Guidance on accounting for income tax of a controlled foreign company (CFC)

The CFC – Controlled Foreign Company is a relatively new solution in the Polish legal order – entered into force 1 January 2015 by law of 29 August 2014 amending the Corporate Income Tax Act, the Personal Income Tax Act and certain other laws 1 and so far have been updated several times. Significant changes have been made 1 January 2019 – CFC operation regulated under Article 24a and Article 27(2a) Act on 15 February 1992 on corporate income tax 2 and under Article 10(1)(8a), Article 30f and Article 45(1) a a a bill of 26 July 1991 on personal income tax[3].

1. Comment

1.1. Preliminary information

The introduction of rules is intended to combat tax avoidance, which was achieved by international tax planning, in particular by artificial transfer of the income of Polish entities to subsidiaries established in jurisdictions with a more favourable level of taxation than in Poland or to tax havens. The CFC rules are designed to effectively ensure that the total tax paid on foreign unit income is at the same level as if the foreign subsidiary were taxed in Poland. The CFC rules shall cover mainly passive income, in particular:

• 1) from dividends and other revenue from the participation of legal persons,
• 2) the sale of shares,
• 3) from the claim,
• 4) interest and benefits on all types of loans,
• 5) of the percentage part of the leasing instalment,

1. with guarantees and guarantees. The new rules also fall within the guidelines of the Organisation for Economic Cooperation and Development (OECD), set out in Action Plan No. 3 Base Erosion and Profit Shifting (BEPS) project and implementation Directive 2016/1164 to 12 July 2016 laying down rules to prevent tax avoidance practices which have a direct impact on the functioning of the internal market[4].
2. 2. Amendments from 1 January 2019

The definition of a foreign controlled company in the Corporate Income Tax Act and the Personal Income Tax Act was expanded; from 1 January 2019, it is referred to as ‘foreign controlled entity’. The entity scope of foreign units has been extended by three groups of entities:

• 1) foreign foundations, trusts or other trusts/titles,
• 2) foreign tax groups or group companies,
• 3) an organisational or legal separation of foreign companies or other entities having legal personality or not having legal personality.

On the grounds that the taxable person has held 50% shares, voting rights or the right to participate in the foreign profit of an entity have been removed under the condition that they are held continuously by the minimum 30 days (so it is enough held for even one day), and a very general phrase was added: ‘or has actual control over a foreign unit’ (Article 24a(3)(3) point (a) the Corporate Income Tax Act, Article 30f(3)(3) point (a) u.p.d.o.f.). A definition of the right to participate in profit and actual control has also been introduced, as well as a small circumvention clause (see below).

1.3. Definition of a foreign entity

For the proper application of the CFC rules, First, whether the foreign subsidiary meets the definition of a foreign entity. A foreign entity shall mean:

• 1) legal person,
• 2) a capital company in the organisation,
• 3) an organisational unit without legal personality, other than such a company,

1. a company having no legal personality, where, in accordance with the provisions of the tax law of the State of establishment or management, it is treated as a legal person and is subject to taxation in that State on all its income, irrespective of where they are achieved,
2. a foundation, trust or other body or legal relationship of a fiduciary nature,
3. tax capital group or company from tax capital group,
4. an organisational or legal division of a foreign company or other entity having legal personality or no legal personality

• who do not have the registered office, management or registration in the territory of the Republic of Poland, in which the Polish tax resident, alone or jointly with associated entities, holds, directly or indirectly, a participation in the capital, the right to vote in control bodies, acting as or managing persons or the right to participate in profits, including their exspectives, or in which in future he is entitled to acquire such rights, including as a founder or beneficiary of a foundation, trust or other entity, or a legal relationship of a trust nature, or over which the taxpayer exercises actual control.

The provisions on CFC apply mutatis mutandis to the foreign establishment of the Polish taxpayer (e.g.

branch, representative office, branch), unless the income of that establishment has been taken into account by the Polish taxpayer in its tax base established on general terms (this will be the case in the case of an establishment in a country with which Poland has not signed a double taxation agreement), as well as according to a foreign taxpayer (non-resident) establishment in Poland.

