Limiting the ability to settle tax losses

Date 1 January 2021 the provisions of the amended Personal Income Tax Act, the Corporate Income Tax Act, the Flat-rate Income Tax Act on certain income generated by individuals and certain other laws entered into force (Journal of Laws of 2020, item 2123 as amended, hereafter as ZmPDOFizPrRyczU20(2), effectively expanding the range of taxpayers who will not be able to benefit from the deduction of losses in the case of restructuring operations.

Limiting the ability to settle tax losses

The analysis of the revised provisions of the PDOPrU shows that the project promoter of the above-mentioned amendments, i.e. the Ministry of Finance, was primarily guided by the intention to reduce the optimisation efforts on the part of taxpayers.

General rules for the settlement of tax losses

According to the PDOPrU, revenue from the source of revenue is the excess of the revenue generated from that source over the cost of obtaining it in the tax year. If the cost of obtaining revenue exceeds the total revenue, the difference is a loss from the source of revenue. This means that when a taxpayer generates more revenue costs than tax revenues, it shows a tax loss. At the same time, according to Article 7(5) PDOPrU, taxpayers have the ability to settle tax losses on two the following ways:

by reducing the income from this source in the next successively following 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
by one-off reduction in income generated from this source in one of the next successively following five tax years not exceeding 5,000,000 PLN, the outstanding amount shall not exceed the amount of the reduction in any of those years; 50% the amount of that loss.

At the same time, it should be pointed out that the possibility of a one-off deduction of the tax loss was introduced into the PDOPrU provisions at the date of 1 January 2019 i – as ZmPDOFizPrRyczU20(2) – only losses incurred after 1 January 2019

The taxpayer in 2018 suffered a loss of 5,000,000 PLN.

In 2019 the taxpayer generated a profit of 7,000,000 PLN.

The taxpayer is entitled to a profit settlement of 7,000,000 PLN quotas 2,500,000 PLN (50% 5,000,000 PLN), Because the loss was incurred before 1 January 2019

The taxpayer in 2019 suffered a loss of 6,000,000 PLN.

In the year 2020 the taxpayer generated a profit of 7,000,000 PLN.

The taxpayer is entitled to a profit settlement of 7,000,000 PLN losses in full 5,000,000 PLN, Because the loss was incurred after 1 January 2019, One-off income reduction did not exceed the amount 5,000,000 PLN.

Restrictions on the ability to deduct tax losses in the legal state before 1 January 2021

To the end 2020 – as indicated Article 7(4) PDOPrU – no account was taken of the revenue and revenue costs referred to in Article 7(3) PDOPrU, and in the event of a transformation of the legal form, merger or division of entrepreneurs, also losses of the enterprises converted, merged, acquired or divided, with the exception of companies converted to other companies.

This means that, for example, when companies were converted by new companies, it was not possible to deduct losses incurred by companies converted before they were converted. The only exception to this rule is the transformation of the company into another company – e.g. companies from O.o. into a public limited company.

Thus, it was not possible to recognise the loss of the merged companies by setting up a new company or by the companies acquired in the merger by the acquisition, but this was possible in the case of the loss incurred by the acquiring company during the merger by the acquisition.

Amendment of the PDOPrU rules – limiting the ability to settle tax losses

Date 1 January 2021 an additional provision has been introduced in the PDOPrU; namely, as indicated by the added Article 7(3)(7) PDOPrU – no account shall be taken of losses of the taxpayer when determining the taxable income:

1) take over another entity, or
2) has acquired an undertaking or an organised part of an undertaking, including through a non-monetary contribution, or
3) has received a financial contribution for which he has acquired an undertaking or an organised part of an undertaking,

as a result of which:

(a) the object of the taxable person's actual principal business activity after such acquisition or acquisition, in whole or in part, is different from that of his actual principal business before such acquisition or acquisition, or

(b) at least 25% the taxpayer’s share(s) is owned by an entity or entities which, at the end of the tax year in which the taxpayer suffered such a loss, did not hold such rights.

Thus, the revised provisions of the PDOPrU mean that taxpayers will not be able to account for losses in situations where the company has taken over other entities and as a result, the subject matter of the business is completely different than before the acquisition. At the same time it will not be possible to deduct losses in the event of a significant change in ownership, that is, if at least 25% the shareholders after the acquisition, which was not at the end of the tax year in which the loss was incurred.

