Financial transactions in capital groups – analysis of case law of Polish administrative courts – part. 1

This article is intended to present the issues of financial transactions carried out in capital groups and their tax consequences. Transactions related to the financing of the activities of entities belonging to capital groups, groups of affiliated undertakings are the dailyness of those entities' managers.

Operating in a group of companies facilitates the acquisition of external capital as well as the distribution of financial resources at the disposal of individual entities. The rules on the tax consequences of such transactions are rather laconic, in many cases taxpayers are faced with the need to apply the general tax rules accordingly.

The consequences of such situations are often emerging doubts as to the correct application of those provisions, which are sometimes removed by coherent case-law and, in other cases, the differences in case-law cause even greater uncertainty.

In this series of articles, we bring these decisions that may be crucial In 2020 And years after that.

1. Introduction

Financial transactions in groups of related companies (i.e. those between which capital or personal links exist) are an unavoidable element in the financing and management of projects carried out by companies belonging to those groups.

The functioning of a group of related companies undoubtedly increases the possibility of financing activities, both in the case of planned investments related to development, current operations and in the case of unforeseen events and circumstances.

The granting of an intervention loan to a subsidiary that is faced with extended payment dates from counterparties or the guaranteeing of an obligation of another group company to a bank where it does not have sufficient credit capacity on its own seems to be a very practical solution and without many costs and risks.

A further benefit of informed funding planning at the level of a group of related companies is the better management of the financial resources at the disposal of the group and the improvement of its liquidity.

The benefits of funding as a group, rather than as an individual company, are already recognised not only by CFOs but also by banks and other financial institutions.

Such entities, assessing the creditworthiness and the risks associated with their cooperation with the counterparty, are not limited to examining their individual credit capacity, but are also investigating affiliated entities, and in many situations they expect the borrower to ‘write’ into the agreement of specific companies in the group, thereby increasing their security as lenders.

To meet emerging needs, banks offer special financial solutions dedicated to capital groups such as cash pooling or umbrella credits[1]. Given these circumstances, it can be concluded that the planning of the financing of activities in the group is increasingly important.

Meanwhile, as already noted in the literature and the press: adding a company to a credit agreement should not be treated as a mere formality[2]. It is also worth noting the role of the entity in such agreements, whether it is a guarantor, a joint and several debtor or perhaps one from borrowers.

So what are the limitations when using these solutions, which must be met by management and financial directors? As in many other cases, when there are restrictions, First, the content of extensive tax legislation should be analysed. In the context of financial transactions, it is worth noting first and foremost the provisions of the Income Tax Act which relate to two important issues:

• Article 12(1)(2) Act on 15 February 1992 on corporate income tax 3 (Next: the Corporate Income Tax Act) – as regards the possibility of treating certain financial transactions or their elements as an unpaid benefit constituting income for income tax purposes,
• Article 11a-11t the Corporate Income Tax Act (provisions accordingly Article 23a-23t Act on 26 July 1991 on personal income tax 4 , (c) in relation to the appropriate application of transfer pricing regulations to financial transactions.

These provisions can be summed up by concluding that any transactions related to the financing of activities in capital groups should be carried out in principle in return for payment and the conditions under which those transactions are carried out should be in line with the so-called market conditions, i.e.

companies operating in groups should apply the same conditions as companies between which no links exist[5].

This rule may seem quite simple – it means that the person responsible for managing the group's financing should ensure that there are no unpaid financial transactions in the group and that the remuneration is reflected in the conditions under which comparable financial services are offered on a similar market.

This simple rule, however, faces significant practical difficulties, as mentioned below.

2. The diversity of financial transactions

Under the concept of financial transactions, all transactions related to the financing of activities within the group can be identified, an example of a list of financial transactions distinguished for transfer pricing purposes proposed by A. Chojnacka:

• • transactions relating to the granting or obtaining of financing (credit, loan, purchase of bonds),
• • cash pooling transactions,
• • granting or receiving a guarantee or guarantee,
• • deposit or accept a deposit of funds,
• • sale or purchase of insurance-related services (e.g. insurance, reinsurance, insurance intermediation),
• • payment services, cash netting,
• • fixed-term contracts, hedging,
• • factoring[6].

