Tax optimization through tax capital groups: Criteria for illegitimacy

In this optimization scheme, there are a number of circumstances that point to the illegitimacy of such transactions and indicate that the objective was to obtain an undue tax advantage (i.e., to avoid taxation on the income derived from Company A’s asset sale, which income it subsequently transferred to Company B via donation).

Such circumstances include, but are not limited to, the following:

1. Entity restructuring, preceding the sale of assets, to a more complex business structure with intermediary involvement in transactions despite the lack of economic justification;
2. Related entities or fiscal ties between the entities participating in the transaction, i.e. Companies A, B and C;
3. Carrying out transactions with high administrative costs and business or legal risks that do not suggest any economic benefits to the parties other than tax avoidance;
4. A company disposing all of its assets (or its key components) without obtaining any economic equivalent in exchange or benefit other than a tax advantage;
5. Lack of actual financial transfers (donating receivables);
6. Performing transactions over a short period of time; the effect of which cancels each other out (establishing a PGK for a period of 3 years and then dissolving it after a period of several months).

Commentary regarding points 1-3: Introducing the Intermediary

In the scheme discussed by the MF, Company B (stage 1) and Company C (the purchaser of shares in  a shell company, Company A, in stage 4) would be introduced to the share structure in the period immediately preceding the sale of Company A’s assets. Company B and Company C would be companies previously associated with Company A or the Shareholder.  They would also be companies acquired for the purpose of the transaction (e.g. from a consulting company, which is advising on this optimization).

In the above mentioned exchange of shares in the period preceding Company A’s planned sale of assets, the parties to this transaction would face a number of difficulties and costs such as the following:

• Problems and costs associated with the legal share exchange (adoption of relevant resolutions in the form of notarial deeds, valuation of Company A, registrations in the National Court Register, etc.);
• Problems and costs associated with the renegotiation of Company A’s bank loan. Credit agreements usually require the bank’s prior consent to change the debtor company’s shareholder(s). This may involve changing or setting up additional collateral (such as pledges on shares, shareholder warranties, etc.), bank commissions, etc.
• Typically, the introduction of Company B into the structure would further impede Company A’s dividend payouts to the Shareholder (requiring a two-stage dividend distribution).

It would be unreasonable for a business entity to undertake actions where the difficulties and costs associated with such restructuring outweigh the potential economic benefits. In the cases analyzed by the MF, it was difficult to indicate any benefit from such share exchanges other than an artificial reduction of Company B’s income by the net loss resulting from the sale of Company A’s shares at stage 4, when Company B sold Company A’s shares at a very low price (e.g. PLN 1 – as a result of Company A being a „shell company”).

This may suggest that rational economic reasons did not warrant introducing an intermediary (Company B) nor a purchaser of shares in a „shell company” (Company C).  It can thus be deduced that, by creating illusory costs to offset against income from the sale of shares, such actions were undertaken for the purpose of tax avoidance.

 

Commentary regarding points 4-5: Donation within a PGK

Company A would sell all of its assets and, immediately after the sale, donate the proceeds from the sale.   In doing so, Company A would become a shell company.

In effect, Company A transferred all of its assets to another company without being duly compensated. Normally, when dealing with arm’s length transactions, the corporation’s board of directors would not make such business decisions as they could harm the company. This is a blatant example of engaging in transactions for purposes other than economic gains.

In some cases, the MF recognized even more factors suggesting the illegitimacy of the donation agreement. Sometimes, the donation and sales agreements were not only signed at the same time, but the donation agreement itself was, at times, formally linked to the sales contract (the donation was conditional on the sale of the property). Sometimes, the donation was comprised of not only the cash obtained from the sale, but the price receivable (donation of receivables); such donations did not even require cash transfers between companies A and B. Thus, Company A would be legally deprived of any real proceeds from the asset sale from the outset, as its receivables would have been previously donated to Company B.

Commentary regarding point 6: Abuse of PGK regulations

As part of the activities preceding the asset sale, Companies A and B would sign an agreement creating a PGK. According to the tax regulations, a company may establish a PGK for not less than 3 years by signing a civil law agreement in the form of a notarial deed; there must be at least two companies involved in the PGK. The laws governing PGKs allow for the group members to file their CIT together and also provide for some documentation simplification; however, PGKs do not benefit from any special tax exemptions.

Following Company A’s sale and its donation of income to Company B, the PGK would then be terminated; this usually occurred only a few months after the PGK’s establishment at Stage 2. Thus, the basic legislative purpose of forming a PGK, namely the member companies’ joint settlement of income tax for a period of 3 years, would not fulfilled.

It should be pointed out that, creating a PGK requires certain formalities to be adhered to. The MF’s analysis of individual optimization cases indicated, however, that in certain situations, Companies A and B may even have additional difficulties or negative consequences associated with the establishment of a PGK:

• the need to conclude a contract in the form of a notarial deed and notify the tax office in advance; obtain a PGK registration decision;
• in PGKs that were formed during the tax year, Companies A and B will need to file their individual taxes for the tax year as there is an obligation to prepare a tax return for the day preceding the formation of PGK and submit a CIT-8 declaration;
• no possibility of settling A’s and B’s losses during the PGK’s lifetime.

