In this edition:
- Supreme Administrative Court confirms tax authorities’ position on fixed establishment for VAT purposes.
- Costs of Advisory services to be excluded.
- First Occupation – VAT Act vs. VAT Directive.
- Supreme Administrative Court soon to decide on relief for bad debts in VAT.
SUPREME ADMINISTRATIVE COURT CONFIRMS TAX AUTHORITIES’ POSITION ON FIXED ESTABLISHMENT FOR VAT PURPOSES
We have already discussed a radical change of approach that the tax authorities adopted towards the issue of fixed establishments within the territory of the state for the purposes of goods and services tax (hereinafter ‘VAT’). The end of 2016 saw the first signs showing a new interpretative approach being shaped, which was far removed from the position that the tax authorities had taken on the issue before. The new stance on the matter is currently being verified in the jurisprudence of administrative courts. On 23 November 2017 the Supreme Administrative Court upheld the judgment by the Voivodship Administrative Court of Warsaw dated 15 June 2015 (case file III SA/Wa 3332/14). The fact that the abovementioned first instance judgment became final and legally binding proves that a new ruling practice of great consequence is being shaped. The reasons for the SAC judgment are yet to be made public and we can only rely on the now binding judgment of the VAC.
The case pertained to a Finnish company that deals with the production and sale of boats. The company had registered in Poland for the purposes of VAT and VAT-EU. Prior to commencing business activities it had filed a request for an individual ruling, moving to have the fact that considering their business model, they wouldn’t have a fixed establishment in Poland confirmed. The company’s activities within the territory of Poland were to be confined to cooperating with an independent producer who would receive transports of materials needed to obtain the final product. The company was not supposed to purchase production services but the right to dispose of the final product. It is important to note that the materials were to be purchased both within the territory of the state and outside its borders. The final product was to be delivered pursuant to the EX Works principles. The Finnish company doesn’t plan to be in possession of any warehouse space within the territory of Poland and any potential storage of goods would take place on the premises belonging to the Polish contractor effecting the delivery of final products. The company did not have, nor was it planning to have any employees and was not able to define the timeframe for using their business model as it was contingent on unforeseeable business factors. The reasons provided by the company were based on the Council Implementing Regulation (EU) No 282/2011of 15 March 2011 laying down implementing measures for Directive 2006/112/EC on the common system of value added tax (Official Journal of the European Union L 77/1). The company claimed that pursuant to the provisions of the above, it did not meet the criteria that require them to have a fixed establishment in Poland. However, acting on behalf of the Minister of Finance, the Head of the Tax Chamber in Warsaw took issue with such a position. The authority pointed out that the company’s structure of operations within the territory of Poland meets the basic criteria of permanence and technical and human resources even if compliance with these criteria is achieved by means third parties. The position taken by the Minister of Finance was endorsed by the adjudication panel of the Voivodship Administrative Court, which dismissed the company’s complaint. To substantiate their reasoning the Court referred to the judgment of the Court of Justice of the European Union dated 16 October 2014 concerning Welmory sp. z o.o. The court put particular emphasis on the fact that in order for a company to have a fixed establishment on the territory of a given state it is not important whether the technical and human resources are under direct control of a given entity. It is enough for such resources to be comparable to the entity’s own resources. It is also of crucial importance if a suitable structure in terms of human and technical resources enables it to receive the services supplied to it and use them for its business. The VAC’s panel construing the regulations, stressed that it was fully aware of the fact that the actual state of affairs referred to in the judgment of the Court of Justice of the European Union pertained to related entities. They also underscored the breakthrough nature of their ruling, as their conclusions were applied to trade relations binding unrelated entities for the first time. This breakthrough position being endorsed by the court of higher instance might mean revolutionary changes in the approach to the matter of having a fixed establishment within the territory of Poland.
The Courts’ jurisprudence validating the restrictive approach adopted by the tax authority might foreshadow a broad range of inspections concerning the accuracy of settlements made by foreign entities conducting business activities within the territory of Poland and their contractors.
COSTS OF ADVISORY SERVICES TO BE EXCLUDED
On 27 October 2017 the lower house of the Polish parliament (Sejm) passed the Act on Amending the Personal Income Tax Act, Corporate Income tax Act, and the Act on Flat-Rate Income Tax on Selected Revenues Earned by Individuals, pursuant to which the CIT Act will feature the addition of Article 15e effective as of 1 January 2018.
The regulatory changes are to prevent generating costs by means of transferring intangibles to related entities and subsequently making use of these intangibles under a license or thanks to repurchasing them at a new (inflated) tax value.