Company A which produces footwear generated in 2018 loss in amount 5,000,000 PLN.

In 2019 the company took over another building service provider. A merger transaction was made by acquisition.

After the merger, Company A conducts business activity in the field of construction services. Company A has no right to settle the tax loss from 2018 because the object of its actual core economic activity after such acquisition is different from that of its prior acquisition.

Company A which produces footwear generated in 2018 loss in amount 5,000,000 PLN.

In 2019 the company took over the daughter's company, which also produces footwear. Company A will have the right to settle the tax loss after acquisition with 2018, because it did not change its business profile and retained the shareholder structure.

Problems of taxpayers after changing the provision Article 7(3) PDOPU

one the main problems arise from the formulation of a condition preventing settlement of the loss, which is specified in Article 7(3)(7) point a PDPrU.

This is a condition relating to a change in the subject of the taxable person’s actual business activity after taking over or acquiring, which ‘in whole or in part is different from that of the taxable person’s actual business prior to such acquisition or acquisition’.

This wording in the PDOPrU causes that even if the core business of the acquiring company is continued after the change in the subject-matter of the business, but it will be expanded due to the fact that the acquired company had a core business other than the acquiring company and economically justified that the activity would be continued, it would not be possible to settle tax losses from the period before the acquisition.

In this sense, the provisions of the PDOPr do not leave any freedom to partially change the profile of activities.

Company A which produces footwear generated in 2018 loss in amount 5,000,000 PLN.

In 2019 the company took over the daughter's company, also producing footwear and advertising services.

After the merger by taking over, Company A operates in the field of footwear production and is engaged in advertising services.

Company A will not have the right – after acquisition – to settle the tax loss from 2018, because although the shareholder structure has been preserved, it is a business profile of the company And partly changed (extended).

Attention should also be paid to second condition (Article 7(3)(7) point (b) of the PDOPrU, i.e. changes in ownership structure.

By way of an amendment of the KSH in 2020 the possibility of issuing to the shareholders of the acquired own shares which the acquiring company acquired as a result of the merger was allowed. This facilitated the so-called reverse mergers, i.e. situations where the acquiring company is a subsidiary and the acquired company is a parent company. Thus, the acquiring company was able to issue its own shares to the shareholders of the company, without having to increase the share capital in advance.

Therefore, in the case of reverse mergers, there is a situation where the shareholders of the acquired company receive shares of the subsidiary, i.e. the acquiring company. This mechanism is often used to simplify the organisational structure in capital groups, for economic reasons.

Thus, in most cases where such a transaction is carried out, the ownership structure referred to in Article 7(3)(7) point (b) of PDOPrU, i.e. at least 25% the share(s) of the taxpayer (the acquiring company) will be held by an entity or entities which, at the end of the tax year on which the taxpayer suffered such loss, do not have such rights.

No intertemporal provisions

The revised rules entered into force 1 January 2021, However, the legislator has not indicated any transitional provisions in them. As a result, it is not known how to approach taxpayers who, in the period before the entry into force of the rules, have applied certain restructuring measures, for example, have merged companies.

For it is not clear whether after 31 December 2020 they may apply earlier loss accounting rules. Taxable persons who before 1 January 2021 have done so, they will most likely apply for individual interpretations.

Summary

The activities of the Ministry of Finance aim to implement the policy of combating tax optimisation by taxpayers. The provisions introduced prevent:

1) to taxable persons who combine entities to make changes in the types of business activity carried on, and
2) to taxable persons whose reinsurance activities are linked to the introduction of new investors, to deduct the tax losses of the acquired or merged entities.

Depending on the possibility of deducting taxpayers' losses from a more defined significant change in their business activity, there is no economic justification as taxpayers usually carry out restructuring operations in situations where they invest, introduce new investors or expand markets and product groups.

The above amendment of the PDOPr makes it difficult for taxpayers to restructure, which the Ministry of Finance assesses as a potential risk of taxpayers obtaining excessive tax benefits.

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Legal basis

Article 515 KSH,

Article 7(3)(7), Article 7(5) PPOPU.

The article comes from the book C.H. Beck Publishing House Changes in Taxes and Accounting 2021 including anti-crisis shields (series: Law in practice, year: 2021) + CD, under the editor-in-chief of Professor Artur Hołday - Ksiegarnia.beck.pl.

Limiting the ability to settle tax losses