Provision Article 24 a the Corporate Income Tax Act (Article 30f u.p.d.o.f.) contains its own definitions of terms: right to participate in profit, subsidiary, actual control, financial instruments, affiliated entity (here the definition includes mother companies, daughter companies and sister companies).

1.4. Definition of a foreign controlled entity

The next step is to determine whether a foreign entity is a controlled entity. Both tax laws list three categories of entities classified as foreign controlled entities.

1. 4.1. Units established or managed or registered in the territory of a tax haven (Category A)

Category A consists of units established or controlled or registered in the territory or country which is included in the list of tax havens (countries and territories applying harmful tax competition), in accordance with the Finance Minister’s Regulation of 28 March 2019 on the identification of countries and territories applying injurious corporate tax competition[5].

It does not matter the time of the taxpayer’s participation in such an entity and the value of its participation, because the provisions the Corporate Income Tax Act and u.p.d.o.f.

(Article 24a(9) the Corporate Income Tax Act, Article 30f(9) (u.p.d.o.f.) introduce a presumption of having always all rights to participate in the profit of that entity and throughout the tax year. Such presumption shall not be overturned according to the literal wording of the provisions.

1. 4.2. Units established or managed or registered in the territory of a country with which there is no basis for the exchange of tax information (‘Category B’)

Category B comprises bodies established or managed or registered in the territory of the State with which:

• 1) Poland has not ratified the international agreement, in particular the double taxation agreement, or
• 2) The European Union has not ratified the international agreement
• – the basis for obtaining tax information from the tax authorities of that country.

Provisions the Corporate Income Tax Act and u.p.d.o.f.

introduce, and in this case, the presumption of having all the rights to participate in the profit of such an entity throughout the tax year; however, unlike Category A units, for Category B units, it is possible to contest such presumption by demonstrating by the taxable person that the actual right to participate in the foreign profit of the controlled entity is different (Article 24a(10) the Corporate Income Tax Act, Article 30f(10) The Category B unit may also be exempted from the CFC rules regime if the taxpayer demonstrates that it is not at least fulfilled.

one from the conditions specified below for Category C units. However, even then it should be included in the register of foreign units (Article 24a(11) the Corporate Income Tax Act, Article 30f(11) u.p.d.o.f.).

1.4.3. All other entities meeting the criteria set out in the Act (Category C)

Category C consists of all other units which meet the total three the following conditions:

1. in that unit, the Polish tax resident, alone or jointly with related entities, has directly or indirectly over 50% equity or over 50% voting rights in control bodies, acting as or managing bodies, or more than 50% rights to participate in profit or exercise actual control over a foreign entity (there is no significant time to hold such rights);
2. at least 33% the income of that entity achieved in the tax year comes from the categories listed under Article 24a(3)(3) point (b) the Corporate Income Tax Act (by Article 30f(3)(3) point (b) u.p.d.o.f.) These are mainly passive income, such as dividends, interest or copyright revenue, but also revenue from transactions with related parties where an entity does not produce economic added value in connection with these transactions or this value is negligible. The threshold 33% the revenue and categories of revenue surveyed relate only to the stage of qualifying the entity for controlled categories. If it is found that a foreign entity meets the criteria for considering it as a CFC, the tax base will already take into account the entire income of the entity, regardless of whether it belongs to those categories. This effectively results in the taxation of all income generated by CFCs, including non- passive incomes;
3. the actual income tax paid by that entity is less than the difference between corporate income tax that would have been due to it if that entity had been a Polish tax resident and the income tax actually paid by it in its country of establishment, management, registration or location. The tax actually paid shall mean non-refundable or deductible tax in any form, including to another entity.