This directory should be considered as an example, no exhaustive all examples of financial transactions that may occur between associated entities. In many cases, funding is implemented as one of the elements of the underlying transaction, e.g.

construction investment contracts, contain provisions on financial contributions from individual parties to the contract.

The often encountered financing transactions include cost-sharing agreements in which related entities define the rules on which the costs associated with investment in equipment, software or other assets used in the business are accounted for.

The mere diversity of the above-mentioned examples of business finance transactions makes it a complicated task to set the right conditions of remuneration for these transactions.

Even if we move in the area of the same type of transaction, there are difficulties in properly characterising this transaction, which is intended to allow proper application of the comparability criteria, but this is a difficulty that can be classified as the second group described below.

However, the basic problem with the diversity of financial transactions is that many of these transactions have specific conditions which occur only in the case of cooperation between associated entities or between a group of related companies and an external financial institution.

one from the most striking examples that can be cited in this context are cost-sharing agreements. This is the type of agreement between the participants in which they determine how they will share the costs of the investment from which the different participants of the group benefit.

This type of arrangement is very rare between entrepreneurs who have no economic links[7]. The vast majority of contracts of the kind that operate on the market are closely related to the group and therefore also to its specificity, size, industry and market in which the group operates.

However, the market price principle requires that in the case of such contracts, the conditions ‘which unconnected undertakings would apply’ should be applied.

It seems that no matter how many reports and comments will be prepared on this subject, taxpayers trying to make such a reference still function on the basis of hypothetical assumptions.[8].

Another example of this type of situation is the umbrella credit – a solution dedicated to companies operating in capital groups.

In the case of this solution, it is worth asking: how should the conditions applied in the multilateral agreement in which the bank and several affiliated entities participate be applied to transactions between unrelated traders?

It is difficult to find a clear answer here, and in its search it should be addressed by tax authorities, and there are indications that documentation obligations, price testing obligations relate to such non-standard economic situations.

Director of KIS in interpretation of 3 February 2020 it stated that: ‘The obligation to draw up transfer pricing documentation covers situations or behaviours of connected entities which are unusual from the point of view of economic turnover in order to confront situations or behaviours of independent entities.

This procedure is based on the arm’s length principle, according to which related parties should, in mutual relations, establish conditions which would determine between unrelated parties[9].

In the author's assessment, the above statement contains an internal contradiction: the interpretative body suggests to examine behaviours which are not typical of economic turnover by reference to activities of independent entities, i.e. those which are somehow to set certain standards under the conditions in question.

However, it is clear that tax authorities and courts are faced with a difficult task: the market price survey system adopted in Polish tax law on the basis of the solutions proposed by the OECD is based on the assumption of a price survey in controlled transactions by comparing their conditions to uncontrolled transactions.

The Polish legislator has accepted that at some level such a reference should be carried out in any case, if it cannot have the form of a full comparative analysis, the taxpayer should submit a ‘at least’ conformity analysis to the authority[10]. In such a regulatory environment, it is difficult to expect from tax authorities the formal statement that in some cases it is impossible to carry out a marketability survey.

In summing up this part of the study, it is worth pointing out that there is no rule from the provisions of the applicable law that when examining the conditions of remuneration and the prices applied in cooperation between associated entities, the focus should be on "non-typical in terms of economic turnover".

Financial transactions are also not always such atypical situation, on the contrary, in many cases they are identical to those occurring between independent companies, and therefore, if there are transparent conditions for granting a loan to a related entity in which the amount, duration, purpose, collateral and repayment conditions are known, then these atypical aspects should not be sought – often the use of available data on the credit market will be sufficient to demonstrate the market nature of the transaction.

In practice, there are enough complex and difficult to identify economic flows in capital groups, and the complexity of these simple and transparent ones will certainly not serve taxpayers.

