On 17 February 2021, the Ministry of Finance issued a general ruling on the admissible scope of amendments to lease contracts and recognizing revenue from selling the object of lease by the lessor during the term of the contract. It addresses the issues that have long raised numerous doubts not only among leasing companies but also entities using leasing services.
Problems associated with making amendments to lease contracts have long been the scourge of the Polish lease market, yet, in the times of the global COVID-19 pandemic, they are afflicting a growing number of entities. The long-awaited ruling is of particular significance to companies which, faced with the continued COVID-19 hardships, look for ways to reduce the running costs of business, e.g. by changing contract duration, amending or suspending lease instalments or selling the objects of lease. The ruling was issued pursuant to Article 14a(1)(1) of the Polish Tax Code, and, consequently, it grants taxpayers who invoke it a comprehensive legal protection.
Admissible scope of amendments to lease contracts – key considerations
Companies often face the need to modify the lease contracts while they are still in force. Up to now, persisting interpretation inconsistencies among the tax authorities gravely affected tax security of businesses which were forced to make such amendments, e.g. due to unfavourable economic situation. Companies tried to avoid amending lease contracts, out of concern that the changes would be perceived as made to material contractual provisions, and as such would lead to interruption of the original term of the lease contract.
Undoubtedly, the fact that the ruling provides for a list of amendments that can be made without prejudice to tax classification of operating or financial lease contracts is of great help to business. Specifically, the amendments can be made to the payment schedule. They may consist in:
- reducing lease instalments due by extending the term of the contract,
- increasing lease instalments due by shortening the contract duration (however, up to the period not shorter than 40% of the standard depreciation period for the object of lease),
- suspending instalments for a specified period,
- reducing instalments for a specified period,
- extending the term of the contract and reducing lease instalments due, with simultaneous suspension of payments for a specified period and
- increasing/reducing lease instalments after a specified period (by the value of the lease instalment principal).
Therefore, any changes to the terms of the contract (including the payment schedule) that do not impact the recognition of the agreement as an operating or financial lease contract and do not change the classification of the contract that would lead to converting one type of lease into another, are not only admissible but do not entail any additional re-assessment of the contract from the tax perspective.
At the same time, any amendment that would lead to converting one type of lease into another (i.e. change of classification of the contract) would be inadmissible, since the continuity of depreciation of the lease object for tax purposes may not be disrupted.
To sum up, if the parties to a lease contract want to amend it, they should first check whether the proposed modifications would in any way affect the contact's classification for tax purposes. In situations where the parties decide to amend the operating lease contract, they need to verify whether the amended provisions would meet the criteria set forth under Article 17b(1) of the CIT Act (Article 23b(1) of the PIT Act). Analogically, in situations where the parties decide to amend the financing lease contract, they need to verify whether the amended provisions would meet the criteria set forth under Article 17f(1) of the CIT Act (Article 23f(1) of the PIT Act).
Even though the new ruling dispelled some doubts as to the amendments to lease contracts, it should be kept in mind that the lease market, faced with new challenges, especially with deteriorating business situation induced by economic downturn, tries to accommodate the expectations of clients by amending the existing agreements and offering new lease products. Given the above, any potential amendment to lease contracts not covered by the ruling should be thoroughly discussed with a qualified advisor.
Lease contract assignment
The ruling also takes into account situations where the amendments come with the contract being taken over by a different party, through assignment or entering into a lease relationship (as a lessee or a lessor).
Pursuant to Article 17a(2) of the CIT Act and, analogically, Article 23a(2) of the PIT Act, if a contract is taken over by a different party or parties or amendments thereto are made, the original term of the lease contract shall be considered observed, unless other provisions of the contract have been amended. For many years, taxpayers have struggled with proper interpretation of which contractual amendments should be identified as changes to “other provisions of the contract”.
Fortunately, the term “other provisions of the contract” used in Article 17a(2) of the CIT Act (and Article 23a(2) of the PIT Act) was clarified by the Minister of Finance in the new ruling. Under the ruling, other provisions of the contract shall mean only those contractual terms that determine legal existence of the contract in the context of income tax. Thus, an amendment made to “other provisions of the contract” means only such an amendment, as a consequence of which the contract would no longer meet the conditions for being considered a lease contract for tax purposes.
It should be stressed that tax classification of a lease contract is not affected by those amendments, which are of importance from the civil law point of view, including amendments made to:
- collaterals of lease contract,
- contact details of the parties,
- principles of charging the lessee with additional fees, except for fees that may arise during the term of the lease contract (this applies in particular to cases where the rights and obligations of the lessee will be entered into by an individual running a sole proprietorship).
In summary, amendments to lease contract provisions (including the payment schedule), combined with the contract being taken over by another party through assignment or entering into a lease relationship (as a lessee or a lessor), which do not affect the classification of the contract for tax purposes, are admissible. Furthermore, amendments to lease contract provisions important from the civil law perspective and involving the contract being taken over by another party (e.g. changes of contact details) do not affect tax classification of the lease contract and do not constitute amendments to “other provisions of the contract”, referred to in Article 17a(2) of the CIT Act.
Sale of the object of lease by the lessor
The last of the issues addressed by the ruling are tax consequences of selling the object of lease by the lessor during the term of the contract.
Transfer of ownership to the object of lease during the term of the contract brings a change of one party to the contract, i.e. the lessor. Furthermore, sale of the object of lease gives rise to the obligation to determine the revenue earned by the lessor from the transfer of ownership to the object of lease to the new lessor, i.e. to verify whether the revenue from the sale of the object of lease is equal to the value of the principal not yet paid by the lessee.
Pursuant to Article 14 of the CIT Act (Article 19 of the PIT Act), revenue from the disposal of tangible property or property rights against payment shall be their value expressed in the price specified in the agreement. However, if the price differs substantially from the market value, the revenue shall be determined on the basis of the market value.
Interpretation of the provision presented above is rather problematic, especially in the case of transactions consisting in sale of the object of lease by the lessor for an amount corresponding to the value of the principal still not paid by the lessee, yet higher than the market value of the object of lease. The issue of how to properly define the market value for an object which cannot be freely disposed of by the owner (lessor), since its use is limited by the rights of the lessee, including the right to transfer ownership to the lessee for a price specified in the contract, has been at the heart of a debate, in which the standpoint of many advisors was that the unpaid capital should be taken into account when determining the market price of the leased asset.
In this regard, the Ministry of Finance makes a reference to the ruling of the Provincial administrative court in Warsaw of 9 June 2016 (case file III SA/Wa 1674/15), pursuant to which adopting a position on the necessity to determine the assignor's income at a value equal to the market price of the item, solely based on the premises of Article 14 of the CIT Act would bring with it the risk of non-repayment of the item's initial value by the user.
As a result, according to the Ministry’s opinion expressed in the ruling, in the case of sale of the leased asset by the lessor during the term of the lease contract, the lessor’s revenue will be the value expressed in the price specified in the contract, whereas if the sale price is at the level of the principal not paid by the lessee, it should be considered to be in line with the market value.
Anna Sęk, Manager, Tax FS Department, KPMG in Poland
Patrycja Deredas, Tax Consultant, Tax FS Department, KPMG in Poland