Draft withholding tax clarifications full of controversy before consultation

Or rather, on the premise of beneficial ownership, since, despite the name of the project (‘clarifications on withholding tax collection’), their scope is limited to the aforementioned aspect. The deadline for comments is 10 October. The draft clarifications raise even more questions than the original one from June 2019.

Lack of precision and confusion of concepts

The published draft contains little in the way of specifics. About half of the text is taken up by presenting the history of the notion of beneficial owner under the OECD Model Convention and in CJEU case law, with little that tells payers and taxpayers who are supposed to apply the law. The authors of the explanations are also quite selective in the sources presented, citing largely publications authored by Ministry of Finance staff and only those rulings that present a view favourable to the fiscal’s thesis.

The draft lists numerous requirements with regard to beneficial ownership status, e.g. regarding the management of the foreign company, its office, personnel, costs incurred and balance sheet structure. However, there is a lack of precise or at least banded expectations regarding, for example, the number of employees and their remuneration, office space and costs, the proportion of passive income to operating income or transactions between related and unrelated parties. With explanations formulated in this way, taxpayers are further left in the dark as to what specific prerequisites their foreign counterparty should fulfil in order to apply reduced withholding tax rates or exemption.

The draft, although divided into sections devoted to further aspects of beneficial ownership, mixes up the legal bases and the terms used. Thus, among the rationale of real economic activity, the aspects addressed earlier in the section on the recipient’s action for his own benefit are repeated. On the other hand, the aspects of economic justification and artificial structure, specific to the anti-abuse clause provided for in another provision, are generally treated as part of the real owner regulation. Many of the explanatory theses are even of a legalistic nature, such as the derivation from CJEU case law of the beneficial owner requirement for the dividend exemption, which the Polish legislator has not implemented into domestic law.

Surprising developments

The draft also contains some unexpected twists and turns, compared to the views of the tax authorities presented so far. As recently as during the July meeting with entrepreneurs, representatives of the Ministry of Finance declared that their intention was to enable the use of the so-called look-through concept, i.e. the recognition of withholding tax obligations with respect to an indirect recipient, if the direct recipient does not have the status of the beneficial owner. The draft explanatory notes turn their backs on this idea entirely, pointing out that the look-through concept is not entrenched in Polish tax law. What is also puzzling is that, despite the declared lack of legal basis, the authors of the explanations nevertheless see the possibility of applying the look-through approach in one exceptional situation. Thus, on the one hand, the drafters justify their position with the principle of legalism, while a sentence later they derive a special principle, also without any legal basis for it.

There is also a change of approach in the other direction (i.e. in favour of taxpayers), in terms of the premise of the non-exemption of the recipient from taxation of his entire income. To date, the Lublin Tax Office, as well as the Ministry of Finance in statements to the public, have stood firm on the position that exemption from Polish withholding tax is excluded in a situation where the recipient of the payment is exempt from tax in its country of residence for that payment (i.e. subjective exemption). The problem mainly relates to dividends, as exemptions for recipients of these payments are in place (under certain conditions) in most EU countries. The draft explanatory notes indicate that, in the case of dividends, the premise of non-exemption should be understood subjectively. That is, that the exemption in the recipient’s country, in order to disqualify the Polish preference, must apply to the recipient’s entire income and be dictated by its subjective status (e.g. selected investment funds). Or at least it seems that this is how it can be understood, as the draftsman used a rather enigmatic formulation and there will certainly be requests to describe this conclusion more precisely.

Dangerous theses

It is worrying that the draft contains many conclusions that lead to discrimination against certain categories of entities or even entire industries. Negative circumstances in the context of the status of the beneficial owner were indicated, among others, receiving the majority of revenues from cross-border financial payments from affiliated entities, locating the recipient in a jurisdiction with an extensive network of double taxation avoidance agreements or ranking high on the list of foreign direct investments in the territory of Poland (due to financial transactions). It appears that in a veiled manner, the Ministry of Finance has let it be known that it will not recognise withholding tax preferences for payments to countries such as Cyprus, Malta, Luxembourg or the Netherlands. Such an apriori conclusion contradicts European Union regulations and perhaps also agreements in the field of the promotion of mutual investments (so-called BITs).

Another dangerous thesis of the explanatory notes is the exclusion from self-employment income (i.e. that ‘good’ income in the context of beneficial ownership status) of all payments of a passive nature. This far-fetched conclusion, in addition included in the form of a footnote, 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 existence of these platforms is now a widespread and legitimate economic phenomenon (e.g. in real estate or private equity), enabling investments to be entered into at various levels of its portfolio. It is difficult to find a justification for top-down disenfranchisement of lower withholding tax rates for precisely such businesses.

Furthermore, the draft clarification goes in the direction of a very extensive obligation to obtain information. The numerous data and circumstances that the payer will have to establish will require a very large amount of money, work and cooperation from foreign recipients, which is often difficult in practice. Meanwhile, the Fiscal seems to continue to assume that, within a single group, each entity has unlimited and immediate access to all information on all other entities and that it has unlimited human and financial resources, which, like business intelligence agencies, will conduct international audits instead of handling their business.

To be continued

In its current version, the explanatory notes, although enumerating many requirements and considerations, do not, in the absence of specifics, improve the position of payers and taxpayers in terms of what should be checked or done in order to apply withholding tax preferences. Numerous linguistic errors and confusion of terminology suggest that the draft was published in a preliminary version, before it was finalised. It remains to be hoped that more detailed and rational solutions will be worked out in the course of the consultation, although the very short deadline set by the Ministry of Finance does not inspire optimism.