1 January 2021 brought a number of major amendments to the Polish CIT Act. One of the most commented solutions they offer are undoubtedly the extension of CIT obligations to limited partnerships and introduction of the Estonian CIT, both of which have been thoroughly analysed in this issue of CIT Point Magazine.
Meanwhile, the legislator, without much publicity, introduced even more changes being of equal importance to taxpayers, such as restricted right of settling tax losses by entities taking part in reorganizing activities.
Pursuant to Article 7(2) of the CIT Act, if the tax-deductible costs exceed the sum of revenues from a given source, the difference constitutes a tax loss. In subsequent years, the taxpayer is entitled to offset the loss previously incurred under a given source of income against the profit constituting the taxable base. In principle, the loss may be settled in five tax years following the year in which it was incurred. Nevertheless, under the applicable provisions, the deduction in any of the years may not exceed 50% of the loss amount. In 2019, the regulator introduced a taxpayer-facing solution, consisting in the possibility to offset a loss in the amount of up to PLN 5m in any of the five subsequent tax years. If the taxpayer's loss exceeds the amount indicated above, its outstanding amount should be settled on general rules, i.e. further deduction in any of the tax years may not exceed 50% of the loss amount. It should be emphasized, however, that this solution relates solely to losses incurred since 2019.
Simultaneously, the provisions of the CIT Act in force so far provided for certain restrictions on the possibility of reducing the tax base by the value of losses incurred in the past, imposed, inter alia, on companies involved in various reorganization proceedings. Pursuant to Article 7(3)(4) of the CIT Act, the losses incurred by entities which have been transformed, merged, acquired or divided, in a situation where a change of legal form, merger or division of entities takes place, shall not be taken into account when determining the tax base. This, however, did not apply to companies transformed into other companies (e.g. a limited liability company transformed into a joint-stock company).
Furthermore, this meant that merged companies (in mergers by formation of a new company) and acquired companies (in mergers by acquisition) lost the possibility to offset the losses incurred. Nevertheless, the restrictions did not apply to losses incurred in the past by the acquiring company in a merger by acquisition.
Notwithstanding the above, it should be emphasized that the very fact of excluding the possibility of recognizing tax losses by merged and acquired companies constituted a significant breach of the doctrine of universal succession.
However, the regulations in force so far in no way limited the possibility of recognizing losses by taxpayers who made or received contribution-in-kind of an enterprise or its organized part.
The amended provisions imposed significant constraints on settling tax losses by entities taking part in reorganizing activities. This is because the list of instances in which tax losses cannot be deducted, following the reorganizing procedures, got importantly extended by the legislator.
Pursuant to the amended regulations, in force as of 2021, the limited possibility of settling losses resulting from restructuring activities will also apply, in some cases, to acquiring companies. Pursuant to Article 7(3)(7) of the CIT Act, when determining the tax base, the taxpayer may not recognize the loss incurred, if the reorganization proceedings in which they were involved resulted in:
Moreover, as a result of the actions taken, one of the following conditions has been met:
a. following such purchase or acquisition, the scope of the core business activity actually carried out by the taxpayer became different, in whole or in part, from the scope of the core business activity actually conducted by the taxpayer prior to such purchase or acquisition, or
b. at least 25% the taxpayer's shares are owned by the entity or entities that did not have rights thereto at the end of the tax year in which the taxpayer incurred a loss.
Therefore, the new provisions will apply to those restructuring proceedings which result in changing the object of business of the acquiring company or the shareholding structure of the acquiring company. According to the Ministry of Finance, the goal of the amendments is to take away the right to settle tax losses from entities that have carried out reorganisation proceeding for economically unjustified reasons. For example, if, within a capital group, the parent company takes over a daughter company without changing its business profile (at the same keeping the existing shareholding structure), it will still be entitled to settle the loss.
Despite the explanations provided by the legislator, one can get the impression that, although aimed at entities engaging in reorganization proceedings for the sole purpose of achieving tax advantage, the newly introduced limitations on offsetting the loss may backfire on entities performing economically sound transactions.
In the context of premise no. 1 (relating to a change in the scope of actually performed business activity), the situation when, as a result of a merger or receipt of an in-kind contribution, the object of the taxpayer's activity changes only partially, may bring many practical challenges. Should such a situation arise, the limitations will apply only to transactions in which the scope of activity of the acquiring company (receiving the in-kind contribution) remains practically unchanged and gets expanded only to a small extent with the acquired assets (which may be justified by the synergy of both types of activity). Under the new regulations, the taxpayer will be denied the right to settle its own loss from previous years, even if the income declared in the given year derives in 100% from the activities carried out before the transaction. This, in turn, seems to support the thesis on the legislator's excessive interference with the rights of taxpayers undertaking reorganization activities for economically justified reasons.
On the other hand, the second premise for the application of the new provisions (referring to changes in the acquiring entity's shareholding structure) seems particularly unfavourable from the perspective of downstream mergers. Downstream mergers involve a subsidiary taking over its direct shareholder and are used, inter alia, to simplify organizational structure in capital groups. A characteristic feature of downstream mergers is that the shareholders of the acquired company receive shares in the subsidiary, being the acquiring company. In most cases, this will mean meeting the condition, pursuant to which at least 25% the taxpayer's shares are owned by the entity or entities that did not have such rights at the end of the tax year in which the taxpayer incurred a loss. Thus, even if a downstream merger is performed for economically justified reasons, the acquiring company will lose the right to offset the tax losses incurred.
Another issue relates to periods covered by the new regulations. A question arises whether the reorganization proceedings that took place before the effective date are covered by the scope of the new provisions. Unfortunately, the legislator did not take into account the demands for inclusion of interim provisions made during the bill consultation phase. During the consultations, the Ministry of Finance stressed its intention to apply the new restrictions also to the restructuring proceeding that took place before the amended regulations entered into force.
Restrictive approach adopted by tax authorities is likely to translate into numerous disputes between taxpayers and authorities to be settled by administrative courts. In this context it must be noted that such a stance is in clear opposition to the principle of protection of the taxpayer's acquired rights exhibited in the jurisprudence of the Polish Constitutional Tribunal.
According to the explanatory memoranda, the goal of the restrictions is to eliminate restructuring operations aimed at artificially inflating the taxpayer's losses in order to reduce the income generated by another enterprise. According to the legislator, the scope of regulations prohibiting the settlement of the loss of the acquired company was too narrow, since it provided for the possibility to use of optimization structures in which entities incurring losses, where the possibility of obtaining income from activity in subsequent years was rather doubtful, acquired another enterprise (or its organized part) which in turn allowed to reduce the original entity's tax base on profitable activities.
While the arguments presented by the authorities is convincing, the scope of the regulations aimed at counteracting optimization practices seems rather excessive. In fact, by introducing the amended provisions, the legislator 'throws out the baby with the bathwater': on the one hand, it restricts activities aimed at artificial lowering of the tax base, on the other hand, the solution it offers have grave impact on entities engaging in reorganization proceedings for legitimate business reasons, especially in terms of downstream mergers, which by their very definition are covered by loss settlement restrictions provided for by the new regulations. An important flaw of the new solution is the lack of interim provisions that would clearly indicate the timeframes to which the introduced regulations apply. The above-mentioned issues will most likely have a negative impact on the taxpayers' willingness to get involved with restructuring proceedings, even those having sound economic justification, which may have grave implications in the post-crisis reality.
Marcin Michna, Manager, Corporate Tax Advisory, KPMG in Poland
Maciej Kopycki, Consultant, Corporate Tax Advisory, KPMG in Poland