So far, the issue of holding companies conducting real economic activity has not been subject of lively discussions in Poland. Nevertheless, the provisions introduced by the legislator as a weapon to fight tax avoidance, in particular the provisions on controlled foreign companies (CFC) and the new rules for collecting withholding tax, require dotting the i’s and cross the t’s in this respect. The conclusion should be simple. Holding companies cannot be excluded from the group of entities conducting actual economic activity. However, they must have a sufficient material and personal substrate, or the so-called economic substance.
The essence of the problem
The regulations on controlled foreign companies (CFC), which have been in force in Poland since January 1, 2015, have introduced legal and tax fiction, according to which a Polish taxpayer should include in his tax base income of a foreign entity being a separate income taxpayer, at a rate of 19 percent, in the part corresponding to the possessed rights to participate in the profits of that entity.
The regulations on CFC have undergone numerous modifications over the years, including the exclusion of their application. In the current legal status of these provisions – except for the obligation to keep a register of controlled foreign companies – does not apply if a controlled foreign company, subject to taxation on its entire income in an EU Member State or belonging to the EEA, carries out significant real economic activity in that country.
Subsequently, the provisions indicate a sample catalogue of criteria that should be taken into account when assessing whether an entity conducts actual economic activity. In brief, they come down to the requirement for a material and personal substrate (premises, equipment and staff) allowing third parties to objectively determine the physical presence of an entity in a given country. It must be commensurate with the activity carried out, and at the same time the activity must have an economic justification and must not be clearly in conflict with the general economic interests of an entity.
Regarding the provisions on withholding tax collection, the entry into force of which has been partially deferred until January 1, 2020, these provisions extend the scope of tax remitters’ obligations in verifying the legitimacy of using exemptions and preferential withholding tax rates in connection with the payment of e.g. dividends, interest and remunerations for certain intangible services. The settlement of tax in connection with such payments is the responsibility of a tax remitter, i.e. a person or entity that makes them – if they are a legal person, an organizational unit without legal personality or a natural person who is an entrepreneur.
Without entering into details, a tax remitter is required – from January 1, 2019 as part of due diligence procedures – to verify that a recipient of a claim is its beneficial owner within the meaning of the Polish Income Tax Acts. However, after the entry into force of temporarily deferred provisions, the fact that a recipient of receivables has the status of their beneficial owner will be a condition for a tax remitter’s option not to collect or apply preferential withholding tax rates.
The problem is that one of the structural elements of the definition of beneficial owner is the requirement for a recipient to conduct the real economic activity. At the same time, the legislator clearly indicates that when assessing whether an entity conducts actual economic activity, one should rely on the same criteria that apply to CFC.
Holding as a form of conducting (real) economic activity
Holding is a form of capital concentration and simplification of the corporate structure. Its essence is managing by one entity (in principle a company) other entities, coordinating their activities and strategic or organizational planning thanks to capital or personal dependencies.
It is difficult to find reasons why holding companies should be excluded from the group of entities conducting the economic activity. The Polish Corporate Income Tax Act – unlike the Personal Income Tax Act – does not contain a definition of economic activity. However, it is included in the Tax Ordinance and it seems that this definition should apply to the conduct of economic activity by legal persons and other entities subject to corporate income tax. It has a wide scope, broader than the definition provided for in the Polish Law of Entrepreneurs.
The Ordinance indicates that economic activity should be understood as any gainful activity carried out on one’s own behalf and on one’s or someone else’s own, even if other Acts do not classify this activity as economic activity. As a result, the risk of not including some of the economic activity manifestations in the definition has been reduced.
Of course, the activity of a holding company – in order to be considered as an economic activity – cannot be limited to only passively benefiting from ownership rights (e.g. receiving dividends). The company should actively participate in the management of subsidiaries.
Another issue is whether a holding company’s activities are real. Here, the criteria mentioned earlier are at stake, which in essence boils down to determining whether there is a sufficient material and personal substrate that actually helps the entity in conducting holding activities.
By its very nature, such activities generally require a large capital commitment with relatively low personal involvement. Therefore, it should be assumed that a company’s premises, equipment and personnel should commensurate with the scale of its operations, i.e. that it can manage subsidiaries in an efficient and independent manner.
What does the legislator say?
Currently applicable regulations do not provide an unambiguous answer to whether holding companies can be treated as conducting economic activity. However, there are signals indicating that the Ministry of Finance recognizes a holding activity as an economic activity. Such a signal is a draft of explanations regarding the rules for collecting withholding tax. In these explanations we read that in practice there will be different premises for conducting actual economic activity by production/ commercial and service companies as well as companies dealing with broadly understood financial activities – e.g. investment or holding activities.
This issue cannot be considered in isolation from the broadly understood European acquis. The Code of Conduct Group (Business Taxation) issued guidelines stating that the establishment of a holding company, like any other entity, may have legitimate business reasons. It cannot be ruled out that such a company does not conduct (real) economic activity. However, it must meet the criterion of real economic activity, which means objective elements such as premises, staff and equipment, and the criterion of substantial economic presence, which refers to the proportionality of assets held to type and scale of activity, i.e. whether the resources held are quantitatively and qualitatively adequate to the services rendered. Similar conclusions follow from the case law of the ECJ and the courts of EU Member States.
How will it finally be?
The Polish rules undoubtedly lack an unequivocal answer to the question of whether a holding company can be considered as conducting economic activity. The first signals in the form of a draft explanation from the Ministry of Finance give some indication in what direction the Polish legislator will be heading. This direction seems right, taking into account existing European models. Unfortunately, holding companies will still have to wait for dotting the i’s and cross the t’s in this respect.