Michał Gosek

Tax adviser (Poland)
Associate Partner
Phone: +48 61 624 49 39

In our previous articles (part 1 and part 2) we discussed problems with interpretation of Article 15e(4) of the CIT Act in the context of enterprises operating in special economic zones. The article is worded unclearly. However, part 1 and 2 were drafted when the tax authorities' approach to the matter was still unknown.

The first two advance tax rulings by the Head of the National Tax Information Service (NTIS) have now been published: one on 14/09/2018 (0111-KDIB1-1.4010.239.2018.1.BK), and another one on 19/09/2018 (0111-KDIB1-2.4010.248.2018.1.MM).

Tax-deductible costs allocated to tax-free income

In the context of facts and circumstances described in the ruling of 14/09/2018 the applicant asked if the limit referred to in Article 15e(1) of the CIT Act, read together with Article 15e(4) and Article 7(3) of that Act, applied to tax-deductible costs which were allocated to income exempt under Article 17(1)(34) of the CIT Act.

The applicant claimed that according to the literal interpretation of the above-mentioned regulations the article should not have applied to the tax-deductible costs allocated to the costs of business in the zone. To back up his interpretation the taxpayer invoked the lawmakers' objectives in implementing the new provisions (to combat aggressive tax optimisation) and concluded that since the lawmakers wanted to prevent tax erosion, all restrictions to protect the taxable base should apply exclusively to those revenues and expenses which "make up" the taxable profit.

The Head of NTIS rejected that view claiming that the restriction under Article 15e(1) of the CIT Act should apply to expenses incurred in the course of both taxable and non-taxable activities.

We are of the opinion that this taxpayer-unfriendly approach is wrong. Setting aside the tax authorities' standpoint itself, the content of the advance tax ruling leaves much to be desired. Basically speaking, the Head of NTIS cherry-picks and criss-crosses some provisions of the CIT Act in such a way that even after reading and re-reading the ruling a number of times it is difficult to tell how the taxpayer should proceed.

He begins his elaboration by describing what special economic zones are and explaining that income from business conducted in the zone under a permit is exempt from tax. Further on, he quotes Article 7(1) and (2) of the CIT Act, which defines taxable income (sum of income from capital gains and income from other sources) and how it should be calculated (surplus of revenues from a given source over the costs of earning those revenues in a tax year). That part of the justification ends with a conclusion that only thus calculated income may be exempt from tax under Article 17(1) of the CIT Act.

What can qualify for eligible costs?

Having defined income the Head of NTIS moves on to regulations on tax-deductible costs to conclude that they should include all reasonable and economically justified expenses related to the business activity which were incurred to earn, secure or maintain a source of revenue. Then, the Head of NTIS quotes Article 15e(1) of the CIT Act which disqualifies certain expenses from tax deduction, and Article 15e(4) which says that Article 7(3) of the CIT Act applies as appropriate to the revenues and expenses referred to in Article 15e(1). It also says that revenues and tax-deductible costs related to sources which are not liable to or are exempt from income tax should not be included in the calculation of taxable income.

After quoting those regulations the Head of NTIS says that although Article 15e(4) of the CIT Act requires Article 7(3) of that act to be applied as appropriate, this does not mean that expenses which are allocated to income exempt from tax are completely immune to the restrictions under Article 15e. The authorities believe that this results from the justification to the act which implements the regulation in question (Parliament paper 1878 of 2017). The thing is that the justification invoked and cited by the Head of NTIS says about tightening up the tax system by curbing aggressive tax optimisation practices and about restoration of the principle of tax fairness and equal treatment (large enterprises can afford the costs of tax avoidance processes and this puts them in a privileged position against small enterprises that cannot afford this).

Another argument quoted by the Head of NTIS is that the lawmakers have not excluded enterprises operating in special economic zones because they also incur expenses for associated enterprises. A contrario, if the lawmakers wanted to exclude such enterprises from the restrictions stipulated in Article 15e of the CIT Act, they would have included a relevant exclusion there. Article 15e of the CIT Act does not say that its restrictions are not applicable to expenses for services and fees listed in Article 15e(1) in connection with a business in a special economic zone.

We find the tax authority's standpoint to be wrong and we should remain hopeful that administrative courts will modify the authorities' interpretation of that regulation in the future. All the more so as their standpoint is based almost exclusively on the justification to the act that has introduced e.g. the changes in question and where the lawmakers have not dealt at all with enterprises operating in special economic zones. This is unless the opportunity to do business in a SEZ should be treated as an example of optimisation not available to everyone.

Expenses for services and fees related to the business in a SEZ

We find it equally difficult to agree with the Head of NTIS claiming that the regulations do no say that the restrictions are not applicable to expenses for services and fees related to the business conducted in a special economic zone. So why do the lawmakers refer to Article 7(3) of the CIT Act and what does it say at all? The tax authority did not address that question.

We can assume that the lawmakers wanted the income exempt from tax not to be included in EBITDA calculation. This would seem clear especially as it fits the content of Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market, which underlines the Polish mechanisms. Assuming that the lawmakers act reasonably, it seems that if they wanted the new regulations to apply also to income earned in a SEZ, they would have formulated the EBITDA calculation rules differently than by a reference to Article 7(3) of the CIT Act.

Another unknown is how to apply Article 15e of the CIT Act to the exempt income in practice. The Head of NTIS claims that we should first calculate the combined income (taxable and exempt) and at this stage exclude the ineligible expenses for intangible services from tax-deductible costs. The exemption under Article 17(1)(34) of the CIT Act should be applied only afterwards. But how does Article 7(3), which says that when determining taxable income, the taxpayer should not take into account (...), go with that? And how to split the non-tax-deductible expenses between profit(loss) on the taxable and tax-exempt activities? According to the revenue-based allocation key? The regulations do not allow that. And even if we adopt this approach, what procedure should be followed by taxpayers who buy services that are entirely related to the business in the zone? Finally, does the assumption that all of the costs incurred by a taxpayer to buy services should be compared with EBITDA calculated exclusively on the business in the zone fit one of the goals named by the lawmakers, namely to restore the tax fairness?

By the way, we must say that we find some of the applicant's arguments questionable. We find it difficult to agree with a claim that since the lawmakers want to combat "tax optimisation" practices and prevent erosion of taxable base, the new regulations should apply solely to taxable income. Incorrect determination of a profit (loss) on operations in a zone may later affect the use of the exempt income and defer the time when an enterprise from the zone is obliged to pay taxes according to standard rules. On the other hand, tax authorities and administrative courts raise a similar argument to regularly refuse the right to offset losses incurred on the business in a SEZ claiming that it is purely an economic loss, not a tax loss.

In case of further questions, please do not hesitate to contact us. Our tax advisers in Rödl & Partner offices in Cracow, Gdansk, Gliwice, Poznan, Warsaw and Wroclaw will gladly review your documentation related to your investment in the Special Economic Zone in Poland and propose a solution to minimise your tax risks. We are also on hand to answer any other tax-related questions you may have. Our offices offer legal support in conducting business within a SEZ and in any other aspects of your operations.