With respect to first from the conditions, it should be indicated that the amount of indirect participation or right is equivalent to:

• 1) the size of the share or the right connecting any two entities of all entities to be included in the determination of indirect participation or rights where all the size of the shares or rights connecting those entities is equal,
• 2) the lowest size of the participation or rights of the merging entities, between which the amount of the indirect participation or rights is determined, where the shares or rights of the merging entities are different,
• 3) the total amount of indirect holdings of shares or rights, where the amount of indirect holdings of a share or rights is determined, combines more than one the indirect participation or right.

Where it is not possible to determine the amount of the right to participate in the foreign profit of a controlled entity or an exemption or restriction of that right has been made, the highest percentage of the taxpayer’s share of capital or voting rights in the control bodies that are or manage the audited entity shall be taken to be determined.

The exercise of control over the tax group shall be determined by reference to the parent company or to all companies in the group.

When calculating the difference in question In the third the condition, shall not be taken into account by a foreign foreign controlled entity which is not taxed or exempt from tax in the country of residence of the foreign controlled entity.

In the case of a company in a tax group, the income tax actually paid by that company should be understood as a tax which would have been paid by that company if that company had not been part of the tax group.

It should be noted that the tax is actually (effectively) paid and not just its nominal value. When calculating a hypothetical tax to be paid in Poland, any reductions, deductions, etc. should be taken into account.

This way of regulating the CFC legal regime is in practice extremely burdensome, as it requires taxpayers to keep parallel accounts for foreign units, which is intended to calculate a hypothetical Polish tax. The Director of National Tax Information drew attention to this issue in an individual interpretation from 27 December 2018

Individual interpretation of the Director of KIS from 27 December 2018 6

From the wording of this regulation (Article 30f(3)(3) point (c) (u.p.d.o.f.) it is clear that the tax actually paid shall be the tax which the foreign company (here: Estonian company) has actually paid, and such tax shall not be refunded or deducted in any form, including to another entity.

This therefore requires a comparison not only of the tax rates provided for by law in Estonia and Poland, but of the amount of tax actually paid abroad by a foreign company with the amount of tax that would be hypothetically due to it in Poland if such a company were a Polish tax resident.

The tax payment in Estonia is closely correlated with the company's distribution of profits to its shareholders and the company may postpone it in an unlimited manner.

Consequently, since the income of Estonian company is taxable at the rate 20% only when it pays the profits will there be no actual taxation for that period in the tax year. This means that Estonia will not pay any tax. If the company is a tax resident in Poland, such comparison should be made according to Article 30f(3)(3) point (c) u.p.d.o.f., would pay 19% income tax even in the case of non-payment of profit in a given tax year.

Therefore, the Estonian company, in which the applicant has a stake, should be regarded as a controlled foreign company within the meaning of Article 30f(3) u.p.d.o.f.

1.5 Taxation of a foreign controlled entity

1.5.1. Tax base and rate of tax

The tax base shall be the amount corresponding to the foreign income of the controlled entity in proportion to the period during which the foreign entity was controlled by the taxpayer in its tax year (for Category A and Category categories B there is a presumption that it is always their entire tax year; for Category B units, such presumption may be overturned if the taxpayer demonstrates that the holding period is different), in such a part as corresponds to the holding rights to participate in the profit of that unit (for Category A and Category B units there is a presumption that the taxpayer has all the rights to participate in the profit of the unit; for Category B units such presumption can be overturned), after deduction of the amounts:

• 1) included in the taxable amount of the dividend received from a foreign controlled entity,
• 2) income from the taxable person's sale of a foreign controlled entity, in part included in its tax base.

Amounts not deducted in a given tax year shall be deducted in subsequent successively following five tax years.

The deduction from income from the foreign controlled entity concerned shall be subject only to dividends received by the taxpayer from that particular entity and amounts received from the disposal of the participation in that particular entity.

Where, in a foreign controlled entity of Category A or Category B, he holds more than one share in the capital, the right to vote in the control bodies or the right to participate in the profit one the Polish taxpayer, in the absence of any contrary proof, assumes that the shares of those taxable persons relating to the right to participate in the profits of that entity are equal.