3. Difficulties in the practical application of the comparability criteria

In the light of the provisions cited, entities operating in groups of related companies are obliged to compare the terms of the planned and implemented transactions to those applicable to undertakings between which no links exist. Even if the conditions which are in principle necessary to find potential comparative data are met, namely:

• • the transaction is described as accurately and accurately as possible, allowing the parameters on the basis of which the data search process will be carried out, and
• • data on potentially comparable transactions are available;

that there is no guarantee that, on the basis of these parameters and the available data, a comparison will be possible to determine the conditions that a transaction should fulfil in order to ensure that the taxpayer is acting in accordance with the market price principle when cooperating with a related entity.

This situation can be illustrated by the following example. Tax payer - special purpose company operating in a group of related entities in the development industry, realizes an investment consisting in erecting one from commercial facilities which constitute the whole of the construction investment.

The company does not have its own assets in addition to its core capital and financial resources. Due to delays in payments from one of the payers and practically exhaustion of all the assets, the company requested the bank to increase the limit of the operating credit.

The Bank agreed to increase the cap by an amount 300,000 PLN subject to the guarantee of the full amount of the increased limit by the associated entity, a company engaged in commercialisation of the property.

The company obtained such a guarantee, at the same time the companies decided to introduce a payment for the guarantee service, so it began to examine at what level the company should apply remuneration from the financial service provided.

On the basis of the identified comparable data, it was found that the liability guarantee services to companies operating in the industry and on the market in which the audited company operates are provided for remuneration in the range from 0.5% to 0.9% the value of the covered liability on an annual basis.

When analysing the comparative data, the company also took note that the data obtained did not include cases where the services would be used by companies with no assets or assets.

This means that the adoption of the level set by the analysis described to determine the level of remuneration for the guarantee in the situation of the companies concerned is a serious error of comparability and, moreover, such an error cannot be far removed by the application of an adjustment of comparability because the guarantee service providers do not cooperate with the recipients who do not have a certain minimum level of assets to secure their claims.

The above example shows that, even if potentially comparable data are available, the specificity of financial transactions carried out in capital groups does not always allow for effective and compliant and applicable practice of using such data to carry out exhaustive research.

However, the most common problem in seeking comparability is that when examining the available information on the basis of correctly established criteria for the comparability of taxpayers, it is concluded that it is not possible to identify any data to compare its own financial transaction with market conditions. In such a case, the taxable persons shall be at the disposal of an attempt to establish an appropriate compatibility analysis.

1. Historical conditionality (specificity of long-term functioning in capital groups) and time volatility

In cooperation with capital groups that have been using the planned financing of activities at the level of the group as a whole for many years, it is often possible to meet transactions that have been carried out on unchanging terms for many years or these conditions change over time. However, their exact genesis is very difficult or even impossible to investigate due to the significant passage of time in which both internal (groups of entities between which the transaction is carried out) and external (circumstances concerning the market environment in which economic operators operate) conditions have changed.

According to the author's observations, very many financing transactions have their origin in the findings that took place above 15-20 years before the market-based nature of these transactions was examined.

The problem here is that in many situations, for the time when decisions were taken which involved the adoption of certain financing rules in the group, there was neither such a formal obligation nor an educated practice of securing information that could be used to examine or justify the price used.

The problem of the timing of the findings also concerns the examination and verification of transactions by tax authorities and courts.

In many cases, tax authorities examine transactions many months or years after the agreement between the parties, as can be illustrated by the WSA judgment in Warsaw with 28 May 2019, in which the court referred to the valuation of loan transactions in years 2013-2014 11 .

Such verification shall be carried out with one of the parties regarding the scope of the information they have collected and may make available to the Authority the taxable person himself on his transaction, and from second parties limited access to source information which the authority may obtain by itself by carrying out verification activities.

In the author's opinion in the above third the categories cover most of the reasons for the difficulty of applying the principle of remuneration and the principle of market price for financial transactions in groups of related companies. Not all cases are included in one of the categories indicated, some of them have characteristics two Or even everyone. third.

