2017 Transfer Pricing Provisions of the CIT Act: Related Entities

On January 1, 2017, new regulations came into force that impose additional reporting obligations on companies. Specifically, they introduce documentation requirements on transactions between related entities. These amendments to the Corporate Income Tax Act (further: CIT) incorporate the regulations developed by the European Union and the OECD.

According to the new provisions, entities, whose capital ties are greater than 25% (an increase from the 5% requirement through December 31, 2016) and whose revenues or costs reached € 2 million in the previous year, must prepare current transfer pricing documentation. They must document related party transactions that have had a material impact on the amount of their income or loss. The reporting obligation is also imposed upon entities transacting with entities registered in tax havens.

Under art. 11(1)(1)(1) and 11(1)(1)(2) of the CIT Act, a related entity is defined as one where a natural person, legal person, or entity without legal personality participates directly or indirectly in the management or control of a business entity or is a shareholder of not less than 25% in the capital of such business entity (art. 11(5a) CIT). This provision applies to both foreign companies that operate outside the territory of Poland as well as to domestic companies that are either registered or headquartered in Poland or to those whose principal place of business (from where its officers conduct the company’s important business) is located in Poland as well.

Businesses may also be deemed related where the same natural person, legal person, or entity without legal personality concurrently participates either directly or indirectly in the management or control of a domestic and foreign entity or is a shareholder of not less than 25% of such entities (art. 11(1)(3) CIT and art. 11(5a) CIT). Similar provisions apply in establishing whether two or more domestic entities are related (art. 11(4)).

Furthermore, to determine the value of an entity’s indirect shareholding in the capital of another entity, the following principle is followed: if the first entity holds a shareholding in the capital of a second entity and the second entity holds the same share in the capital of a third entity, the first entity then holds an indirect share in the capital of that third entity. Where these values are different, the value of the indirect shareholding will be the lesser or the two (Article 11 (5b) CIT).

Additionally, in the context of transfer pricing documentation, foreign entities transacting with a permanent place of business of their own located in the territory of Poland as well as domestic companies transacting with a permanent place of business of their own located outside the territory of Poland are also considered related entities and are subject to the transfer pricing documentation obligations (art. 9a(5a) and (5b) CIT).

Accordingly, the following entities are considered related entities under the CIT Act:

A) International relations

1. a natural person, a legal person, or an entity lacking legal personality that is registered, headquartered, or whose principal place of business is in Poland (domestic entity) directly or indirectly participates in the management of an entity located outside of Poland (foreign entity);
2. the domestic entity participates directly or indirectly in the control of a foreign entity,
3. the domestic entity owns, directly or indirectly, at least 25% of the share capital of the foreign entity,
4. the foreign entity participates, directly or indirectly, in the management of the domestic entity,
5. the foreign entity participates, directly or indirectly, in the control of the domestic entity,
6. the foreign entity holds, directly or indirectly, at least 25% share in the capital of the domestic entity,
7. the same entity concurrently participates, directly or indirectly, in the management of a domestic entity and a foreign entity,
8. the same entity concurrently participates, directly or indirectly, in the control of a domestic entity and a foreign entity,
9. the same entity concurrently owns, directly or indirectly, at least 25% share in the capital of the domestic entity and foreign entity.
10. foreign entity transacts with a permanent place of business of their own located in the territory of Poland,
11. domestic entity transacts with a permanent place of business of their own located outside the territory of Poland.

B) Domestic relations

1. the domestic entity participates, directly or indirectly, in the management of another domestic entity,
2. the domestic entity participates, directly or indirectly, in the control of another domestic entity,
3. the domestic entity owns, directly or indirectly, at least 25% of the share capital of another domestic entity,
4. the same entity concurrently participates, directly or indirectly, in the management of two or more domestic entities,
5. the same entity concurrently participates, directly or indirectly, in the control of two or more domestic entities,
6. the same entity concurrently holds, directly or indirectly, at least 25% share in the capital of two or more domestic entities,
7. there are family ties between the domestic entities,
8. there are employment ties between the domestic entities,
9. there are property ties between the domestic entities,
10. the entities are related where the management, control, or supervisory functions arise from the employment or property ties between the entities.
11. any entity that centralizes the management, control, or supervisory functions of two or more domestic entities.

Nevertheless, courts are still addressing uncertainty surrounding related entities.  As recently as June 30, 2017, the Director of the National Tax Information published an individual interpretation (case no. 0114-KDIP2-2.4010.79.2017.1.AZ ) clarifying which entity – the entities forming a Tax Capital Group (PGK) or the PGK itself – is responsible for preparing transfer pricing documentation with respect to transactions between PGK members and non-member related entities. In its application for the individual interpretation, the applicant argued that the responsibility to prepare the transfer pricing documentation should fall on the individual PGK members and not the PGK itself.

According to the applicant, although a literal analysis of the provisions of the CIT Act regarding PGKs leads to the conclusion that the PGK is a CIT taxpayer, the formalities required by the transfer pricing provision could not be satisfied by the PGK itself because it is generally created solely for corporate income tax settlement purposes. Specifically, the applicant argued that in situations where the individual PGK members transact with non-member related entities, the PGK itself does not suddenly become a related entity to those non-member entities. This is because it does not have the legal capacity to do so.  It doesn’t hold any shares in the capital of the non-member entity; it doesn’t  participate, directly or indirectly, in the management of the non-member entity; it doesn’t have any voting rights among the non-member’s shareholders or board members; nor does it have the right to participate in the profits of the non-member. Thus, whereas the PGK members themselves may possess such rights in non-member related entities, the PGK itself does not have the legal capacity to do so.

The Director of the National Tax Information did not agree with the applicant.  Instead, the Director opined that because the PGK is the CIT taxpayer for the group, as opposed to the individual entities forming the PGK, and because the transfer pricing provisions explicitly refer to transactions or other events affecting the taxpayer’s income (loss), (i.e., the PGK as a whole and not the individual entities that form it), the transfer pricing documentation concerning transactions between PGK members and non-member related entities should be prepared by such entity as indicated by the provision – the taxpayer. Because, under the CIT Act, the PGK is the taxpayer is and not the individual entities that form it, that should be the entity onto which the responsibility to prepare transfer pricing documentation should fall. For these reasons, the Director argued, the applicant’s argument was incorrect.

This example highlights the importance to seriously consider each element of a given provision within the tax code as uncertainty may be lurking in what may appear to be the most unambiguous provision.