Accounting of tax losses — loss of liquidated foreign tax establishment

The article presents a legal tax case on the possibility of settlement in Poland, by a limited liability company, the loss of a foreign plant established by it, which was liquidated. The authors discuss the actual situation and formulate their position on the problem.

In their analysis they refer to the provisions of the Act of 15 February 1992 on corporate income tax 1 (Come on. the Corporate Income Tax Act), and the decisions of the Court of Justice of the European Union and Polish administrative courts on cross-border settlement of losses.

The authors also state in the justification of their assessment the fiscal position regarding the settlement of the foreign loss of the undertaking to be wound up.

1. Facts

Alfa sp. z o.o. operating in the cosmetics industry In the first In the 21st century, she established a branch in Bulgaria to perform parts of production in that country.

It constitutes an Alfa tax establishment within the meaning of an agreement between the Republic of Bulgaria and the Republic of Poland on the avoidance of double taxation in the field of income and property taxes (agreement with 11 April 1994 2 – Further: UPO-PL/BG). The profits of the branch are taxed in Bulgaria.

The Alfa tax year corresponds to the calendar year. Production activities of the branch from 201X-2 r. began to bear losses. In 201X, Alfa sp. z o.o.

decided, for business reasons, to eliminate the branch, which formally took place 20 November 201X loss of the branch from years 201X-2-201X have not been cleared in Bulgaria before its liquidation (see diagram).

1.2. Problem

Can Alfa sp. z o.o. in the settlement of income tax for 201X (in which the branch was liquidated) settle losses incurred during the period 201X-2-201X?

1.3. Authors' position

Provisions the Corporate Income Tax Act do not grant the possibility to settle a loss of foreign plant in Poland. The Court of Justice of the European Union (hereinafter the TEU) and the Polish administrative courts for cross-border settlement of losses conclude that such a possibility exists in the event of final losses, i.e.

those which can no longer be settled in their home country. Definitive losses may arise, among others, as a result of the liquidation of the branch (establishment). Alpha sp. z o.o. can, therefore, in the settlement of income tax for 201X (in which the branch was liquidated) settle outstanding losses in Bulgaria of the disbanded branch.

1.4. Reasons

1.4.1. Tax duty

According to Article 3(1) the Corporate Income Tax Act taxpayers, if established or managed in Poland, are subject to taxation on all their income, regardless of where they are achieved (Polish residents).

The subject of income tax is income which is the sum of income generated from capital gains and income obtained from other sources of income[3]. The revenue from the source of revenue is the excess revenue from that source of revenue over the revenue costs achieved in the tax year.

If the cost of obtaining revenue exceeds the total revenue, the difference is the loss from the source of revenue[4].

In determining income, income from sources of revenue located in Poland or abroad shall not be taken into account, inter alia, if income from these sources is not subject to income tax or is tax-free and the cost of obtaining these revenues and the revenue resulting therefrom[5].

Based on Article 17(1)(3) the Corporate Income Tax Act Tax-free income is generated outside Poland by taxpayers who are Polish residents, if the international agreement to which Poland is a party so provides.

1.4.2. Rules resulting from UPO-PL/BG

Under Article 7(1) UPO-PL/BG has been established that the profits of the contracting company will be taxed only in that country, unless the undertaking carries on an economic activity In the second to a Contracting State by an establishment located there.

In the latter case, profits of the company may be taxed In the second the country, but only to the extent that they can be attributed to that establishment. Subject to Article 24(1) UPO-PL/BG if a person residing in a Contracting State (here: Alfa sp. z o.o.

with its registered office in Poland) achieves income or holds assets which may be taxed in accordance with the provisions of this Agreement In the second to the Contracting State (here: income generated by an establishment located in Bulgaria), first listed country (i.e. Poland) exempts such income or assets from taxation.

However, in calculating the amount of tax on the remaining income or assets of that person, he may apply a tax rate which would have been applied if the tax exempt income had not been so exempt from taxation.

It follows from the above that, where the activity carried out in Bulgaria generates losses and UPO-PL/BG provides for the application of the exemption method in Poland, internal rules (mainly Article 7(3) the Corporate Income Tax Act) they do not give the possibility to deduct in Poland the loss resulting from the operation of the plant located and taxed in Bulgaria.

1.4.3. European Union law

The consequence of Poland's accession to the EU is the adoption of its acquis, which also consists of legal principles developed by Community (EU) law and the case law of the TEU (formerly the ECJ).

When applying law, internal institutions should seek to ensure the effectiveness, priority and direct effect of Union law in relation to national law and to make a pro-EU interpretation of national rules[6]. Direct taxation falls within the competence of the Member States.

However, they are obliged to exercise their powers in compliance with Union law.