These rules mean that the presumption that the Polish taxpayer or the Polish taxpayer together with other Polish taxpayers have in such a unit throughout its tax year 100% shares in profit, not to be overturned.

From 1 January 2019 provisions the Corporate Income Tax Act and u.p.d.o.f. also contain detailed rules on the determination of the proportion of rights to participate in profit in relation to foundations, trusts or other entities or legal relations of a trust nature.

It should be noted that income is allocated in proportion to the period during which the foreign entity was controlled by the taxpayer in its tax year.

Thus, even if, for example, the taxpayer was not entitled to profit on the dividend day and did not actually receive it, the CFC income would be attributed to it in proportion to the period of its control.

This was highlighted in the explanatory memorandum to the draft law amending the provisions of 1 January 2019, indicating that CFC taxpayers may avoid taxation under those provisions by decommitment or sale to another entity controlled by them before that company receives income in a given tax year and then repurchase those shares in the following tax year.

The income generated in the tax year is the surplus of the total revenue over the costs of obtaining them, determined in accordance with the provisions of the Polish Tax Act, regardless of the source of revenue, determined on the last day of the tax year of the foreign controlled entity.

The foreign income of the controlled entity shall not be deducted by losses incurred in previous years. In principle, the rules of the country in which it is established shall determine the tax year of the foreign controlled entity.

If the foreign controlled entity does not have a fixed tax year, or if that year exceeds the subsequent period, which follows. 12 months, the tax year of the foreign controlled entity is assumed to be the tax year of the taxpayer.

Tax on foreign income of the controlled entity obtained by the Polish tax resident is 19% the tax base, regardless of the source of that income.

1.5.2. Tax deductions

The calculated income tax shall be deducted from the amount equal to the income tax paid by the foreign controlled entity (for its tax year) in the country of its registered office or management, registration or location or in another country in proportion to the income of the controlling entity obtained from the CFC (in its tax year) to the total income of that entity determined in accordance with the Polish tax law (in the tax year of the entity).

The amount of tax paid in a foreign country shall be converted into Polish gold at the average rate announced by the NBP on the last working day preceding the day of payment of that tax or the day of income.

In the case of corporate income tax taxable persons, deduction will be possible provided that there is a legal basis under the double taxation agreement or another ratified international agreement to which Poland is party which entitles to obtain tax information, as Article 22b the Corporate Income Tax Act shall be applied mutatis mutandis.

In addition, the tax to be paid by the taxpayer for the control of the foreign controlled entity shall be deducted from the tax paid by the subsidiary (defined in u.p.d.o.p.

and u.p.d.o.f.) on the basis of the provisions on controlled companies or foreign units in force in the country of residence, management, registration or location of the subsidiary if the subsidiary:

1. possess directly or indirectly at least 50% the right to participate in profit in that foreign controlled entity, and
2. the subsidiary is a Polish tax resident or foreign tax resident, but there is a legal basis resulting from a double taxation agreement, another ratified international agreement to which Poland is party, or another international agreement to which the European Union is party, for obtaining tax information by the tax authority.

The purpose of this principle is to eliminate multiple taxation of the same foreign income of a controlled entity when there are several entities (subsidiaries) in the control chain located in the country applying the CFC tax regime (this may also be several entities in the chain located in Poland). In such a situation, the CFC regime can be taxed even at any level of the chain.

1.5.3. Records and registers of foreign units

Tax payers are required to keep a register of foreign units and an additional separate accounting record for each CFC. After the end of the tax year (foreign controlled entity), no later than the expiry of the time limit for the submission of a statement of the amount of foreign income of the controlled entity achieved in the tax year, taxable persons shall be obliged to record events occurring in the foreign controlled entity in the records separate from the accounting records of the taxpayer in such a way as to ensure that the amount of income, the tax base and the amount of tax due for the tax year (foreign controlled entity).

It is another obligation to include, in the accounts of fixed assets and the WNiP, the information necessary to determine the amount of depreciation.

Thus, the foreign entity maintains its own accounts in accordance with the requirements of its tax residence, and the Polish tax resident controlling it conducts its own accounts second, parallel accounting records according to the principles of the Polish Income Tax Act (for the purposes of the CFC legal regime).

