The changes to the KSH relating to transfer prices raise a lot of controversy, and a large number of experts believe that they require the adaptation of the other provisions, which is at least currently lacking prospects. Tax payers should therefore exercise caution when issuing binding orders and take into account the effects of these measures, even in relation to transfer pricing rules.
On 13 October 2022 the amendment of the Commercial Companies Code entered into force (Law of 9 February 2022 amending the Act - Commercial Companies Code and some other laws (Journal of Laws, item 807 as amended), introducing the concept of a ‘group of companies’ and equipping parent companies with tools to facilitate supervision and to act to achieve a common interest in the group. However, the problem arises when new regulations combine with existing transfer pricing rules, which may significantly complicate the application of the applicable holding law.
Regulation of holding companies through groups of companies
The introduction of regulations governing the management and supervision of the parent company of the group to the Code of Commercial Companies (hereinafter KSH) is a response to the needs reported for a long time by entrepreneurs operating in relationships of dependencies with other entities.
Problems arise when new regulations come together with existing transfer pricing rules that can significantly complicate the application of the applicable holding law.
As a general rule, companies (including those included in the group) should act in their own interest to maximise their profits. However, to date, such action may not have taken into account the interests of the group as a whole, and the action against this principle may have led to a risk of liability for board members.
In the previous version, KSH regulated the issues of holding law in a limited manner, taking into account contractual holding companies, i.e.
those in which the parent and subsidiary conclude a management agreement with the parent company or a profit-taking agreement with the parent company (Article 7 KSH, which has been deleted and which in practice did not function at all).
Due to the lack of standardization of legal issues concerning the so-called real holding companies, i.e. the companies between which the relationship of dominance and dependence was created, and which constitute a vast majority in Polish economic practice, the need to introduce rules governing this aspect was recognised.
Therefore, it was introduced into KSH Division IV, entitled ‘Group of companies’, which regulates the operation of actual holding companies.
At the same time, it should be noted that these provisions may also apply to contractual holding companies, as the contractual holding normally meets the statutory conditions for the existence of the actual holding.
Definitive difficulties with the term ‘group of companies’
At the outset, it is worth noting the concept of ‘group of companies’ introduced to KSH, which means ‘a parent company and a company or subsidiaries, which are capital companies, following the resolution on participation in a group of companies, a common strategy for the realisation of a common interest (interest of a group of companies), justifying that the parent company has a single management over a subsidiary or subsidiaries’.
It is therefore necessary to adopt a decision on participation in the group of companies indicating the parent company and the disclosure by each group of companies in the register of participation in the group of companies in order to define and apply the group of companies in question.
If the parent company is established abroad, participation in a group of companies should be disclosed in the register of the subsidiary. It is therefore necessary to take additional action as there is no "automatic" application of the rules in the case of capital groups.
Even at this stage, there are differences in the definition layer compared to transfer pricing rules. Under transfer pricing regulations, a related entity in the group may be not only a capital company (as in the case of a group of companies), but also a natural person or a personal company.
The tax legislation on determining the existence of a link goes much further than the KSH rules on a group of companies. A sufficient reason for establishing the existence of a relationship is the fulfilment of the conditions set out in the Corporate/Physical Income Tax Act, which are quite broad.
In this context, the group of entities that may be regarded as a ‘group of companies’ and which operate within the capital groups has been significantly reduced by the amendment of the KSH, as this concept constitutes a ‘qualified’ relationship of dominance and dependence based on the realisation of a common interest and a common strategy which can be more effectively achieved by the management of the parent company.
This leads to a situation where the introduced regulations aimed at facilitating the management and better supervision of the group by the parent company can only be applied to a limited number of entities in the group. It is therefore difficult to talk about better governance or a holistic approach to achieving the group's common interest.
In addition, it should be mentioned when the dominant entity in the group is a passenger company. At that time, according to the new wording of KSH, such a company, together with its subsidiaries, cannot constitute a ‘group of companies’.
Problems with binding command
Another important change is the introduction of the concept of “binding command” to the KSH. It is a tool to help the dominant companies to realise the common interest of the group of companies. For its validity, such an instruction should be given in writing or electronically. Further according to Article 212(3) amendments, binding instructions shall indicate at least:
- 1) the behaviour of the subsidiary in the performance of the binding order expected by the parent company;
- 2) the interest of the group of companies which justifies the exercise of a binding order by the subsidiary;
- 3) the expected benefits or damage to the subsidiary which will result from the execution of the binding order, if any;
- 4) the intended manner and time-limit for compensation to the subsidiary of the damage suffered by the execution of the binding order.
Both the execution and refusal to execute a binding order require a resolution by the subsidiary. In the event of refusal to execute a binding order, the resolution shall contain an appropriate justification.
Under the transfer pricing rules, this regulation poses a risk of strengthening non-market practices and issuing binding orders relating to the conclusion of transactions at a level diverging from the market, at the same time justified by the interest of a group of companies. In addition, such behaviour would conflict with the obligation to enter into controlled transactions at market level, i.e. under conditions that would determine unrelated entities among themselves), expressed by the arm’s length principle.
According to the new wording of the KSH, in the event of the execution of a binding order, a member of the board of directors, a supervisory board, a review committee and a liquidator of a subsidiary shall not be liable for the damage caused by the performance of the binding order.
Similarly, liability is limited in relation to a parent company acting in the interest of a group of companies. The question therefore arises: what about the transaction with a non-market-related entity when the transaction resulted from the execution of a binding order?
Other doubts
According to the transfer pricing rules, if tax documentation is required and a TPR form is submitted, the members of the board (the head of the unit within the meaning of Article 3(1)(6) Accounting Act) are required to make a statement (from 2022 the statement is part of the form) in which they confirm that the controlled transaction has been concluded at market conditions.
What, then, of the criminal-tax liability of the board members who make a declaration of the conclusion of a transaction on market terms which may prove incompatible with the reality that the transaction referred to in the statement and the form was executed as a performance of a binding instruction, in order to act in the interests of a group of companies?
Transfer pricing rules impose obligations on companies from an individual perspective and, in the case of tax checks, the result of the group as a whole is not taken into account, but the profitability of the company to be controlled.
Thus, action to achieve the group's common interest can ultimately expose the company to unpleasant consequences and sanctions. The failure to bring tax rules into line with the applicable holding law therefore raises numerous questions and concerns.
A partial response to these ambiguities can be seen in the explanatory memorandum to the draft bill amending the KSH. According to him, "the new rules concern only private law, so they do not affect the application of public law standards, including tax law standards". The legislator stresses that in practice there are clearly voices that, outside the private sphere, also see the need to regulate the issue of "taxing transactions using so-called transfer prices".
However, despite this, the legislature has decided to introduce a holding law in the option of limited regulation. This argues for the more frequent occurrence of a restricted regulatory option in European Union countries and the "negative practical experience" of countries that followed full regulation. The question here is how much doubt they will encounter in the way of a capital group, seeking to benefit from the revised rules, covering the matter of group management in a limited way.
Consequently, there are currently no prospects for comprehensive regulation of holding rights, and companies applying company group rules in the future should carefully shape mutual relations with regard to transfer pricing. As explained in the draft law, ‘the proposed regulations do not exempt related parties, within the meaning of the transfer pricing provisions, from tax obligations, including the application of the arm’s length price and other obligations under the transfer pricing rules.’ Thus, the tax effects of the activities undertaken by the companies cannot be justified solely by compliance with the applicable rules of holding law, which will not avoid possible sanctions for the transfer of profits.