Establishing links for transfer pricing – personal links, practical problems, planned changes – part 2

This Article provides for second Part of the regulatory analysis on the rules for establishing links for determining transfer pricing tax documentation obligations. Parts first 1 the capital links, part of the second It is devoted to other types of links, as well as, in view of the intensive legislative work to be carried out, to the legislation on links in the light of the bill on amendments to the Income Tax Act[2].

Introduction

As mentioned In the first part of the article, under the current rules Article 11 Corporate Income Tax Act (hereinafter: the Corporate Income Tax Act) 3 and Article 25 Income Tax Act on Individuals (hereinafter cf. 4 can be distinguished two essential types of links, i.e.

Capital and personal links, with (a) management and control links (b) resulting from employment relationship; (c) property; (d) family.

As far as territorial scope is concerned, in the current state of the law only the management and control links have international scope, while other personal links should be considered only on national grounds.

Management and control links

This kind of relationship has been formulated in tax laws in a quite general way – we deal with it whenever a person participates in the management or control of another entity. A practical interpretation of this very sparingly constructed provision leads to the conclusion that having such participation or control can take various forms. The most obvious seems to be the fact that the board of directors or the supervisory board of the company, but, in addition, the following situations may, for example, be identified:

• acting as a prosecutor;
• representation as a proxy;
• combining the functions of a member of the Management Board with that of the Supervisory Board/Procurator/Proxy of another entity;
• a civil-law entity management agreement.

As can be seen from the above calculations, personal links are a rather vague category to identify; the most helpful interpretive indication is that we should examine whether, in the context of a given relationship, there is a real possibility of influencing management activities, current activity, business decisions in a given unit.

The situation is even more complicated if we take into account the fact that, under the current provision, it is possible to establish a management and control link in the indirect option. The legislator's authorisation of this possibility results in particularly cumbersome doubts about the existence or non-existence of the link. There is no indication as to which interpretation direction should be pursued by seeking links from this category.

When analysing interpretative approaches, an attempt can be made to identify for the purposes of the provisions in question the fact of holding a share of capital with the possibility of having influence.

This would mean that a person with an adequate share of the capital (most prominently in the case of holding a control package) has the possibility to exert such a real influence and thus forms between the person concerned and the entity's management and control relationship.

However, this is a minority view, which is somewhat contrary to the system interpretation of the rules under consideration, in which a separate category was introduced for links resulting from the fact of participation – literally separated from links by participation in management or control by means of an alternative separated by a ‘or’ combination.

Such reasoning was confirmed by the Provincial Administrative Court in Warsaw in its judgment, in which it was explained that ‘the use of a ‘or’ combination indicates that taking part directly or indirectly in the management of an undertaking located outside the territory of the Republic of Poland or its control is not equivalent to participation in capital’ 5 .

Relationships resulting from employment relationship

Such links are rarely identified or analysed by taxpayers, but may be of great importance. The need to identify them is due to regulations which refer to the types of links referred to above: ‘The provisions ... shall also apply to family or employment or property relationships (...)’ 6 .

The legislator therefore pointed to the employment relationship without defining it in any particular way for the purposes of the tax law, which means that labour law should be referred to in this respect. This would mean that benefits provided on the basis of civil law contracts (e.g.

works contracts), cooperation agreements between the self-employed person and the entity should not result in a personal link being established.

Relationships with the employment relationship should therefore be identified, paying attention to existing relationships between the employee and the employer – at least after one there will always be a natural person on the pages. Relationships resulting from employment relationships can be considered two planes: after first, by analysing the bilateral relationship between the employee and the employer unit, second, noting the relationship between the entity in which the employee is employed and the employer’s unit.

In the first we would have to identify the link and, consequently, examine the market nature of transactions carried out directly between the employee and his employer, but rather not the obligation of taxpayers to care for the market level of remuneration for work, but for any other transactions, e.g. performed in person outside the employment relationship to the employer or the benefits of the employer to the employee.

In practice, however, it is more interesting second that case, concerning benefits provided between the entity in which the employee is employed and the entity of the employer, e.g.

when the person acting as the director of the division in Company A on the basis of the employment contract is also a member of the management board of Company B, and between these companies a purchase transaction of production materials from B to A is carried out.

In this case, companies A and B should be identified as related entities (as a consequence, to examine the marketability of the purchase of materials for production and to draw up tax records after meeting other conditions).

