Draft tax explanations on transfer pricing regarding presumption and due diligence

Magdalena MICHAŁOWSKA
Junior Tax Consultant

The Ministry of Finance has published draft tax explanations on transfer pricing regarding presumption and due diligence in transactions with tax haven entities. The draft explanations are now subject to tax consultation that will last until 20 April 2021. This consultation is open to all entities.

Introduction

The discussed draft relates to the provisions of Article 11o. par. 1b of the CIT Act and Article 23za par. 1b of the PIT Act, in force since 1 January 2021, regulating presumption and due diligence in the verification of any settlements of the other party to the transaction with the entity having its place of residence, registered office or management board on the territory or in a country applying harmful tax competition. These provisions shall apply to transactions carried out in 2021 and in the years to follow. Please be reminded that the changed rules in transactions with tax haven entities are mostly about:

1. The extended scope of transactions that must be verified in terms of their compliance with the arm’s length principle that now includes transactions where the beneficial owner has its place of residence, registered office or management board in a tax haven (even if your contractor has Polish tax residency);
2. new transaction thresholds:

• PLN 500,000 for transactions where the beneficial owner is situated in a country or territory that applied harmful tax competition;
• PLN 100,000 for controlled and uncontrolled transactions with tax haven entities.

The list of countries or territories practicing harmful tax competition is presented in the regulation of the Minister of Finance. This list includes the Principality of Andorra, the Republic of the Marshall Islands or the British Virgin Islands.

The essence of presumption

According to the draft explanations, Article 11o par. 1b of the CIT Act includes a presumption that the beneficial owner is a tax haven entity if the other party to the transaction with the taxpayer makes settlements with a tax haven entity in the fiscal year. If this is found to be the case, there is an obligation to prepare a local file for transfer pricing in the first place. This presumption is applied in the case where it is established that the other party to any transaction exceeding the value of PLN 500,000 makes direct settlements with a tax haven entity in that fiscal year.

What exactly are these settlements? First of all, it is about settlements that take place in the fiscal year of the taxpayer and not the fiscal year of the other party to the transaction. Secondly, it is about regulating any receivables/liabilities with the contractor that can be in cash (payment), in kind (transfer of another asset or provision of a service) or as a set-off of mutual receivables and liabilities. In order to determine whether the other party to the transaction makes any settlements with a tax haven entity in a given fiscal year, it is essential to find any settlements of the other party to the transaction, i.e. making any payments (receivables/liabilities). If the other party to the transaction is found to have made settlements with a tax haven entity, it can be presumed that the beneficial owner is a tax haven entity. To challenge this presumption, you need to prove the opposite, i.e. that the beneficial owner is not a tax haven entity. If the presumption has been effectively challenged, there is no requirement to prepare a local file.

Due diligence

The concept of due diligence is well known to all VAT taxpayers, as the Court of Justice of the European Union has issued many rulings on this. The Polish legislator has decided to introduce this concept to the field of transfer pricing, as well. In line with the draft explanations, Article 11o par. 1b of the CIT Act defines a standard of expectations towards what taxpayers do in order to verify if the other parties to their transactions have made any settlements with a tax haven entity in a given fiscal year. The standard of due diligence is a gradual one. (…) In the case of related entities, the verification should be broader, because they have greater cooperation options within a group when it comes to verifying relevant circumstances.

What should be done then? According to the draft explanations, in order to exercise due diligence in transactions with unrelated parties, regardless of their place of residence, it should suffice for the taxpayer to obtain a written statement from the other party to the transaction that the said other party to the transaction does not make any settlements with a tax haven entity in the taxpayer’s fiscal year. The statement relates to the settlements of the other party in the fiscal year, hence it should be obtained ex post, i.e. once the taxpayer’s fiscal year is over. The Ministry suggests that the requirement to make a statement itself can be included in the contract concluded between the parties in the fiscal year.

At the same time, it cannot be assumed that due diligence has been exercised in the case where the taxpayer has access to the information on the basis of which he knew or should have known that the received statement was inconsistent with the facts. (…) Should there be any doubts as to the statement’s consistency with the facts, the due diligence requirement means you have to further verify the circumstances relevant for the explained provision. Additional sources of information obtained from a related entity may include:

• transfer pricing documentation (local file, master file);
• CbC reports;
• financial statements with the auditor’s report and opinion;
• ownership structure;
• opinion of a public representative (e.g. auditor, lawyer, tax advisor).

Unfortunately, the procedure put forward in the draft is going to increase the administrative burden on taxpayers.

Summary

The explanations definitely clarify many things; however, they bring on some further doubts and create more practical problems, as well. Is it really the intention of the legislator to impose this requirement on taxpayers by which they have to get a statement from all their contractors, both related and unrelated, both Polish and foreign? What about entities that do not receive this statement, what should they do? If the transaction has been completed during the fiscal year, should the taxpayer actually wait until the end of the tax year before requesting this statement from their contractor? We hope this it will all be addressed in the tax consultation that is under way. For the time being, we are under the impression that these new requirements are absolutely unfeasible for a majority of Polish entities, both from the practical and technical point of view.