Where several foreign units are controlled, separate accounting records shall be kept for each of them, the tax base shall be determined separately and the tax payable shall be calculated.

At the request of the tax authority, the taxable person shall be required to make available within the time limit 7 days from the date of receipt of the request, records and records kept.

If the taxable person does not make these records or records available or if it is not possible to determine the income on the basis of the records kept, the income shall be determined by estimation, taking into account the subject matter of the activity (transaction) from which the income has been obtained.

The provisions of the Act of 29 August 1997 - Tax Ordinance[7].

1.5.4. Tax return

Taxable persons who generate income from activities carried out by foreign controlled entities are obliged to provide a separate statement, according to the established formula, of the amount of income from the foreign controlled entity achieved in the tax year of that entity, to the end ninth the month following the tax year of that unit.

They should also pay the tax due by that date. If the taxpayer achieves income from more than one A foreign controlled unit shall provide a separate statement of the income from each of these units. The tax is paid on a one-off basis, without payment of advance payments per year.

The CIT-CFC and PIT-CFC forms will be appropriate: a statement of the amount of income generated from a foreign company controlled by the taxpayer's corporation tax (physical).

1.5.5. Tax exemption

The foreign income of a controlled entity, which is subject to taxation on all its income in a Member State of the European Union or in a State belonging to the European Economic Area, is not taxed and carries on a significant economic activity in that State. In assessing whether a foreign controlled entity carries on an actual business activity, account shall be taken in particular of whether:

1. the registration of a foreign controlled entity involves the existence of an undertaking in which that entity actually carries out activities constituting an economic activity, including, in particular, whether that entity has premises, qualified personnel and equipment used in its business,
2. the foreign controlled entity does not create a detached structure,
3. there is a correlation between the scope of the activity carried out by the foreign controlled entity and the actual premises, personnel or equipment held by that entity,
4. the agreements concluded are in line with the economic reality, have an economic rationale and are not manifestly contrary to the general economic interests of the entity,
5. the foreign control body itself performs its basic economic functions using its own resources, including those present on the site of the managers.

It should be noted that the catalogue of circumstances set out above (Article 24a(18) the Corporate Income Tax Act, Article 30f(20) u.p.d.o.f.) is not closed – these are only examples of conditions to be examined.

In assessing whether the actual economic activity is material, account shall be taken, in particular, of the ratio of the revenues generated by the foreign controlled entity from the actual business activity to its total revenue.

In the case of such an entity, it is not necessary to keep separate accounting records for CFCs and to include in the fixed assets and intangible assets the information necessary to determine the amount of depreciation.

An interesting and useful warning from MF can be found here 8 before tax optimization using foreign companies due to the regulations on the so-called seat of the board. In its letter, the MF lists elements indicating the absence of a board of directors of a foreign company (SPV) in its country of formal residence, but similar elements can be taken into account when assessing the actual activity of:

• Members of the board (directors) of SPV are natural persons/other entities performing these functions in a service manner, also in parallel to other clients who have no professional experience in the field of industry/business formally conducted by SPV, usually resident in the State of the seat of SPV (nominee directors; standard service provided by a legal or accounting firm or other establishment/ supplier of SPV);
• the members of the board of SPV are also members of the board of directors in Polish companies/other companies in the group;
• members of the board of SPVs reside and perform their functions in the territory of Poland (as confirmed for example by their tax residence/citizenship);
• failure to assign responsibilities/competence to individual members of the SPV board;
• lack of documentation concerning tasks performed by SPV board members (including lack of correspondence on the conduct of its cases);
• no local email/telephone/visit addresses of SPV board members;
• visits of members of the board of SPV in the country of the company's registered office are formal activities, consisting in the adoption of a resolution or the signing of a contract, the content of which has been established/negotiated in Poland;
• the signing of resolutions/agreements/reports from SPV meetings, mainly by proxy agents (non-SPV-related support service), usually provided by a law firm/other starting/delivering entity;
• the bank account of a foreign company to which access is in Poland and banking operations are ordered in Poland or even collected cash with a “company” card from ATMs in Poland;
• employment in the company only (or almost only) administrative staff (especially when it provides services to other entities, including in particular other clients of the law firm/other entity providing SPV);
• the outsourcing by SPV of most of its basic functions (e.g. the wide use by SPV of so-called "domiciliation" services);
• use of a wide range of fiduciary services;
• consulting SPV decisions mainly with Polish advisors (including tax advisers);
• lack of actual ability to conduct SPV cases in its country of establishment (no office/conference room available);
• lack of storage at the SPV of accounting/corporate/legal records.