On the basis of the existing votes in the literature of the subject and the case law, it should be pointed out that in the case of links resulting from the employment relationship, the key aspect is also the possibility of having an influence on the decision-making of the individual in the case of the employee concerned.

If, in this example, the person employed as Director may have such an effect on the decisions on the acquisition of Company A and at the same time it is clear that, as a member of Company B's management board, it also affects second a party to the transaction, it should not result in an identification of the link if the job does not involve the exercise of decision-making functions.

Family relations

As with the links arising from the employment relationship, the issue of defining family ties has been solved by the obligation of taxpayers to apply the provisions on other links properly. Tax laws do not properly provide any guidance on how to seek these links.

In implementing regulations 7 it was pointed out, however, that family relationships must take into account the relation or affinity to second grade. As with the aforementioned categories of links, in view of the objective of the said regulation, it is appropriate to examine the effect on transactions of being related or related.

This means that it is necessary to consider situations in which transactions between entities in the sphere of influence resulting from the indicated relationship may be carried out.

Thus we can rename at least two the types of situation encountered in practice:

where family ties give rise to the possibility for individuals to remain in the sphere of mutual influence in which "related" persons have practical decision-making powers (impacts), e.g. Jan Kowalski is President of Company A and the wife is a member of the supervisory board of Company B,
when the relation or affinity is related to transactions in which the party may be related or related, e.g. company A, whose president is Jan Kowalski, buys production materials from Andrzej Kowalski – the brother of Mr Jan. However, in the case of such dependence, it is crucial to determine whether a person’s personal service falls within the scope of his economic activity.

In practice, establishing family relationships requires a very good knowledge of the family relationship of persons associated with the company and in many cases their identification depends on the disclosure of such information by the directly involved persons.

Property relationships

Such links may appear to be a category similar to capital links, given the fact that there is a certain property and its common ownership.

However, holding shares directly or indirectly in other entities should be left to the extent discussed In the first Part of the capital link, while in the case of property links, attention should be paid to the property held by the common ownership.

The most characteristic feature of the property relationship is, for example, the co-ownership of real estate, e.g.

if A and B companies with common ground (in the absence of any other links) carry out transactions involving the transfer of equipment, then it may be necessary to examine the level of marketability of the prices used in such a transaction due to the existing asset relationship.

When discussing cases of personal, management, family and property relationships, it is clear that these links are intertwined.

The above examples show that for the purpose of establishing the existence of links from the group concerned, different configurations should be taken into account, such as those in which Company A, as a result of the decision of the President, sells a fixed asset to the son of the President of Company B, who is also vice-president of Company A.

Despite the lack of a direct relationship, there is a risk of a real impact through indirect management and family ties. Unfortunately, the lack of legal definitions, as well as very modest case law in this area, creates great uncertainty about identifying specific aspects of this type of situation.

Relationships in the light of draft amendments to the Income Tax Act

In view of the ongoing legislative work, it is worth noting the planned changes in the definition of the links to take place after the entry into force 1 January 2019 Act amending the Personal Income Tax Act, the Corporate Income Tax Act and certain other acts 8 (the Amending Act).

This law provides for the introduction of new chapters on transfer pricing to each income tax law. In an attempt to systematize this issue, the project's authors included a short vocabulary 9 , in which the following conceptual definitions may be relevant for the identification of links:

the entity — means a natural person, a legal person or an organisational unit without legal personality, including a foreign establishment;
related entities — this means:

(a) entities from which one the entity has a significant influence on at least one another entity,

or

(b) entities with significant influence: the same other entity or spouse, relative or related to second the degree of natural person having a significant influence on at least one entity,

or

(c) a company not having legal personality and its partners,

or

(d) the taxable person and his foreign establishment;

links - this means relationships between related parties; In the context of the above definitions, the concept of significant impact will therefore be a key factor in the interpretation of the new rules. As indicated in the explanatory memorandum to the draft law, the concept of significant impact is a key element of the definition of related entities, which constitute one of the conditions of the relationship between two or more entities.

The legislator also attempted to clarify the new provision, specifying what situations would be considered to have a significant impact by indicating third areas 10 :

possession directly or indirectly at least 25%: (a) shares in capital or (b) voting rights in control bodies, acting as or managing bodies, or (c) shares or rights of participation in profits or assets or their exspects, including units and investment certificates,

or

the actual ability of a natural person to influence key business decisions by a legal person or an organisational entity without legal personality, or
being married or having a relationship or affinity for second grade.