The Court found it incompatible with the Treaty establishing the European Communities (TEC; now the Treaty on the Functioning of the European Union – hereinafter the TFEU) 7 ) tax rules that differentiate the treatment of domestic and foreign entrepreneurs.

Contrary to the principle of freedom of establishment, now expressed under Article 49 TFEU, there is a differentiation of the situation of the entities affecting the decision in which the Member State in which the trader will operate[8].

Preventing a company established in one Member State from deducting, when calculating profits, of losses on the establishment of a permanent establishment in another Member State on the basis that, in accordance with the applicable double taxation agreement, the corresponding income generated by that permanent establishment is not taxable In the first Member State is against the freedom of establishment[9].

However, the admissibility of settlement of losses generated by a foreign establishment cannot be absolute. Regarding the limitation of the possibility of deducting foreign losses of the TS in the judgment of 15 May 2008 10 indicate the conditions which such restrictions may justify:

• 1) the risk of double taking into account losses,
• 2) the need to preserve the distribution of tax competences between countries,
• 3) the risk of tax avoidance.

It appears that each individual argument may constitute a stand-alone basis for justifying the restriction of freedom of establishment, since the TS argues that, given the diversity of situations in which a Member State can rely on such justifications, it cannot be required that all the above mentioned elements should occur so that national tax rules limiting freedom of establishment can in principle be justified[11].

Such restrictions do not appear to be confirmed in the case of an undertaking which is liquidated and at the time of liquidation it is not possible to settle the entire loss associated with its activities. The above-mentioned judgment of the TS of 15 May 2008 (in the Lidl Belgium case) is based on the concept of ultimate loss, i.e.

those which cannot be used in the country of establishment[12].

In the present situation, the Bulgarian plant will no longer generate tax revenue in Bulgaria. The situation in which the loss of the plant will be settled in Poland is not affected by the division of tax competences between Poland and Bulgaria. If it is not possible to settle the foreign loss of the plant in the country of its location (here: Bulgaria), the refusal to settle the loss in Poland violates the freedom of establishment.

1.4.4. Polish case law

The Supreme Administrative Court has repeatedly confirmed the admissibility of the settlement by a company resident in Poland of the loss of its foreign, liquidated establishment due to the inability to settle it in the country of its location[13].

In these cases, the NSA stressed that both provisions the Corporate Income Tax Act, as well as the provisions of the relevant UPO should be read taking into account substantively relevant provisions of Union law and in such a way as not to violate the principle of its primacy.

The order of EU law, as a system of supranational law sui generis, requires its priority in enforcement not only before national law, but also in the field of this European integration, also before specific international agreements between Member States. Only then can the objectives of the founding treaties be effectively implemented.

Thus reducing the tax law issue, which is cross-border loss settlement, only to the provisions the Corporate Income Tax Act and the relevant UPO is not justified.

Importantly, the NSA assessment 14 , In the same way as national courts, government administrations (including tax authorities) also have to apply Union law correctly, taking into account the need to ensure priority and full effectiveness. This also applies to the case law of the CJEU.

The interpretation of the provisions of Community law contained in the judgments of the Court is binding not only on the court in which the legal question was raised but also on other courts and bodies of the Member States.

This follows the purpose of the questions referred for a preliminary ruling under Article 267 The TFEU is to ensure uniform interpretation and application of Community law. This binding is also justified in the case of Article 10 The ECA principle of the effectiveness of Union law which would be jeopardised in the absence of such a link.

Therefore, the tax authorities must not refrain from taking into account Union law, including the case law of the Court.

1.4.5. Position of tax authorities

In spite of the fact that there was a favourable legal line for taxpayers, the tax authorities long denied taxpayers the right to account for the loss of a foreign undertaking to be liquidated[15].

The argument was based on the fact that from the existing provisions the Corporate Income Tax Act it is clear that the profits of the loss of the company (branch) located abroad do not link with the profits/losses subject to taxation in Poland.

Thus, the losses of the foreign establishment must not reduce the income to the tax shown in the testimony submitted in Poland. Losses of a foreign establishment shall be settled in the State of establishment and therefore the principle of freedom of establishment may not be infringed.

However, there was no reference in the positions of the tax authorities to the inability, e.g. as a result of the liquidation of the plant, to the settlement of losses in the country of its location. Many times the change of adverse position of the tax authority was due to a favourable judicial decision[16].

For example, the Director of IS in Bydgoszcz in an individual interpretation from 16 August 2016 17 and most recently Director of KIS in an individual interpretation of 1 March 2019 18 .

1.4.6. Accounting for branch losses

Importantly, the result achieved by the Polish tax resident of his business conducted by an establishment located in another country in the form of a loss calculated taking into account the tax law in force in that other country does not mean that this activity automatically results in a loss within the meaning of Polish tax legislation or loss in an economic sense.

