When paying dividends and interest to a foreign company, the firm that makes the payment has an obligation to verify who is the actual beneficiary of the payment. Above all, it must check whether the income tax will be paid within the EU. If not, the firm is obliged to deduct 19% or 20% withholding tax (WHT).
Companies must verify the eligibility of non-withholding tax
Companies paying capital profits to foreign entities must check if these profits reach the actual beneficiary of the payment and how the recipient will be taxed. This ruling was made by the Supreme Administrative Court in a verdict of January 31, 2023 (in case II FSK 1588/20). This position of the NSA shapes a line of court rulings that are unfavorable for holdings of foreign companies that utilize international organizational structures in their operations.
Structure of a holding of foreign companies without CIT and withholding tax
A Polish limited liability company (LLC), operating within an international holding of companies, held the position that it is exempt from the obligation to deduct income tax from legal entities when paying dividends and interest to a Cypriot holding company. The sole shareholder of the company in Cyprus is a company based on the island of Guernsey. Thanks to constructions of appropriate double taxation avoidance agreements, the Cypriot company was not paying CIT in Cyprus, and when paying out amounts to its sole shareholder in Guernsey, it did not have to subtract withholding tax.
According to Art. 21 para. 3c of the CIT Act, the exemption from income tax concerning payments from a source located in the territory of Poland within a holding of companies applies on the condition that the foreign holding company, which is the real beneficiary of the amounts, does not benefit from the exemption from income tax on all its income, regardless of the source of their income.
Dividend payment by a Polish company is not taxable in Cyprus
The Polish tax authorities established that such a construction of a holding of companies means that the payment of dividends and interest will not be taxed either with income tax or withholding tax within the European Union. According to statements by the Cypriot company, it is the actual beneficiary of dividends and interest paid by the Polish LLC. The representative of the Polish company argued that the Cypriot company meets the conditions for being exempt from CIT in Poland, as defined in Art. 22 para. 4 of the Corporate Income Tax Act. According to Cypriot law, dividends received by a shareholder from Polish companies are exempt from income tax in Cyprus provided that these companies do not include the paid dividends in their income earning costs.
The Polish company was convinced that as a payer when applying the exemption and not deducting withholding tax it does not have to investigate who is the actual owner on the recipient’s side and whether it is completely exempt from taxation in the country of its residence.
Authorities found that someone else is the beneficiary
Authorities have established, however, that the operations of the Cypriot company are financed by its sole shareholder – the company from Guernsey. Therefore, in reality, it’s not the company in Cyprus, but from Guernsey that is the actual beneficiary of the shares in the profits paid out, as it receives the payments from the dependent companies, including the Polish LLC. This company has a qualified management team, comprising of a 10-person board of directors, which makes strategic decisions in the holding of companies. And Poland does not have a Double Taxation Avoidance Agreement with Guernsey.
According to Polish regulations, the income tax on income from interest earned on the territory of Poland by foreign companies is 20% of their value, and from capital profits is 19%. The payer, or the company that pays out these interests and dividends, is responsible for their deduction.
Income tax on capital profits must be paid within the EU
In a verdict from July 5, 2023, the Lublin Voivodship Administrative Court referred to the NSA ruling. It repeated the NSA’s point that the aim of the EU directive 2011/96/EU on a common taxation system applicable in the case of parent companies and subsidiaries of different member states is to exempt dividends and other forms of profit distribution paid out by dependent companies to parent companies from taxes deducted at the source of income and to eliminate double taxation on the parent company level. Inconsistent with this aim is the situation of non-taxation of dividend payout made to a company from an EU or EEA member state, which, not being its actual beneficiary, merely mediates in transferring the dividend to the next company located in a tax haven. This does not lead to the elimination of double taxation, but to double non-taxation of the income source. The obligation to verify the status of the recipient imposed on the company paying the dividend serves to prevent abuse of double taxation avoidance regulations.
The mechanisms of the EU directive cannot be used contrary to their purpose. As assessed by the NSA, the Polish regulations that condition the eligibility of withholding tax (WHT) exemption in the case of the payer’s due diligence by checking whether the recipient of the amounts is their actual beneficiary are justified. It is permissible to benefit from this tax preference when the dividend payment is only made to an intermediary, who passes it on to the actual beneficiary, provided that this beneficiary is based within the EU or EEA. If the beneficiary turns out to be a company resident outside the EU, the exemption from taxation of a dividend payout in the EU country of its source would mean that, it would not be taxed at all within the EU. Guernsey does not belong to the EU.
Summary
Once again, the tax administration is shifting onto business owners the obligation to thoroughly investigate how their foreign partner will settle the received dividend with his tax authorities. However, primarily, this line of court rulings and the standpoints of tax authorities will make it impossible for entrepreneurs grouped in holdings of foreign companies to benefit from the tax exemption provided for in regulations. The requirements that authorities and courts expect companies to meet to use the exemption are not resulting from regulations. On the contrary, they are inconsistent with the EU directive on the common taxation system of holdings. Depriving entrepreneurs of relief, while other public burdens, employment costs and social insurance contributions are growing, may discourage foreign and domestic investors from doing business here. This will bring about a result contrary to that expected by the tax authorities, which is to increase tax revenues.
Author: Robert Nogacki, attorney-at-law, managing partner, Skarbiec Law Firm, specializing in legal, tax, and strategic consulting for entrepreneurs
