The end of November 2020 brought the completion of parliamentary works on the new corporate income tax mechanism, so-called “Estonian CIT”. The subsequent amendments were introduced by way of Act of 28 November 2020 on amendments to the Corporate Income Tax Act and Certain Other Acts (Journal of Laws of 2020, item 2122), published on 30 November 2020, where the new scheme was referred to as 'the lump sum tax on the income of companies'.
The income tax system in Estonia is known for its rather simple, and thus taxpayer-friendly, structure. Its main assumption is that the tax is not payable on current income earned in the course of business but becomes due only when dividends are paid out to shareholders. This translates into facilitated business operations and provides for improved development fuelled by the generated profit. It should be noted that said taxation manner is the default framework for tax settlements in Estonia.
In principle, one of the goals behind introduction of this solution in Poland was to use the postponed taxation as an incentive for companies to finance their operations with the profits. Other benefits of the solution indicated by the Ministry of Finance include determining the tax result based on accounting data, limited reporting obligations and absence of monthly advance payments. The narrative placed the lump sum taxation in the context of levelling the playing field for SMEs. Yet, it is hard to escape the impression that the Polish version of the “Estonian tax” is branded with over-complexity, typical for Polish tax legislation.
In fact, the new model of taxation relies on determining income based solely on accounting data, pursuant to the Polish accounting provisions. Companies that opt for the lump sum taxation will benefit from special taxation rules (e.g. higher tax rates - 15% and 25% - which are then balanced through deductions - different reporting obligations, exemption from the minimum tax on real estate, and waived obligation to report domestic tax arrangements, under MDR provisions (Chapter 11a of the Tax Code). On the other hand, lump-sum taxpayers cannot apply the IP-Box scheme, i.e. a preferential 5% rate applied to the income derived from qualified intellectual property rights.
Application of lump sum taxation must continue for a period of at least 4 years and is subject to meeting a number of subjective (relating both to the company itself and its shareholders who must be natural persons) and objective requirements discussed below.
Who can use it?
The major difference between the Polish lump sum taxation and the original Estonian solution is that it remains a scheme alternative to other applicable taxation methods. In fact, this way of taxation may be applied solely by companies within the meaning of the Polish Comercial Companies Code, i.e. solely limited liability companies and joint-stock companies. This means, that the solution remains unavailable for limited joint-stock partnerships and limited partnership, the latter becoming CIT payers as of 2021. The lump sum tax on company income may be used by both existing and new entities.
The legal form criterion comes with other requirements pertaining to:
- the company's ownership structure,
- amount and types of revenues,
- capital expenditures and/or remuneration value,
- employment level,
- types of business activity conducted, insolvency or bankruptcy status,
- the way in which the taxpayer was established,
- preparation of financial statements in line with the Polish accounting regulations, excluding IAS,
- notification of applying lump sum taxation.
Ad 1) Ownership structure
In order to be authorized for applying lump sum taxation on income, the company's shareholders must consist only of natural persons who do not hold property rights related to the right to receive benefits as founders (originators) or beneficiaries of a foundation, trust or other fiduciary entity or relationship. This means, among others, that the solution can become inaccessible to companies with shareholders being founders or beneficiaries of entities such as family foundations.
Moreover, it precludes the possibility of using the scheme to companies participating in the share capital of another company, having equity participation in a partnership, participation titles in an investment fund or collective investment institution, or finally - similarly to partners - holding rights related to the right to receive benefits as founders (originators) or beneficiaries of a foundation, trust or other fiduciary entity or relationship.
Thus, the model user of the solution seems to be a company with natural persons as shareholders, free of any participation in other entities. Furthermore, both the taxpayer and partners (shareholders) thereto may not use any fiduciary structures.
Ad 2) Amount and kind of revenues
The Estonian CIT solution has been designed for companies with gross revenues not exceeding PLN 100,000,000. It should be borne in mind that the indicated values should include the VAT due.
Under the applicable revenue threshold, the scheme may be used both by companies paying CIT at the rate of 19% and small taxpayers using the 9% CIT rate.