Factors such as:

• • with the legitimacy/objection of the taxpayer SPV (e.g. the initiative came from legal or tax advisers and the establishment of the company had no business justification);
• • the form of acquisition (e.g. the use of ready-made companies, the so-called ‘shelf companies’);
• • scope of activity (e.g. SPV only one transactions or one the type of transaction that was decided in Poland).
• 1.6. A small circumvention clause

From 1 January 2019 The so-called "small circumvention clause" has been introduced to the CFC regulation.

According to it, the relationship between entities that are not established or maintained for reasonable economic reasons, including those intended to manipulate the ownership structure or to create circular ownership structures, is not taken into account for the purpose of determining the foreign status of an entity or the condition of control over a foreign entity.

For example, creating artificially many smaller companies in the structure, each of which is a partner of another in closed circulation: Company A as a shareholder of Company B, Company B as a shareholder of Company C, Company C as a shareholder of Company A and the same relationship In the second direction.

The terms "ownership structure manipulation" and "circular ownership structure" are not defined anywhere in the Polish Tax Act and open the field for broad interpretation by tax offices.

The Provincial Administrative Court in Warsaw referred to the question of artificial structures in the judgment of 15 September 2016 9 : In shaping the mechanism for taxing foreign incomes of controlled companies, the Member States of the European Union are operating in a rather narrow framework, designated by the Treaty freedoms in the interpretation given to them by the case law of the Court of Justice of the European Union: in particular, the judgment of 12 September 2006 on Cadbury Schweppes, reference no.

C-196/04 and the decision 23 April 2008 on Test Claimants in the CFC and Dividend Group Litigation, reference no. C-201/05.

In both cases, the Court held that differentiated tax treatment under the CFC rules and the disadvantage resulting therefrom of resident companies having a subsidiary subject to a lower level of taxation in another Member State may hinder the exercise of the freedom of establishment of such companies, discouraging them from setting up, acquiring or holding a subsidiary in the Member State in which it is subject to such a level of taxation, thus constitute a restriction on the freedom of establishment.

However, this restriction may be justified by combating tax avoidance where such consideration (the foreign income of a controlled company) concerns only purely artificial structures aimed at avoiding a national tax which would normally be due.

Consequently, the use of such a form of taxation should be discontinued if it proves to be, on the basis of objective and verifiable elements by persons third, that, regardless of the existence of the tax recitals, the company is actually established in the host Member State and actually carries on an economic activity there (points 52-54 and 64-66 judgment of the Court).

These objective and verifiable elements relate to the physical existence of the company, including premises, personnel and equipment (open catalogue).

2. Explanation to the pattern of instructions

2.1. Use of instructions

The instruction shall be subject to the application of the income of foreign controlled entities achieved by corporate income tax taxable persons and personal income tax taxable persons.

2.2. Operators following the instructions

The instructions are given by corporate tax payers and individuals tax payers.

2.3. Legal acts used in the instructions

Tax payers implementing the instructions for the clearing of foreign income tax of a controlled entity shall apply:

• 1) Article 24 a and Article 27(2) a the Corporate Income Tax Act,
• 2) Article 10(1)(8) a, Article 30f(30c)(6) and Article 45(1) a u.p.d.o.f.
• 3. Model loss accounting instructions from previous years

___________________________________________________________