, which, unlike transfer pricing, do not demand much technical skill to be implemented.

Thin capitalization rules

Thin capitalization rules restrict the tax deductibility of interest payments in situations where the amount of loan financing from a shareholder (holding more than 25 percent of the share capital) exceeds a multiple of three times the level of issued share capital. Interest is disallowed in proportion to the excess amount of the loan (Article 16, Para 1, Point 60 of the Law).

For example, if a company has a share capital of zł.150,000, it can borrow up to zł.450,000 with potentially all interest being tax deductible. If it were to borrow zł.600,000, then 75 percent of the total interest on the loan would be tax deductible (zł.450,000/zł.600,000).

Investors should also remember that a loan from a company which is a fellow subsidiary of the same shareholder also falls within the thin capitalization restrictions (Article 16, Para 1, Point 61 of the Law).

There are two relatively simple ways to avoid the thin capitalization provisions. A loan from the shareholder of the Polish company's shareholder(s) is outside the rules. Alternatively, this ultimate shareholder could set up a finance company in a tax-planning-friendly jurisdiction like Cyprus or Sweden, in order to make the loans.

Other areas

Apart from the thin capitalization rules, under Article 11 of the Law the tax authorities can also disallow interest payments if they exceed amounts which would typically be paid on agreements between unconnected parties acting on an "arms-length" basis. Conversely, under Article 12 of the Law, an interest rate which is considered to be less than an open market rate may expose the company to a potential tax liability on the value of a benefit deemed to have been received.

One other area to be looked at carefully is withholding tax on interest payments. The standard, non-treaty rate of withholding tax on interest paid abroad by a Polish company is 20 percent. However, under the EU Interest and Royalties Directive of June 3, 2003, if this is paid to a connected corporate recipient within the EU, this rate is reduced to 10 percent. From July 1, 2009 this rate will be reduced to five percent and on July 1, 2013 withholding tax on interest will be abolished.

However, if a relevant double taxation avoidance treaty gives a better rate, that takes precedence. Under the Poland-Cyprus treaty, the rate is 10 percent, so there is no advantage, but under the Poland-Sweden treaty the rate is 0.0 percent. In accordance with Article 26 of the Law, the Polish company must be in possession of a valid certificate of tax residency issued by the Swedish tax administration before applying this zero rate.

Civil law activity tax

Finally, no review of loan financing is complete without a mention of civil law activity tax, which applies to loans at a fixed rate of two percent. However, there are a number of exemptions and planning opportunities available to avoid this charge.

Richard Wernick is managing director of Totalserve (Polska) Sp. z o.o.

He is a chartered tax advisor and registered trust and estate practitioner and has been practicing in Poland since 1997

Source: wbj.pl