The amount to be deducted from losses incurred by the company's undertaking in the individual tax years should be determined by the company, in accordance with the provisions of the law. the Corporate Income Tax Act

Provisions the Corporate Income Tax Act do not grant the possibility to settle a loss of foreign plant in Poland. The Court of Justice of the European Union and the Polish administrative courts on cross-border settlement of losses conclude that such a possibility exists in the event of final losses, i.e. those which cannot be settled in the country of origin. Final losses may arise, among others, as a result of the liquidation of the branch.

From 1 January 2018 (by law of 27 October 2017 amending the Personal Income Tax Act, the Corporate Income Tax Act and the Flat-rate Income Tax Act on certain revenues generated by individuals[19], hereinafter: Amending Act) split into the Corporate Income Tax Act revenue from capital sources (capital gains) on income from other sources of revenue.

Where the taxpayer achieves income from capital sources and other sources of income in a given tax year, the income tax is the total income obtained from both sources.

If income is achieved only from one source and the loss from the other, income tax is subject to income generated from one source, without discounting it by the loss from second.

Under Article 6 amending act, introductory wording the Corporate Income Tax Act the above changes, it was established that the losses incurred by corporate tax taxable persons for the tax years preceding the tax year started after the 31 December 2017, are deducted from the income in question under Article 7(1) the Corporate Income Tax Act as amended by the Amending Act, in accordance with and at the level of the provisions the Corporate Income Tax Act in the current version, i.e.

in force to the end 2017 Thus, the deduction of losses from tax years started before 1 January 2018 is still possible from the sum of all income, regardless of the source of the income, according to the order and proportion chosen by the taxpayer.

From 1 January 2019 the taxable person may alternatively:

1. reduce revenue from this source in the following successively five tax years, except that the amount of the reduction in any of those years may not exceed 50% the amount of that loss, or
2. reduce the one-off income from this source In one of the next successively following five tax years not exceeding 5,000,000 PLN, the outstanding amount shall be settled during the remaining years of that five-year period, except that the amount of the reduction in any of those years may not exceed 50% the amount of that loss.

Provisions the Corporate Income Tax Act they do not regulate the specific situation as the settlement in Poland of the loss of a foreign establishment when the bilateral agreement UPO-PL/BG provides for the exemption method.

If the method of credit (tax credit) were applied, the loss of a foreign establishment would reduce the taxable person’s income from national sources in a given tax year.[20]. In the absence of a clear norm, we consider per analogy that the uncalculated loss of a branch in Bulgaria calculated on the basis of regulations the Corporate Income Tax Act may be settled in the tax year in which the loss of the undertaking became ‘final’, subject to the applicable limits.

The loss will be deducted, depending on the actual year of its payment, or on the total amount of all revenue, regardless of the source of its receipt (regards the loss incurred In 2017) or income from a given source, here: income from a source other than capital gains (for losses incurred in 2018 and 2019).

1.4.7. Multilateral Convention

It is worth noting the multilateral convention implementing the measures of the Treaty tax law to prevent the erosion of the tax base and the transfer of profits 21 (Multilateral convention to implement tax treaty related means to prevent base erosion and profit shiftin, in short: MLI), resulting in changes to double taxation agreements.

The Convention allows for the simultaneous amendment of several dozen agreements signed by Poland to avoid double taxation without the need for long-term bilateral negotiations. Poland has notified the Convention for inclusion 78 double taxation agreements (including UPO-PL/BG).

Convention entered into force 1 July 2018 Poland has ratified it 27 October 2017 in the form of a bill[22]. one from changes in UPO-PL/BG (notified by Poland) 23 ) will replace the exemption method (Article 24(1) UPO-PL/BG) credit method (tax credit).

At the date of writing this comment UPO-PL/BG is used in its current form, unchanged by MLI.

1.4.8. Summary

Provisions the Corporate Income Tax Act do not grant the possibility to settle a loss of foreign plant in Poland. The Court of Justice of the European Union and the Polish administrative courts on cross-border settlement of losses conclude that such a possibility exists in the event of final losses, i.e.

those which cannot be settled in the country of origin. Definitive losses may arise, among others, as a result of the liquidation of the branch (establishment). Alpha sp. z o.o. can, therefore, in the settlement of income tax for 201X (in which the branch was liquidated) settle outstanding losses in Bulgaria of the disbanded branch.

Legal basis

Article 3(1), Article 7(1)(2)(3)(5), Article 17(1)(3) the Corporate Income Tax Act, Article 49(267) TFEU, Article 10 EC, Article 7(1), Article 24(1) UPO-PL/ BG, Article 6 Amending Act.

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