Beginning on 1 January 2018 taxpayers subject to CIT will be required to exclude certain costs from their tax deductible expenses. These will include:
- cost of advisory services, market research, advertising services, managerial and supervisory services, data processing, insurance, guarantees and sureties or other obligations of similar nature
- all payments and liabilities for using or for the right to use intangibles set out in Article 16b, Paragraph 1, Subparagraphs 4-7 of the CIT Act
- costs of transferring the risk of debtors’ insolvency due to loans other than those granted by banks and credit and savings unions (SKOK), including the obligations arising from derivatives and other obligations of similar nature
paid directly or indirectly to related entities, set out in Article 11 of the CIT Act, or entities whose place of residence, registered office or seat of management is located on a territory or in a country engaged in harmful tax competition, for the amount of costs whose total in a given tax year exceeds 5% of the amount equivalent to the total of all revenues from all revenue sources, net of revenue derived from interest that is in excess of the sum of tax deductible expenses net of the amount of depreciation expenses classified as tax deductible expenses for a given year and interest. Revenues and costs will be determined pursuant to the provisions of Article 7, Paragraph 3 of the CIT Act, taking into account the costs allocated to a taxpayers subject to Article 5 of the CIT Act (income on joint ownership).
In order to calculate the limit, the sum of tax deductible expenses and interest is calculated without taking account of the limitations resulting from applying the new regulation and Article 15c, Paragraph 1 of the CIT Act.
The amount of costs excluded from tax deductible expenses is included in a given revenue source (a consequence of separating revenues from capital gains) in proportion to the amount of costs incurred within a given revenue source.
The abovementioned regulation is applied to surplus amounts of costs whose total amount has exceeded the threshold of PLN3,000,000 in a given tax year.
Pursuant to Article 15e, Paragraph 11 of the CIT Act, the limitations on classifying expenses as tax deductible does not apply to:
- cost of services, payments and liabilities classified as tax deductible expenses directly related to the production and purchase of goods or provision of services
- costs of services set out in Article 8, Paragraph 2a of the Goods and Services Act
- insurance services provided by entities set out in Article 15c, Paragraph 16, Subparagraphs 6 and 7 of the CIT Act
- guarantees and sureties provided by entities set out in Article 15c, Paragraph 16, Subparagraphs 1-3 of the CIT Act
Limitations on classifying the abovementioned expenses as tax deductible do not apply to costs of services, payments and liabilities insofar as the decision on validity of selecting and applying a method of determining a transfer price between related entities covers the accuracy of calculating remuneration for the services, payments and liabilities in the period which the decision refers to.
Using the list of exemptions from the limits applicable from 2018 might give rise to many practical problems with interpreting the new solutions.
Costs are deemed to be directly related to the revenue earned when the expenses are closely (directly) connected with given revenues which an entity earns due to the nature of the business activities it conducts, e.g. expenses incurred to purchase goods, resources when the business activities involve selling these goods, i.e. when specific revenues in a given period can be assigned to specific costs. Indirect costs, on the other hand, are deemed to include expenses which are not directly reflected in the revenues earned, and therefore no specific revenue can be assigned to them, even though earning revenue is contingent on incurring them, e.g. general administrative costs, costs of banks loans or advertising. Such costs, despite being undoubtedly related to the earned revenues, are not tangibly related to specific revenues. Therefore determining which period or tax year gives rise to revenue substantiating the deduction of such costs requires further analysis of revenue structure.
It is important to note that the lawmakers have not associated the exclusion from the limit of costs with the direct or indirect relation to the revenues earned but with the direct relation to the production or purchase of goods by a taxpayer or to the provision of services.
FIRST OCCUPATION – VAT ACT VS. VAT DIRECTIVE
Pursuant to Article 2 Paragraph 14 of the Act Of 11 March 2004 on Goods and Services Tax, first occupation is defined as the release for use of buildings, civil engineering works or their parts when performing taxable activities for the first customer or user, following their erection or upgrade, if expenditure incurred for the upgrade, as defined in regulations on the income tax, constituted at least 30 percent of the initial value.
On the other hand, in recent years the established jurisprudence has seen the term ‘taxable activities’ defined strictly, which has been detrimental to taxpayers. Thus first occupation is believed to occur solely by means of selling, letting or leasing real estate or as a result of concluding a contract of similar nature.
The first judgment to run counter to the abovementioned jurisprudence was the verdict passed by the Supreme Administrative Court on 14 May 2015 (case file I FSK 382/14). The judgment raised the issue of the VAT Act provisions being non-compliant with Article 135, Paragraph 1j of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax. Pursuant to the regulation, Member States exempt the supply of a building or parts thereof, and of the land on which it stands, other than the supply referred to in Article 12, Paragraph 1a. In light of the judgment, using a part of the building for the purposes of business activities constitutes first occupation, in the meaning of “preoccupancy, utilization,” and any other interpretation of Article 2, Paragraph 14 results in artificially distinguishing the situation when having erected a building, an entity leases its part and uses its section for the purposes of its own business activities. This is due to the fact that both of the abovementioned cases entail using a building.
