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Michał Gosek

Tax adviser (Poland)
Associate Partner
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Income earned by taxpayers from a business activity pursued in a special economic zone on the basis of a relevant permit as well as income earned on a business activity specified in a decision on state aid as referred to in the New Investment Support Act of 10 May 2018 is exempt from tax (Article 17(1)(34) and (34a) of the CIT Act). However, according to Article 17(4) CIT Act, the tax exemption referred to in sub-section 1(34) and (34a), is available only with respect to income from a business activity pursued within the zone or in the area specified in the decision on state aid.

Complexity and sophistication of production processes often force in-zone enterprises to carry out certain supplementary or ancillary tasks outside the SEZ. These may consist in e.g. locating the promotion-marketing or distribution or maintenance department outside the SEZ, or in running warehouses for finished goods manufactured in the zone. The decision may be dictated by the type of goods (e.g. the maintenance of mining machinery will be typically done on site) or the lack of space on the plot covered by the zone permit or the state aid decision.

In-zone and out-of-zone production

Very often, production stages are outsourced outside the SEZ. It also happens that an in-zone enterprise moves a part of the production process to its own plant outside zone. In light of Article 17(4) of the CIT Act, enterprises are in constant battle against tax authorities over whether in such a case the tax exemption applies to all the income from sales of goods manufactured in the zone.

The answer is not clear-cut and requires a case-by-case analysis of the taxpayer's facts and circumstances.

According to Article 12 of the SEZ Act, income from a business activity pursued in a zone on the basis of a permit referred to in Article 16(1) of the act by legal or natural persons is exempt from income tax in accordance with the rules of the Corporate Income Tax Act or the Personal Income Tax Act, respectively. In turn, §5(3) of the SEZ Regulation says that only the income from a business activity conducted in the zone is exempt from income tax. If an enterprise pursues its business also outside the zone, the in-zone activity must be organisationally separated, and the exemption amount should be calculated on the basis of data from the organisational unit which conducts the business activity exclusively within the zone.

Neither in the tax acts nor in the SEZ regulations have the lawmakers stipulated if and to what extent an in-zone enterprise may engage out-of-zone sub-contractors and how this affects the income tax exemption.

Tax authorities rulings

Tax authorities claim consistently that the movement of a part of the production process outside the SEZ (whether to an own plant or a sub-contractor) is not without significance for the amount of available income tax exemption. They base their approach on the literal interpretation of the above regulations claiming that the exemption applies only to the business activity specified in the permit and pursued within the geographical boundaries of the zone (the Finance Ministry's website still includes ridiculous rulings saying that if some part of a production building protrudes from the zone boundary, the business pursued in that part is not exempt from income tax). At the same time, tax authorities very often emphasise that it is up to the taxpayer to properly determine which part of his income does not come from the business in the special economic zone and is taxable according to general rules.

Interestingly, even this taxpayer-unfriendly approach has not been consistent always. Until not long ago tax authorities still issued advance tax rulings invoking a well-known rule that tax exemptions are exceptions to the principle of tax fairness and equal treatment and the provisions governing the exemptions should be interpreted narrowly. In those rulings they held that even if one stage of the taxpayer’s business activity was pursued outside the zone, that business activity was not eligible for the exemption referred to in Article 17(1)(34) CIT Act at all. They claimed that in such a case products completely lose the character of in-zone goods. One example of such a viewpoint is the advance tax ruling of the Director of Tax Chamber in Warsaw of 31 January 2011 (file no. IPPB3/423-685/10-7/DP). Fortunately, that approach did not trigger any firm line of interpretation and is generally not practiced nowadays.

At present, we regularly see advance tax rulings in which the Head of National Tax Information Service (formerly individual Directors of Tax Chambers) says that an in-zone enterprise cannot enjoy income tax exemption only in respect of the part of the production which is done outside the SEZ. Another argument of the taxman, on top of the narrow interpretation of laws, is that the permit for business in a SEZ is for a specific activity not a specific entity. So, exempt from tax is a business activity in a SEZ, not a taxpayer. One example of this business-unfriendly standpoint may be found in the individual advance tax ruling of the Head of NTIS of 21 November 2018 (file no. 0111-KDIB1-1.4010.380.2018.1.NL).

In the application for that ruling the taxpayer stated that it manufactured furniture in the SEZ. The applicant emphasised that the major part of the manufacturing process was in the plant located in the SEZ. The plant was the place where all key aspects of the entire process were handled, such as furniture designing, research on innovative solutions, calculations, material selection, development of technological and manufacturing processes, manufacturing planning and organisation, arrangement and accounting for working time. The SEZ was also home to the major treatment of the glued laminated timber, or glulam, including calibration, filling, cutting, planing, milling, drilling and other specialised treatment of curved parts on CNC machines, plus surface sanding. Further treatment in the SEZ included varnishing or oiling to protect surface from environmental factors. Further on, individual parts were assembled into ready blocks to be packed and shipped to customers.

