Tax havens: new documentation obligations

Kamila DOBOSZ
Tax Consultant at RSM Poland

Changes concerning transfer pricing in transactions with tax havens, effective as of 1 January 2021, will be challenging for taxpayers. Under the new regulations, there is an obligation to have verify whether transactions where the beneficial owner has its place of residence, registered office or management in a tax haven comply with the arm’s length principle (and it is unclear whether the legislator means the actual owner of our contractor or the cash flow generated as a result of a given transaction, as the regulations fail to specify this). What is more, taxpayers must provide economic justification for their transactions with tax havens.

Documenting your transactions with tax haven entities

Transactions with tax havens that involve a documentation obligation can be considered on two levels.

Firstly, the obligation applies to transactions concluded directly with tax haven entities, the annual value of which exceeds PLN 100,000. The type of transaction is not important here: the obligation covers purchase and sale transactions of different natures (both services and goods). So far, the taxpayer had to document only those transactions, where the payment was made to a country applying harmful tax competition (i.e. the Polish taxpayer was the purchaser).

Secondly, a requirement was introduced to prepare tax documentation for transactions whose value exceeds PLN 500,000 in the case where the beneficial owner was located in a country or territory that applies harmful tax competition.

In the first case discussed here, it should not be difficult for a taxpayer to identify that a contractor is seated in a country being a tax haven. Agreements that have been concluded with them will prove useful here. However, what comes as a surprise here is that the documentation obligation also applies to sales transactions, i.e. transactions resulting in a payment made to a Polish taxpayer. After all, transactions of this type do not involve the risk of transferring funds to tax havens.

Verification of the beneficial owner

When it comes to the second type of “tax haven” transactions, the identification of the beneficial owner and the obligation to prepare the documentation for this type of transactions seems to be a rather troublesome requirement.

Pursuant to Article 11o par. 1a of the CIT Act, effective as of 2021, “taxpayers and companies which are not legal persons concluding a controlled transaction or a non-controlled transaction shall be obliged to prepare a local file, provided that the beneficial owner has a place of residence, registered office or the management in a territory or country that applies harmful tax competition, and the value of this transaction for the tax year, and in the case of companies which are not legal persons: for the financial year, exceeds PLN 500,000.” Based on Article 11o par. 1b of the CIT Act, it is presumed that the beneficial owner has a registered office or management in a territory of a tax haven by the mere fact that this contractor concludes transactions with a tax haven entity. Therefore, all it takes is that the contractor concludes any transaction with a tax haven entity (its value does not matter) and the taxpayer shall be required to prepare tax documentation with this contractor (once the threshold of PLN 500,000 is exceeded in the case of a transaction with a contractor).

According to the new regulations, in the case of transactions with tax havens, transfer pricing documentation should include economic justification for this transaction, in particular a description of expected economic benefits, including tax benefits.

Due diligence

In order to determine the above, the taxpayer must exercise due diligence. According to “Transfer Pricing Tax Notes no 4: Presumption and due diligence referred to in Article 11o par. 1b of the CIT Act and Article 23za par. 1b of the PIT Act” of 2 March 2021, you have to obtain a statement of knowledge from the other party attesting that the contractor does not make any settlements with a tax haven entity. This statement shall be obtained ex post, i.e. after the end of the taxpayer’s financial year. However, we may ask the following question: what if the contractor fails to provide this statement? Is the taxpayer in a position to force the contractor to do so, given that the contractor is not required by law to do it? Is there any publicly available data that could help verify this type of information? Unfortunately, the answer is no. At this point, we need to mention that the administrative burden on taxpayers is significant. Obtaining a statement from the contractor and then preparing relevant documentation, if necessary, will be particularly difficult for small and medium businesses, as limited human resources and additional work load will play a role there. In the case of large entities, concluding transactions with a number of contractors, these activities will simply become time- and labour-consuming.

Economic justification for the transaction

In addition, according to the new regulations, in the case of transactions with tax havens (both direct and indirect), transfer pricing documentation should include economic justification for this transaction, in particular a description of expected economic benefits, including tax benefits. The taxpayer will be required to carry out a benefit test, i.e. a description of expected economic benefits, including tax benefits, resulting from transactions with tax haven entities. The reasoning behind the economic rationale of the transaction is aimed at demonstrating that the contractor from a tax haven conducts genuine business activity. While the above may be understandable in the case of purchase transactions, when there is a risk of income being transferred to countries that apply harmful tax competition, such a risk does not exist at all in the case of sales transactions.

Summary

The documentation obligation for transactions with tax havens, formulated in regulations effective as of 2021 is quite controversial. It was widely discussed at the April meeting of the Transfer Pricing Forum, where it was pointed out that the costs and the work load involved in the verification of transactions with beneficial owners are disproportionate to the effects. Let us hope that the recommendations of one of the Working Groups addressing transactions with tax havens will bring some positive changes to the obligations in force as of 2021.