Determining the proper definition of first occupation is important in the context of Article 43, Paragraph 1, Subparagraph 10 of the VAT Act, according to which the supply of buildings, civil engineering works or their parts is exempt from the tax provided that the supply is fulfilled within the framework of the first occupation or prior to the first occupation. Considering the above, with reference to case file I FSK 1573/14, the Supreme Administrative Court requested the Court of Justice of the European Union to give a preliminary ruling on whether the term ‘first occupation’ is compliant with the VAT Directive, and on limiting the eligibility for VAT exemption in the case of the upgrade of an existing building, when the costs incurred for that purpose amount to less than 30% of the initial value of that building.
In the judgment dated 16 November 2017 in case C‑308/16, the Court of Justice of the European Union ruled that national law shouldn’t make the VAT exemption on the supply of buildings subject to the condition that the first occupation thereof arises in the context of a taxable transaction. However, the Court also decided that such a national law may make that exemption subject to the condition, in the case of the ‘upgrade’ of an existing building, that the costs incurred have not exceeded 30% of the initial value thereof, provided that that concept of ‘upgrade’ is interpreted in the same way as that of ‘conversion’ in Article 12, Paragraph 2 of the VAT Directive.
The judgment of the Court is of crucial importance as depending on their needs taxpayers can choose a VAT exemption with the accompanying tax on civil law transactions by directly citing the provisions of the VAT Directive, which are more advantageous in this context due to their incorrect implementation into the Polish legal system. On the other hand, it is important to note that tax authorities cannot quote the judgment in case C-308/16 and apply the provisions of the VAT Directive to the detriment of taxpayers, which was the case when the right to deduct VAT on already concluded transactions was questioned.
To sum up, if the owner uses a building for a minimum period of 2 years, the fact should be equivalent to first supply and its subsequent sale should be exempt from VAT as applying another approach would constitute a violation of EU law.
SUPREME ADMINISTRATIVE COURT SOON TO DECIDE ON RELIEF FOR BAD DEBTS IN VAT
The Supreme Administrative Court has decided to stay its proceedings concerning the complaint filed against the judgment of the Voivodship Administrative Curt of Szczecin on the bad debt relief provisions of the Polish VAT Act being compliant with Directive 112. The rationale behind the Court’s decision was based on the fact that the outcome of Case C-246/16 – Enzo Di Maura vs. Agenzia delle Entrate – Direczione Provinciale di Siraciusa – pending before the European Court of Justice might significantly affect the final decisions taken by the Polish Supreme Administrative Court.
On 23 November 2017 the court passed its judgment in the abovementioned case, which referred to an Italian entrepreneur who took advantage of the right to make a reduction of the output tax based on the amounts indicated on invoices that had not been paid by his contractor. The problem, however, was the fact that insolvency proceedings had been commenced against the debtor, which in the opinion of the Italian tax authorities withholds the right to use the bad debt relief until the proceedings are completed (up to 10 years in practical terms).
In its consideration of the questions referred in case C-264/16 decided that “to accept that it is possible for Member States to exclude any reduction of the VAT taxable amount would run counter to the principle of the neutrality of VAT, which means, inter alia, that the trader, as tax collector on behalf of the State, is entirely to be relieved of the burden of tax due or paid in the course of his economic activities, themselves subject to VAT (see, to that effect, judgments of 13 March 2008, Securenta, C 437/06, EU:C:2008:166, paragraph 25, and of 13 March 2014, Malburg, C 204/13, EU:C:2014:147, paragraph 41). (…)The finding in the preceding paragraph applies a fortiori in the context of national legislation such as that at issue in the main proceedings, under which certainty that the debt is definitively irrecoverable can be obtained, in practice, only around ten years later. Such a period is, in any event, such as to inflict on traders subject to that legislation, when they are confronted with non-payment of an invoice, a cash-flow disadvantage compared to their competitors in other Member States, which would clearly undermine the objective of fiscal harmonization pursued by the Sixth Directive. It follows from the foregoing that the answer to the questions referred for a preliminary ruling is that the second subparagraph of Article 11C(1) of the Sixth Directive must be interpreted as meaning that a Member State may not make the reduction of the VAT taxable amount in the event of total or partial non-payment subject to the condition that insolvency proceedings have been unsuccessful when such proceedings may last longer than ten years.”
Considering the above, it is reasonable to expect that the Supreme Administrative Court should agree with the claims presented in the cassation appeal and decide that the Polish regulations of the VAT Act that preclude the possibility of using the bad debt relief, also in the cases when there are pending insolvency proceedings against debtors, do not comply with the VAT Directive.