It must be kept in mind that the revenue condition also applies to its type. In other words, no more than a half of qualified revenues can constitute of financial revenues i.e. revenues from receivables, interest and loans, sureties, guarantees, financial instruments, as well as revenues from benefits of intellectual property rights and revenues from transactions with related entities (within the meaning of the provisions on transfer pricing), when such transactions do not lead to the generation of significant added value in economic terms.
Ad 3) Capital expenditures
Application of lump sum taxation is also conditional on making investments, as defined by the provision of Article 28f of the CIT Act, in its wording applicable as of 1 January 2021. Capital expenditure should be understood as expenses actually incurred on manufacturing or purchase of new fixed assets. In the case of a significant investment reported to the tax authorities, capital expenditure may also include the repayment of the initial value of fixed assets used under a financial lease agreement.
Moreover, under the applicable provisions, the minimal investment rate is calculated in the following manner:
- 15% - no less than PLN 20,000 - in the period of 2 subsequent tax years of lump sum taxation, or
- 33% - no less than PLN 50,000 - during 4 subsequent tax years,
in relation to the initial value of fixed assets calculated on the last day of the tax year preceding the period of lump sum taxation, for fixed assets included in groups 3-8 of KŚT [Fixed Asset Classification] (thus excluding real estate and engineering structures classified in groups 0-2). Passenger cars, means of air transport, watercraft and other assets which, in the legislator's opinion, are to be used mainly for personal use by partners or shareholders or their family members, were excluded from the catalogue of qualified fixed assets, the initial value of which is to determine the value of the investment.
Taxpayers who do not need to acquire fixed assets, are not subject to the condition of incurring capital expenditure, provided that they increase, in 2 or 4 subsequent years, respectively, the value of remuneration or the number of employees, excluding partners and shareholders, compared to the period in which they were subject to taxation on general principles.
What is more, the new regulations provide for preferential rules in this regard for taxpayers starting business activity and companies classified as small taxpayers.
Ad 4) Employment
Entities eligible for applying the solution are required to maintain an average employment of at least three employees who are not its shareholders, based on employment contracts, for a period of at least 300 days in a calendar year, or 82% of days of a fiscal year which does not overlap with a calendar year. Alternatively, such companies may incur monthly employment expenses under civil law contracts entered into with at least three persons who are not its shareholders, for whom the companies will act as PIT and social security contribution remitters, while the sum of expenditures on remuneration may not be less than three times average monthly remuneration in the business sector.
Also in this regard, the rules set out by the provisions are more relaxed for companies starting business activity and small taxpayers.
Ad 5) Types of business activity conducted, along with possible insolvency or bankruptcy
The new CIT scheme cannot be applied by financial undertakings within the meaning of the provisions on thin capitalization, loan institutions, and taxpayers who obtain exempt income from conducting business activities under special economic zones.
Furthermore, lump sum taxation is also unavailable to companies in liquidation and bankruptcy. It also means that for companies using lump sum taxation, initiation of liquidation or bankruptcy proceedings means return to taxation on general rules.
Ad 6) The way in which the taxpayer was established
The application of lump sum taxation is limited for entities established:
- through merger or division or
- by entities that made contribution-in-kind of assets acquired from shares as a result of liquidation of other taxpayers,
- by entities which in the first year of operation (establishment) of the taxpayer made contribution-in-kind of an enterprise or an organized part of an enterprise with the value exceeding the equivalent of EUR 10,000.
The taxpayers established in the ways indicated above cannot use the lump sum taxation for 24 months from the date of establishment.
This is also the case of companies established by way of partial division or contributed to other entities by:
- an enterprise or an organized part of an enterprise with a value exceeding the equivalent of EUR 10,000.
- assets acquired from shares as a result of liquidation of other taxpayers,
in the tax year of making the contribution, making the division, or in the following year, but not less than 24 months from the date of the division or the contribution.
