Michał Gosek

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

Enterprises operating in special economic zones in Poland often carry out long-term investment projects. Due to the amount of the invested capital and a long process of construction or manufacture of tangible assets, very often payments are made even before the job is done. Apart from advances paid to suppliers, there are also partial payments which are not treated as advances but are made for completing the project milestones.

As some of those payments are made even before obtaining a permit to operate in the SEZ, SEZ enterprises often face doubts as to whether an expense may be classified as an eligible cost in the calculation of tax-exempt amount, and if so, at what point in time the payment may be considered made, according to law. The answer to the second part of the question is particularly important because the expenses are discounted as of the permit date. Consequently, the later the expense is incurred, the lower the related tax-exempt amount. So, in fact, the discounting process reflects the time value of money.

Advance tax ruling by the Head of the National Tax Information Service

What is noteworthy in this context is the approach presented lately in the advance tax ruling of 5 April 2018 issued by the Head of the National Tax Information Service (file no. 111 – KDIB1 – 3.4010.118.2018.1.PC) – the authority confirms that expenses which the enterprise incurs under for partial payments and which are not advance payments are costs eligible for state aid already upon their incurrence. 

The above-mentioned advance tax ruling was applied for by an enterprise operating in the SEZ in the sector of household appliances. As part of its business, the company makes various investment projects in the SEZ, under the relevant permits. One of the projects expands warehousing and manufacturing space by, among other things, building a warehouse. 

To this end, the applicant signed an agreement with the contractor ("the agreement") to complete the individual construction components of the project . The agreement was signed after the company had obtained the permit.

The agreement has features of a long-term contract such as the schedule and the subject matter of the agreement divided into milestones. As the work under the agreement is complex and long-lasting, before the final completion of the project the company makes partial payments to the contractor for a given milestone/task in arrears, i.e. after its completion. The contractor issues VAT invoices to the company to document the payment for a given milestone.

The abovementioned payments made by the company are not advance payments. The company makes and will continue to make all the discussed payments after the dates of the permits. Once all the work is completed and all the tangible assets being the subject matter of the agreement with the contractor are supplied, expenses incurred under partial payments will be added to the initial value of the tangible asset.

In the application for the advance tax ruling the applicant has asked tax authorities whether such payments will be an eligible cost at the time of making them. In the opinion of the company, in accordance with the cash method, partial payments should be classified as eligible costs once they are made. The head of the National Tax Information Service has agreed with the taxable person's viewpoint.

Criteria for classifying expenses as eligible for state aid

A taxpayer operating in the SEZ has a right to use state aid for enterprises in new investment projects. The amount of the aid is a product of the maximum aid intensity available for the area and the project costs eligible for the aid (in accordance with §3 of the SEZ Regulation). The lawmakers have laid down the criteria for classifying expenditures as eligible for state aid in §6 of that regulation. Pursuant to that article, expenditures eligible for state aid are the costs of the investment project incurred in the SEZ during the lifetime of the permit, less the input VAT and excise duty (if they are deductible under separate regulations), which include without limitation the cost of acquisition or the cost of own production of tangible assets, provided that they are included (under separate regulations) in the taxpayer's assets.

The analysis of the above regulations indicate that the following conditions must be met by an expense to be eligible for state aid: 

  • it must be a cost of the investment project,
  • it must be listed in §6(1) of the SSE Regulation,
  • it must be included in taxpayer's assets,
  • it must be incurred within the SEZ during the lifetime of the permit.

What does it mean that an expense has been "incurred"?

Taxpayers find it difficult to determine whether the above conditions are met or not. That is because the lawmakers refer to "incurring an expense" without clarifying what it means. While in the case of a one-off payment there are no major problems with establishing when the eligible cost is incurred, it is not so clear in the case of partial payments (payments made in instalments). 

The term "incurring capital expenditures" has been a bone of contention between taxpayers and tax authorities virtually from the day when it was introduced. As there is no statutory definition of the term to incur an expense/a cost, we should refer to its literal meaning according to which "to incur" means to burden someone with something, and "an expense" or "a cost" is a total amount of money spent to buy or pay for something (Polish Dictionary). 

According to the established line of court judgments, an expense is a cost actually made in the cash meaning, and incurring an expense should be understood as a definite cover of costs from the taxpayer's own financial resources. Tax authorities claim further that for an enterprise to be able to enjoy an income tax exemption, which depends on the amount of eligible expenses of a project, the incurred expense means that it has actually been made, and not that there is just an intention to make it or an obligation to make it in the future. Consequently, to calculate the tax-exempt amount, it is not sufficient to just recognise the expense without actually making it.

Date of incurring the costs of the investment project

When calculating the obtained and available state aid amount, the date of incurring the costs of an investment project is the date on which the cost related to the investment project is actually incurred and recognised in the books of account as assets under construction. It does not matter whether as of the date of incurring such expenses the tangible assets of the new investment project have been brought into service or not. The date of incurring the expense is the last day of the month in which the expense is made, and that is the date to be used as the date of incurring the expense for the purposes of calculating the discounted value of the investment project (in line with §7(6) SSE Regulation).

Therefore, the authors believe that the viewpoint taken by tax authorities is very much correct. Investment projects implemented by enterprises operating in SEZs are often long-term and big-budget projects, therefore their implementation is divided into several stages (milestones). At the same time, after completing a given milestone, the enterprise makes a partial payment thereby fulfilling its liability for the work done so far, and thus the expense is definitive. So tax authorities were right to state that the date of incurring the expense in the above-described circumstances should be the date of the transfer of the partial payments from the company to the contractor which has the right to receive the money for completing a part of the work.

Partial payments and the advance payment towards the purchase of a tangible asset

It should be emphasised that the payments described in the above-mentioned advance tax ruling should not be understood as advances towards the purchase of a tangible asset. According to the definition provided in the Online Polish Dictionary, an "advance (payment)" is a portion of a liability paid in advance towards it. While in the discussed advance tax ruling the payments made by the enterprise operating in the SEZ were for the completion of a specific project milestone, the advance is just a portion of the liability paid earlier towards it. Payment of an advance is not the same as definitive incurrence of the expense because it is not yet the price as such. The payment of an advance is more like a down payment, while the payment of a tranche under a long-term contract has the features of a definitive expense as it constitutes a payment for the completed milestone. 

The table below shows the differences between a partial payment and an advance 

partial payment (in instalments) advance payment
is a form of a definitive settlement of the accounts with the contractor for a specified stage of work is not the same as a definitive purchase
tax authorities consider it a definitive payment tax authorities consider it an intention to incur an expense
the date of incurring an expense (partial payment) is the date of making the payment the date of incurring an expense (advance payment) is the date of payment of the final price

Nonetheless, the above does not mean that a payment of an advance may not be included in the list of eligible costs. Although at the beginning an advance payment may not be considered final, once it is reposted to assets under construction, it is no longer an advance payment – it becomes a definitive expense. 

If you would like to know more on this topic, Rödl & Partner's experts in Cracow, Gdansk, Gliwice, Poznan, Warsaw or Wroclaw will be glad to help you.