In view of the far-reaching uncertainty surrounding the application of the principles of remuneration and market price for financial transactions, it is worth noting the emerging decisions and the jurisprudence of administrative courts, which may give taxpayers some indication of the approach that the auditors may expect in the event of official verification of their financial transactions.

The further part of the study refers to specific specific issues arising from the implementation of financial transactions between related parties and their practical interpretation by courts and authorities, including, inter alia, the equivalent nature of benefits in the context of the recognition of revenue from the unpaid benefit.

Further sections of the publication will present other issues related to the theme, such as:

• • the conditions under which tax authorities apply estimates;
• • the possibility of comparing intragroup financial transactions with data on the financial services market offered by banks;
• • loans from a foreign shareholder as part of the strategic planning of the group's development.
• 5. Equivalent nature of financial transaction benefits — differences between the mutual and the equivalent nature of the transaction and the tax consequences of that difference

first The issue discussed is the possibility to carry out financial transactions in capital groups without the need for payment. According to Article 12(1)(2) the Corporate Income Tax Act revenue is also paid free of charge or partly payable.

According to the settled legal line under that provision, income from the unpaid benefit comes to the point where the taxable person obtains the delivery: “The underlying feature of the unpaid benefit is that the recipient is not obliged to provide any mutual benefit, such as a reduction in the price for the sale of goods or services provided.

The concept of unpaid benefit covers those of them whose consequence is to obtain an advantage at the expense of another entity, or whose effect is free of charge, that is not related to the cost or other form of equivalent asset to that person, having a specific asset or financial dimension.

The key feature of the unpaid benefit is therefore that the recipient is not obliged to perform any mutual benefit.” 12 .

As Mr Kowalski points out, the concept of "free benefit" under tax law is broader than that of civil law, including the part concerning liability relations[13].

In court case law, the understanding of the unpaid benefit comes from an NSA judgment of 28 January 2001, from which it follows that the unpaid benefit must be understood to mean all those legal and economic events in the activities of legal persons which result in free of charge, i.e.

not related to costs or other forms of equivalent, the acquisition of assets of that person having a specific financial dimension[14].

Such an interpretation means that whenever a taxable person receives a delivery and is not obliged to pay a certain price or to satisfy another benefit, there is an unpaid benefit which should be valued for the purpose of examining the relevant income.

Even if the benefit is partially paid, the taxable person should recognise the income in the part where he obtained it without having to provide an equivalent.

The development of the approach of tax authorities to unpaid benefits in the context of financial transactions in capital groups is particularly noticeable in the event of a change of position regarding guarantees, including mutual and equivalent guarantees. Even in years 2010-2012 diverging positions arose on the effects of granting the guarantee to a related entity in a capital group – some taxpayers still received confirmation that the granting of the guarantee itself did not have tax implications in the form of the need to recognise revenue on the party receiving the guarantee, and Article 12(1)(2) it will only be applicable at the time of the execution of the guarantee.

Against this background, the Minister of Finance has issued In 2012 the general interpretation in which it stated that ‘in principle, the provision of an unpaid guarantee by a shareholder or a shareholder (a related entity) to a capital company constitutes an unpaid benefit within the meaning of Article 12(1)(2) the Corporate Income Tax Act and results in revenue arising from this. The fact that the guarantor does not carry out professional activities in the provision of such financial services remains irrelevant to the application of this provision.’ 15 .

The head of the Ministry of Finance, justifying his position, used the above-mentioned understanding of the concept of ‘free benefit’, while indicating that on the ground the Corporate Income Tax Act an unpaid guarantee should be recognised as a free benefit if the following conditions are met:

• • one of the parties receives a material benefit from a guarantee that can be valued,
• • the granting of a guarantee does not entail any costs or benefits for the recipient undertaking,
• • the provision of the guarantee is linked to the will of the guarantor, which means that he is willing to grant the guarantee without remuneration.