Concerning first from the areas indicated – this is practically First, The equivalent of the current definition of capital links, however, to the current legal status, is the reference not only to the fact that it holds nominal equity (shares or shares) but also to the share of profits (which concerns partnerships) of assets or their exspects (which is a far-reaching extension), including units and investment certificates (which aims to eliminate the current doubts about closed investment funds). Indication that the relationship will be established by possession 25% the voting rights in the bodies of units constitute, in turn, the practical inclusion of management and control links in the scope of that definition.

In the second the area clearly identified the aspect of personal links to which attention has been paid In the first parts Article 11 , even in the case of links arising from the employment relationship, the possibility of having a real impact on the entity's key business decisions. The justification for this provision indicates that the current regulations did not give the tax authorities the opportunity to assess many of these decisions due to the lack of a formal basis; therefore, the proposal for a new solution in this regard waives attempts to identify the categories of situations in which such an impact may arise, in favour of the fact that each individual, in this particular case, can have a real impact on economic decisions, may become a reason for the existence of a link.

third from those areas concerning family connections, it transfers the provisions of the abovementioned Regulation directly to the statutory act, but leaves the current solution, based on an examination of the impact of the person concerned to second the degree of kinship or affinity.

It is also worth noting – while remaining in the circle of solutions proposed in the bill amending for the purposes of establishing connections – on two records which explain some of the current doubts:

question about the indirect nature of the link – the project explicitly states that the amount of indirect participation should be calculated regardless of the number of entities between the taxpayer and the related entity, which means that, for example, the capital links of taxpayers will be required to identify as far in the structure as the threshold is exceeded at each subsequent level. 25%,
the introduction of a clause to ignore entities that have been included in ownership structures solely for the purpose of breaking the link chains, the explanatory memorandum to the draft states that the purpose of this provision is to prevent taxpayers from avoiding consequences in assessing the marketability of transactions by artificially inserting additional entities in the structure, or the use of private international law institutions such as trusts and private law foundations.

Summary

When assessing the proposed changes, it can be concluded that a new way of defining connections, despite the extension of the definition layer, does not become more precise. Indeed, some doubts have been removed (most often by indicating that the situations concerned should result in a finding of a link), but at the same time the new catalogue is de facto broader, and the adopted definition approach aims to cover the concept of the relationship of any situation in which direct or indirect decisions on the prices applied could have an effect other than market-economic factors.

1 „Legal and Tax Advice - RB Newsletter", No. 1 August 2018, p. 33, publisher Russell Bedford Poland Sp. z o.o.

2 At the time of drafting this study (September) 2018) ongoing legislative work (project with 15 July 2018, published at the Government Legislative Centre 16 July 2018, http://legislacja.rcl.gov.pl/docs//2/12313855/1252217 7/12522178/document350013.pdf) on the Act amending the Personal Income Tax Act, the Corporate Income Tax Act and some other laws that will substantially change the rules on how to identify links for transfer pricing.

Since the legislative work is at an early stage, the author does not refer to it more broadly, considering that it is still an unconfirmed source of information on the future state of legislation. This publication, on the other hand, discusses the directions of change that are relevant to the definition of links.

3 Corporate Income Tax Act with 15 February 1992, i.e. Journal of Laws of 2018, item 1036 as amended

4 Personal Income Tax Act with 26 July 1991, i.e. Journal of Laws of 2018, item 200 as amended

5 Judgment of the Provincial Administrative Court in Warsaw 14 February 2018, reference no. VIII SA/Wa 903/17.

6 Cf. Article 11(5) the Corporate Income Tax Act

7 Regulation of the Minister of Finance of 10 September 2009 on how and how corporate income is determined by estimation and how and how to eliminate double corporate taxation in the event of adjustment of profits of related entities, i.e. Journal of Laws of 2014, item 1176.

8 Cf. previously mentioned draft law of 15 July 2018, op. cit., http://legislacja.rcl.gov.pl/docs//2/12313855/12522177/12522178/dokument350013.pdf

[9] Article 23m(1) u.p.d.o.f. and Article 11a(1) the Corporate Income Tax Act

[10] Article 23m(2) u.p.d.o.f. and Article 11a(2) the Corporate Income Tax Act

11 „Legal and Tax Advice - RB Newsletter", No. 1 August 2018, op. cit.