Ad 7) Accounting principles applied
The method of determining the taxable base of income for the purposes of the lump sum taxation is the net profit determined for accounting purposes. Under the amended provisions of the CIT Act, the use of International Accounting Standards (IAS) in financial reporting by listed companies or those applying for admission to trading or by entities that are members of capital groups in which the parent company is seated in the European Economic Area, is a negative premise for applying lump sum taxation. This means that the tax base to be covered by lump sum taxation must be established pursuant to the Polish accounting provisions.
Ad 8) Notification of applying lump sum taxation
Application of the lump sum taxation scheme is subject to a prior notification made to tax authorities. The company has to submit a notification on the choice of lump sum taxation to the head of the competent tax office by the end of the first month of the first tax year in which the solution is to become applicable, using the template provided for by the decree.
The subject and basis of taxation according to the accounts
The general CIT regime in force assumes that, based on the properly kept accounts, taxpayers make necessary adjustments and deductions of revenues and tax-deductible costs as provided in the CIT Act. The actions performed result in the determination of a tax base (positive difference between revenues and costs), which may significantly differ from the financial result. The discrepancies between the accounting principles and the tax approach often raise many practical doubts and have been broadly interpreted in the light of the case-law.
The subject of lump-sum taxation will be income corresponding to the net profit determined on the basis of accounting regulations, divided between the partners, which will be distributed (through dividends), and has been earned during the lump sum taxation period (referred to as "income from distributed profit"), or net profit used to cover losses incurred before the lump sum taxation period (referred to as "income from profit intended to cover losses"). This also applies to advance dividends.
The following items will also be deemed income and taxed accordingly:
- income from unrealized gain, i.e. gain other than the income distributed among shareholders or entities associated with them or with the taxpayer (except for certain transactions),
- value of non-business expenditure (income from non-business expenditure),
- in the case of mergers, divisions, transformations or contributions made in the form of an enterprise or its organized part - surplus of the market value of the acquired assets over their tax value (income from changes in the value of assets),
- in the event of termination of the lump sum taxation period - undistributed net profit for the period in which the taxpayer used the lump sum taxation of income of companies (net profit income),
- income from undisclosed business operations, constituting the value of revenues and costs that, contrary to the obligation, have not been accrued and included in the calculation of net profit (loss).
Furthermore, the provisions provide for inclusion in the tax base of income earned abroad and tax on such income payable abroad, depending on the impact of these components on the net financial result achieved in Poland.
Settlement of the lump sum tax on company income
The tax rates in the Estonian model are set at:
- 15% - for small taxpayers and taxpayers whose average annual revenue does not exceed the maximum revenue threshold for small taxpayers (currently EUR 2,000,000),
- 25% - for the remaining companies that will qualify for and decide to apply the lump sum taxation method.
In the case of income from net profit, the rates may be reduced by five percentage points, in situations where the levels of capital expenditure provided for under relevant regulations are maintained.
Nevertheless, in the event of exceeding the revenue threshold, the regulations require from the taxpayer subject to lump sum taxation to settle the surcharge tax individually in the next tax year. In order to settle the surcharge tax, it will be necessary to calculate the surcharge tax base according to the formula specified in Article 28q(2) of the amended CIT Act. The surcharge tax on the base assessed in this manner will amount to 5%.
Additionally, new regulations provide for separate tax payment deadlines for each type of income.
Undoubtedly, one of the benefits of the solution consists in the possibility of settling the lump sum tax on net profit income and the possible surcharge in the period of up to 3 years, with the only additional requirement consisting in notifying the tax authorities about the choice of such a solution, the amounts due and payment dates.
Reporting and information obligations
Lack of current taxation does not come hand in hand with lack of reporting obligations. Just as in the case of CIT taxation under general rules, annual returns must be submitted by the end of the third month following the end of the tax year.
Additionally, by the end of the first month of each tax year, shareholders will be required to notify companies subject to lump sum taxation of their capital links, under fiscal penal liability. Entities with which the taxpayer (company) does not enter in any - even indirect - transactions, will be excluded from the scope of the notification obligation.
The above-discussed information obligation will also cover the requirement to inform the taxpayers on all changes in links. The taxpayer must be provided with this information by shareholders within a relatively short delay of 14 days. It should be also borne in mind that failure to comply with the information requirement will result in the company's obligation to present the matter before the tax authorities competent for the company and the partner or shareholder.