As a result of this general interpretation of the MF, a permanent change in the interpretation line of the authorities on guarantees in capital groups, generally from the moment of that interpretation, all cases where the guarantees provided in capital groups met the criterion of unpaid benefit as set out above, are treated by the tax authorities as situations where income should be recognised on the basis of Article 12(1)(2) the Corporate Income Tax Act

For determining the tax consequences of an event in the context of Article 12(1)(2) the Corporate Income Tax Act It is therefore important to determine whether, when cross-border transactions are carried out between related parties, they are equivalent. Many financial transactions in capital groups have the character of reciprocity, but only some of them can be considered equivalent at the same time. The difference in terms of reciprocity and equivalence has therefore become important. According to the dictionary definitions, these terms in common use in Polish mean respectively:

• • „mutual’ — made or demonstrated to each other,
• • „equivalent’ — a thing equal to another value or a commodity in which the value of another commodity is expressed[16].

In referring to these considerations to the latest case law, it is worth first of all to draw attention to the judgment of the NSA of 14 September 2019, deciding on the basis of an individual interpretation request, concerning one of companies which benefited from the guarantee granted by the related company and at the same time provided another liability to the same related company, with different values of the guaranteed liabilities[17].

In this application, the company argued that since both it receives the guarantee and it provides the same benefit, such reciprocal transactions have an equivalent character at the same time, with any differences in the value of the guaranteed liabilities not relevant and therefore no income should be established on the basis of the Article 12(1)(2) the Corporate Income Tax Act The interpretative body considered that the company and the mutual guarantees received are mutual but not equivalent benefits, precisely because of the difference in the value of the guarantees provided.

Consequently, the Authority considers that, in this case, the benefits partly paid, for which the company achieves income within the meaning of the Corporate Income Tax Act

Finally, the dispute between the taxpayer and the body was dealt with by the NSA in the judgment in which it pointed out, ‘that only if the guarantee received entails an obligation to provide mutual and equivalent, to the guarantor such a guarantee, will there be no income for unpaid benefits within the meaning of Article 12(1)(2) the Corporate Income Tax Act”.

Such a finding by the court confirms that, in fact, the economic turnover in which the related entities operate can occur where mutual and equivalent guarantees can be treated as tax neutral events on the ground the Corporate Income Tax Act

At the same time, the court pointed out that it was not sufficient to establish that a similar service had taken place, but that the value of these mutual benefits is also important: “However, it must be made clear that we can speak about the mutual benefit when the entity receiving the benefit performs a similar benefit for the entity from which it receives the benefit.

However, if the value of the benefit remaining in relation to another benefit is lower, i.e. despite the reciprocity of the benefits, their value determined for tax purposes will not be the same (the benefits will not then be equivalent) the income for receiving partially paid benefits should be indicated.’

The NSA settlement presented can be regarded as setting a certain trend towards a future approach to tax administration not only for guarantees in capital groups but also in the context of other types of benefits that may be reciprocal and equivalent.

This is an important issue as the claim for equivalent benefits has so far been frequently used in the planning of financial transactions between related entities.

The argument expressed, among other things, in transfer pricing policies was often found that in a group of companies they deliberately adopted a mutual guarantee policy with the intention of carrying out such transactions on equivalent terms.

While this assumption has been possible for a long time, in many cases on the basis of statements of will expressed in the internal documents of the capital group, due to the fact that the view expressed in the NSA ruling has been established, it is necessary to prepare for the verification activities of tax authorities, which will rely not only on the examination of assumptions, but also, in fact, on the examination of the actual course of transactions and the real value of the transactions carried out, with particular regard to their equivalent nature in the above-mentioned perspective.

6. Summary

In the first Part of the article gives an overview of the tax aspects of financial transactions in capital groups. It was pointed out what types of issues are the reasons for the practical difficulties in correcting the payment of financial transactions in groups of related companies.

The following sections of the publication will discuss other issues relating to the financing of the activities of capital groups in the context of cases of interpretation doubts, settled by tax authorities and the case law of administrative courts.

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