To a small extent the manufacturing process involved a department located outside the SEZ. It handled pre-treatment of raw materials for manufacturing (cutting and gluing timber, and in the case of particle boards – cutting and veneering or film-wrapping). The applicant stressed that those processes were very preliminary because the precision cutting of the raw material bonded to the particle board and the further treatment of glulam, as well as the main furniture manufacturing were all in the SEZ plant. The applicant added that in the manufacturing for the main customer (which accounted for 70% of total orders) the out-of-zone department was not involved at all.

The applicant asked the tax authorities essentially if it should take into account all income earned on the sale of furniture and all costs of the manufacturing, including the preliminary treatment of raw materials in the out-of-zone department, in the calculation of income exempt from the corporate income tax.

The taxpayer claimed that the work done in the out-of-zone department was ancillary to the in-zone manufacturing and, therefore, the company should calculate the tax-exempt income taking into account all income earned on the sale of furniture and all costs of the manufacturing, including the preliminary treatment of raw materials in the out-of-zone department. The taxman disagreed. 

Polish courts have frequently expressed their stance on correct classification of revenue from the sale of goods partly manufactured outside a SEZ. For instance, the Supreme Administrative Court (SAC) in its ruling of 10 September 2015 (file no. II FSK 1766/13) emphasised that the tax exemption did not require the entire manufacturing process to take place in the special economic zone. Carrying out certain work outside the SEZ or buying raw materials outside the SEZ did not rule out total tax exemption of income from sale of such goods as long as such work was only ancillary. The SAC took the same stance in other rulings (e.g. of 19 November 2014. file no. II FSK 2750/12 or of 15 December 2011, file no. II FSK 1139/10). Most of first instance administrative courts currently share this view.

Consequently, the assessment of the Head of NTIS’s ruling of 21 November 2018 boils down to deciding whether the work done in the department outside the SEZ might be regarded as ancillary activities. According to case law, ancillary activities mean activities which permit or facilitate principal production process. Principal business means manufacturing of semi-finished and finished goods which determine to which industry and sector of the economy a company belongs.

The concept of ancillary activities

Polish case law emphasises that due to the lack of a legal definition of ancillary activities in Polish tax laws, it is necessary to refer to Community laws. Council Regulation (EEC) No 696/93 of 15 March 1993 on the statistical units for the observation and analysis of the production system in the Community (OJ L 93.76.1) includes the following clarification of the concept: ancillary activities within a unit are carried out in order to permit or facilitate production by the unit of goods and services for third parties. The products of ancillary activities as such are not supplied to third parties. Furthermore, the same EU regulation explains that an activity must be regarded as ancillary if it satisfies all the following conditions:

  • it serves only the unit referred to: in other words, goods or services produced must not be sold on the market;
  • a comparable activity on a similar scale is performed in similar production units;
  • it produces services or, in exceptional cases, non-durable goods which do not form part of the unit's end product (e. g. small implements or scaffolding);
  • it contributes to the current costs of the unit itself, i.e. does not generate gross fixed capital formation.

Since there is no statutory definition, the fulfilment of criteria developed in case law must be determined on a case-by-case basis.

In view of the facts and circumstances described in the said application, we believe that the Head of NTIS was wrong. First and foremost, the work done out of the SEZ represents a tiny part of the complex manufacturing process and is inextricably related to it. Consequently, we can logically assume that such work is performed on a similar scale in businesses similar to the applicant. Outside the zone, the company does not produce new tangible assets or develop from scratch complete components of finished goods which would then be merely assembled in the zone. Moreover, that work is within the company’s permit and is not done for any third party.

We need to emphasise that the Head of NTIS in his ruling included only a laconic statement that in that particular case the services performed outside the SEZ could not be regarded as ancillary activities, i.e. only supporting the principal stage of the furniture manufacturing. We find this explanation hardly exhaustive.

Administrative courts also criticise the arbitrariness of the tax authorities by stressing that it would be unacceptable if the exemption referred to in Article 17(1)(34) CIT Act was applied to income from business inconsistently depending on the tax authorities’ subjective, arbitrary assessment of whether the part of the production contracted out of the zone was ancillary or formed a part of the principal manufacturing process (ruling of the Provincial Administrative Court on Gorzów Wielkopolski of 25 January 2018, file no. I SA/Go 484/17, not yet final and non-appealable).

Interestingly, although the tax authorities approach is predominantly unfavourable to taxpayer, there are taxpayer-friendly rulings out there. For instance, in his individual advance tax ruling of 14 June 2018 (file no. 0114-KDIP2-3.4010.118.2018.1.MS) the Head of NTIS confirmed that purchases of semi-finished goods from third parties and using them in business described in the permit was an activity ancillary to the principal business of the in-zone enterprise and, therefore, all income from sale of such products should be exempt from tax.

Summing up, the key thing in classifying certain activities as ancillary activities is to demonstrate an inextricable relation between the principal business and the ancillary activities performed outside the SEZ. If you can demonstrate that link, you can exempt from tax all income from manufactured goods (even if some part of the manufacturing process is located out of zone).

If you have additional questions or doubts about the issues discussed in this article, Rödl & Partner experts in Cracow, Gdansk, Gliwice, Poznan, Warsaw and Wroclaw will be glad to help you.

Michał Gosek, Agnieszka Szczotkowska

18.02.2019