The above difficulties or burdens, in particular the inability to settle losses that could have been very great in some instances, would outweigh any possible benefits that could arise from the formation of a PKG for the purpose of simplifying tax settlements.  This is especially true considering the fact that the PKG would be dissolved within several months.

The MF thus concluded that the PGK tax regulations were violated in those cases where the group was formed for the execution of a specific economic transaction (i.e. the sale of assets by Company A combined with a donation to Company B resulting in a transfer of income between Companies A and B within the PGK for the purpose of tax avoidance).

Consequences

The Ministry of Finance warns that the transactions described above may be subject to the anti-avoidance clause of Article 119a of the Tax Ordinance. The circumstances relating to a sequence of operations carried out over a short period of time (e.g. several months) may indicate the illusory nature of the participating entities and that the restructuring was primarily engaged in for the purpose of obtaining a tax advantage, which is contrary to the objective and purpose of the tax act.

In each individual case, the control bodies will make an independent assessment using all available evidence. If it is determined that the transactions were illegitimate, the control bodies will determine the consequences by applying the anti-avoidance clause and deprive the taxpayer of any tax advantage that may have been unduly received.

Irrespective of the above, depending on the circumstances of each individual case, each individual operation carried out under this optimization scheme may be governed by other provisions of the tax code that may themselves bring into question whether the sole intention was to achieve an undue tax advantage as well as whether the transaction was legitimate.

The circumstances involved in the drafting and signing of a civil law agreement forming a PGK may also be assessed in light of Art. 199a of the Tax Ordinance.  This article allows the tax authority to consider not only the contract provisions themselves, but the extrinsic evidence as well, including the intent of the parties and its purpose. If evidence is found that, from the outset, the intent of the parties had not been compliant with the statutory requirement of forming a PGK for a period of at least 3 years, the PGK registration decision, as well as any tax obligations or benefits resulting from its formation, may be called into question.  (e.g. with respect to the donation).

As a result of operations carried out without any justified economic reasons, a special anti-avoidance clause, Art. 22c of the CIT, may be invoked to deny a tax exemption for the disbursement of profits to foreign shareholders participating in the profits of legal persons.

Furthermore, it should be noted that these financial gains would be recognized from the sale of real property located in Poland. Under the provisions of the bilateral double taxation avoidance agreements and the provisions of national law, any profits earned from the sale of immovable property in Poland should be taxed in Poland. In the event the tax effects of the transactions between Companies A, B, and C are called into question, there may be grounds to determine that the profits disbursed to a foreign shareholder are subject to taxation in Poland because such profits were earned from the sale of immovable property located in Poland.

Individual interpretations in optimization schemes

An analysis of the various optimization schemes shows that, in many cases, companies would obtain individual interpretations based on identical factual backgrounds, i.e. the taxpayers’ certified questions were identical and included identical facts. In many cases, interpretations were also requested by “companies in organization” or companies not yet engaged in any activity.  The interpretation would then be „delivered” to an entrepreneur who would then decide whether to implement the optimization (described in MF warning number 002/17 issued on May 22, 2017).

It should be emphasized that both business restructures and key asset disposals are,  in principle, unique; there are no two large companies that would operate identically and possess identical assets. It’s highly questionable when several dozen/hundred certified questions pertaining to such unique transactions (e.g., a combination of real estate sales and donations within PGK or the sale of an undertaking referred to in MF warning No. 002/17) are identical to those filed by other entrepreneurs, even those in different industries, and which certified questions do not consider such anomalies and their consequences for the taxpayer. This method of obtaining an interpretation raises doubts as to whether the description of the situation (factual or future event) presented in this type of „wholesale produced” certified question actually reflects the operations involved in a particular transaction by a specific entrepreneur. Individual interpretations, as the name suggests, are intended to clarify to a specific entrepreneur the tax consequences of a particular transaction when the application of the tax code is unclear to said entrepreneur.

Under the applicable laws, the application for individual interpretation should provide a detailed description of the facts; an interpretation will only be binding on the tax authorities if the factual description was consistent with reality. For this reason, the Ministry of Finance advises that entrepreneurs, who in recent years have sought individual interpretations for the purpose of implementing tax optimization schemes or have acquired companies with interpretations for specific optimization (through a PGK or any other method, specifically those identified in MF warning No. 002/2017), review those interpretations for specificity. If these interpretations were made on the basis of certified questions that were prepared in a wholesale manner for use in various optimizations, the situation presented therein might not necessarily correspond to the actual operations involved in executing a particular transaction, and consequently, the individual interpretations may not be binding.  In such circumstances, it is advisable to adjust the tax returns and pay any tax arrears that may be due prior to the tax authority commencing control proceedings contesting the optimization transaction to avoid any negative consequences resulting therefrom.

The above remarks do not apply to transactions that are common or repetitive, or where the parties to a single transaction file identical motions for interpretation. Naturally, such circumstances justify an individual interpretation issued on the basis of similarly drafted applications/certified questions.

The following publication is an English version (translation) of a warning against the use of tax capital groups (PGK) for aggressive corporate income tax (CIT) optimization issued by the Ministry of Finance on June 26, 2017 (source: www.mf.gov.pl)