The second sentence of Art. 26(1) of the Corporate Income Tax Act (similarly in Art. 41(4aa) of the Personal Income Tax Act) provides: “In verifying the conditions for application of a rate other than the one specified in Art. 21(1) or Art. 22(1), an exemption, or conditions for not collecting tax…, the remitter is required to maintain due diligence. The nature and scale of the activity pursued by the remitter shall be taken into account when assessing the exercise of due diligence.”
The duty rests on the remitter and always applies to the remitter
Essentially, the duty to maintain due diligence rests on a tax remitter who, when making a payment, does not deduct withholding tax pursuant to a tax treaty, or applies an exemption or reduced tax rate. Further, the duty to maintain due diligence always applies to the remitter, that is, regardless of the amount of the payments to a taxpayer during the tax year.
The notion of “due diligence”
With this in mind, the question arises, what is included in the notion of due diligence? According to published draft tax clarifications dated 19 June 2019 (to this day only a draft), to maintain due diligence, the following measures in particular should be carried out:
- Verification of documents received for consistency with the facts;
- Verification of the tax residency of the recipient of the payment;
- Verification of the status of the counterparty as a taxpayer who obtains income through the receipt of the payment, as well as the beneficial recipient of the payment, including in terms of the actual commercial activity conducted by the recipient.
Fortunately, the Ministry of Finance indicates for us in great detail what exactly this verification for purposes of maintaining due diligence should consist of.
The remitter should:
- Take into consideration generally available information on the recipients of payments (industry press, media reports, public or private registers or databases of entities, and information obtained for anti-money laundering and counter terrorist financing purposes)
- Examine on the side of the recipient what personnel and premises it has, who are the members of the management board, where documents are signed concerning the affairs of the recipient of the payment, whether sessions of the management board can be held in the state of the recipient’s residency, whether the address of the registered office is used simultaneously by numerous entities, and even whether the members of the management board have local email addresses or telephone numbers.
Additionally, when maintaining due diligence between related entities, the remitter should:
- Analyse the articles of association of the recipient of the payment, its financial report, organizational or management structure, the job description of relevant individuals, documents concerning financial flows, and even local transfer pricing documentation.
When maintaining due diligence between unrelated entities, the obvious difficulty in obtaining comprehensive documentation must be taken into account, but nonetheless it is indicated that there is a duty to conduct a thorough verification of data concerning the recipient of payments (comparison of the tax residency certificate against documents in the remitter’s possession and publicly available data), to call the counterparty, to verify the nature of the counterparty’s address, and even to apply special expert tools and consult an opinion or report of an independent auditor or tax adviser.
What should be borne in mind?
It is important to analyse payments made to foreign recipients covered by the withholding tax regulations in terms of maintaining due diligence. The tax authorities will certainly examine whether the remitter used due diligence in verifying the conditions for applying a reduced withholding tax rate or exemption, or the conditions for refraining from collecting withholding tax. If you have any doubts concerning withholding tax, please contact us.
