Direct tax haven transactions – obligations involved in transacting with third parties

The CIT Act-introduced transfer pricing regulations target primarily controlled transactions made between related entities. However, not everyone is aware that they also apply to transactions with third parties having their registered office or management in the territory or in a country applying harmful tax competition, i.e. the so-called tax haven entities. The topic of tax haven transactions was in the spotlight in 2022 due to the introduced extended obligations regarding indirect tax haven transactions – it seems these obligations will soon be repealed.

The obligation to document direct transactions with tax haven entities is not a novelty in Polish regulations. Therefore, taxpayers making such transactions should check whether they have met all transfer pricing obligations for 2016-2020 (years open for inspection). We have noticed that transactions with tax haven entities are targeted by the authorities, while taxpayers – operating based solely on business premises – are not always prepared for an inspection in this area.

We have summarized the key matters you should verify to have tax haven transactions under control.

Counterparty – an entity based in a tax haven

A direct tax haven transaction is one made directly with a tax haven entity: a related one and a third party (!). Territories and countries recognized as tax havens are listed in the regulation of the Minister of Finance on the determination of countries and territories applying harmful tax competition in the field of corporate income tax. Apart from exotic territories with which trade or services exchange is extremely rare, the list also includes countries and territories with which it may occur relatively frequently (e.g. Hong Kong Special Administrative Region of the People’s Republic of China). 

Although China is not a country considered to apply harmful tax competition, transactions with Chinese counterparties may be made through intermediaries – companies based, for example, in Hong Kong. When transacting with a foreign counterparty, you should therefore check where it actually operates and where it has its seat or management board. It may happen that – while maintaining permanent relations with foreign contractors, both from China and from European countries – the Polish taxpayer may be surprised to receive invoices from Hong Kong.

Transactions – types and value

From 2021, TP obligations apply in the case of both purchase and sale transactions. This is important because in the previous years the obligation covered only purchase transactions.

Another important matter is the value of the transaction with a tax haven entity: TP obligations are triggered once the PLN 100,000 threshold is exceeded (value valid from 2019). It is a much lower threshold than for standard transactions with related entities (from PLN 2 million).

In the draft amendment to the CIT Act filed the Sejm, the Ministry of Finance plans to raise the materiality thresholds for direct tax haven transactions: from PLN 100,000 to PLN 2.5 million for financial transactions and up to PLN 500,000 for non-financial transactions (the value would already apply when determining the obligations for 2021). The change seems significant, yet in practical terms PLN 500,000 per year for a commodity or service transaction may be easily exceeded by a medium-sized enterprise. Additionally, the increase in value only applies to obligations relating to 2021 and subsequent years. When reviewing the matter of direct tax haven transactions in 2016-2019, lower thresholds should be applied (PLN 100,000 or EUR 20,000).

What are the obligations?

If a direct tax haven transaction exceeded the documentation threshold, the taxpayer should:

• prepare transfer pricing documentation for the transaction, together with an analysis proving it was made on an arm’s length basis,
• report the transaction using the TP-R form for the given year, and
• notify the direct tax haven transaction in a statement filed with the tax authorities in which the taxpayer states it has TP documentation in place for a given year.

Fortunately, under the Polish Deal Act, in the case of a transaction with a tax haven third party, the taxpayer is no longer required to compile a TP analysis showing it was made on an arm’s length basis. Still, such an obligation, in principle, was in place for transactions made before 2021. Since 2021, documentation for tax haven transactions should feature additional items – for example: the economic justification of the transaction, in particular a description of the expected economic benefits, including tax benefits.

The obligations involved in direct tax haven transactions have changed over the last 5 years. Therefore, when reviewing the documentation and reporting obligations for 2021, it is a good idea to check previous years for direct tax haven transactions subject to transfer pricing obligations.