Taxation of investment funds in light of the amendments to the CIT Act | Jakub Grzyb
Taxation of investment funds
Beginning from 1 January 2017, the amendments to the CIT Act have caused the taxation of investment funds to change significantly. Until the new regulations enter into force, investment funds established under the Investment Fund Act benefited from a subjective income tax exemption.
The subjective exemption subject to the introduced amendments applies only to open-end investment funds and specialist open-end funds. Closed-end investment funds and specialist open-end investment funds (which apply the rules for closed-end funds) can benefit from the exemption in specific cases (objective exemption).
The purpose of introducing the changes
The ratio legis of the introduced changes was to constitute a restriction of the use of closed-end investment funds for tax optimization. In the explanatory memorandum to the bill, it was indicated that closed-end investment funds are one of the basic elements which contribute to the creation of tax planning structures, and their design makes it possible to be applied only by large taxpayers, negatively affecting the competitiveness of smaller entities.
It’s worthwhile to recall that the original version of the project dismissed the subjective exemption for all investment funds, with the objective exemption being intended only for open-end funds. This project received a negative evaluation both from the National Bank of Poland and the Polish Financial Supervision Authority, which determined that taxation on all closed-end investment funds does not fulfill the purpose of introducing the changes (as not all funds were used for tax optimization) and would negatively affect the financial market.
The new regulation determines the objective exemption negatively, by enumerating the instances in which income (revenue) of investment funds is subject to income tax. According to Article 17.1.57 of the CIT Act, income (revenue) of closed-end investment funds or specialist open-end investment funds (which apply the rules of closed-end investment funds) is free from income tax. Not subject to the exemption is income (revenue) earned from investment in tax-transparent entities – Polish companies and organizational units without legal personality, as well as companies and organizational units established or administered in another country and accordance with the law of that country, not treated as legal entities and not subject to unlimited tax liability.
Among income (revenue) earned from the indicated taxable entities, the legislator has included income from shares, interest on loans, interest on equity, donations (free or partially paid benefits), discount on securities and disposal of securities.
Regarding the definition of a company not considered a legal person, as expressed in Article 4a.14 in connection with Article 4a.21 of the CIT Act, it should be stated that income derived (from one of the aforementioned sources) in relation to the activities of general partnerships, professional partnerships, and limited partnerships will be taxable. A limited joint-stock partnership does not have legal personality, yet is subject to CIT and, therefore is not fiscally transparent.
Tax authorities’ standpoint
Considering that the new regulations so far have been in force for a short period of time, it is impossible to determine the specific approach of the tax authorities in the matter. However, it is worth mentioning that the Director of National Tax Information in the tax ruling of 12 April 2017 (no. 0114-KDIP2-2.4010.5.2017.1.AM) has indicated that the objective exemption of the investment funds cannot be applied to income generated by a foreign controlled company (if the conditions provided for in Article 24a of the CIT Act are complied with, the income of the foreign controlled company constitutes taxpayer’s income).
The authority, arguing its position, stated that the general principle of calculating income was recognized in Article 7.2 of the CIT Act. Regarding:
- the determination of income from the shares of legal persons (Article 10 of the CIT Act)
- the determination of estimated income of related parties by a tax authority (Article 11 of the CIT Act)
- the determination of income when it is obtained from a foreign controlled company (Article 24a of the CIT Act),
the determination of income should be conducted under different, specific conditions.
The tax authority has expressed that an objective exemption expressed in Article 17.1.57 of the CIT Act refers only to income determined on the basis of Article 7.2 of the CIT Act and therefore cannot be used in case of income obtained by a foreign controlled company.
The argumentation of the tax authority does not seem to be correct. By applying the reasoning adopted by the Director of the National Tax Information, it would be recognized that income obtained by a closed-end investment fund from the share in profits of legal persons (Article 10 of the CIT Act) should also be determined in a particular way and, as a consequence, objective exemption from Article 17.1.57 of the CIT Act would not be applicable. Adopting the abovementioned interpretation would render the objective exemption virtually illusory.
Tax neutrality of settlements with participants
According to Article 12.4.26 of the CIT Act, obtained payments for participation units or investment certificates do not constitute income, whereas according to Article 16.1.72 of the CIT Act, the amounts paid by the fund for the repurchase of shares or the purchase of investment certificates as well as payments of the income/revenue of the fund to the participants of the fund are not cost-deductible. Because of these provisions, settlements with the participants will be tax neutral for the fund.
Jakub Grzyb, consultant in the Banking&Finance Team, Tax Advisory at
KPMG in Poland
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