Taxpayers who opt for the Estonian CIT solution should perform a number of preparatory activities specified in Article 7aa of the CIT Act and be aware of special regulations pertaining to deduction of losses (and losing the eligibility to deduct them), if they occurred before the tax year in which application of the new CIT scheme begins.
Most of the preparatory activities consist in including in the tax result for the year preceding the use of the solution of tax revenues and costs (other than those excluded from tax revenues and tax deductible costs) which, under the accounting regulations, were previously included in the taxpayer's net financial result, but were not included in the CIT tax base (under general rules of taxation).
A solution which stirs a lot of controversy is the requirement to determine the income on transformation imposed on taxpayers who in the first year following the transformation decide to use the lump sum taxation. The problem will mainly concern those of the transformed taxpayers for which the market value of the assets will be significantly higher than the tax value, because the difference between these values (i.e. the excess of market value over tax value) will constitute the income from transformation. Overlapping of the provisions on Estonian CIT and the provisions extending CIT obligations to limited partnerships leads to the conclusion that the legislator's goal was rather to discourage the partners to the current limited partnerships from subjecting them to lump sum taxation after the transformation.
In fact, the amended provisions stipulate that losses incurred before the period of lump-sum taxation may be deducted from income retroactively in two tax years preceding the use of the scheme, provided that the period of lump sum taxation lasts at least 4 tax years.
Importantly, beginning of lump sum taxation translates into the taxpayer's divestment of the right to further deduct their losses. This means that taxpayers opting for application of the new CIT scheme will have two tax years (before applying the scheme) to use up their losses from previous tax years, provided that they have demonstrated taxable income for this period. The outstanding amount of loss will not be subject to deduction. Moreover, in a situation where the taxpayer makes a retroactive settlement of losses from previous years before being covered with lump-sum taxation, and the lump sum taxation period is shorter than 4 full tax years, the taxpayer will be charged with the obligation to correct the deduction of losses and thus pay the tax arrears increased by interest.
The principles of subjecting company income to lump sum taxation were presented herein in a rather general way. One may get an impression that the Polish approach to the Estonian CIT scheme is rather complex, even when compared to the already existing general rules of taxation. Undoubtedly, reducing the differences between the accounting and tax approach to economic events, deferring taxation until the earning is distributed, general support of investments with tax incentives and reduction of reporting obligations is a step in the right direction.
At the same time, the Ministry of Finance's approach to the new solution seems rather conservative or even focused on discouraging taxpayers from using it (as if the fear of possible abuses prevailed over the intention to support small and medium-sized enterprises). This finds its embodiment both the strict limitation of the group of entities entitled to use the solution, as a result of a number of special conditions (including the exclusion of the new class of CIT taxpayers, i.e. limited partnerships, frequently used by natural persons acting as partners), determining the income from transformation, limiting the deduction of tax losses from previous years, as well as limiting investments to fixed assets (thus excluding intangible assets), or finally the lack of specific incentives regarding intellectual property, despite the exclusion of the right to apply the IP-Box relief.
Thus, in the light of the interim provision providing for reduction of the lump sum taxation period in the years 2021-2024, the conclusion may be that the current form of 'Estonian CIT' is final and after the first couple of years of operation, depending on its reception by taxpayers, it may become subject of further amendments.
Despite immaturity flaws of the lump sum taxation scheme (and whether they will persist or not), the solution surely deserves taxpayers' attention, especially that it may prove more beneficial and less burdensome for SMEs investing in their development than taxation on general principles. Because of the complex preparation it requires, prior to selecting this method, companies and shareholders should perform thorough analyses to determine whether the new form of taxation will fit into the development strategy over a period of at least 4 years and whether it will ultimately turn out to be more beneficial than CIT taxation on general terms providing such incentives as R&D relief, IP-Box, or exemption on income earned on business activities in special economic zones.
Dariusz Wójtowicz, Manager Corporate Tax Advisory, KPMG in Poland