Lack of due diligence and the resulting withholding tax in Poland
When should you perform due diligence in respect of the foreign counterparty verification process? If I pay less than PLN 2 million abroad, am I obligated to verify the payment against any additional criteria? What documents, statements, and additional expert opinions should I obtain? What could be the consequences of failure to perform due diligence when paying abroad? Last but not least, when making payments to related entities, will I have to meet even stricter requirements?
Nowadays, questions such as these constitute a cause for concern for many entities that make cross-border payments. This feeling of uncertainty stems mainly from the postponement of the entry into force of the provisions introducing a change in the withholding tax collection system. The entry into force of the relevant regulations has already been postponed several times and is now scheduled for 1 January 2021.
The planned amendment (the provisions are already part of the CIT Act, though they are not yet in force) concerns the transition from the currently known tax at source relief system which is applicable at the moment of payment abroad assuming certain legal conditions have been met, to a tax refund system, i.e., collection of tax upon payment and a subsequent tax refund. The issue is that part of the regulations, i.e., in the area of due diligence, is already in force (Article 26 Section 1 sentence 3 of the CIT Act) and causes many interpretation problems concerning payments up to PLN 2 million and higher. However, the consequences of failing to comply with due diligence requirements may be significant and entail denial of tax benefits resulting from the application of double taxation agreements or regulations implementing EU directives, as well as being subject to the standard withholding tax rate of 20%, 19% or 10% respectively.
Explanations provided by the Minister of Finance
The CIT Act does not stipulate which actions shall be considered as due diligence. The Minister of Finance referred to the matter in the "Explanatory notes on the principles of withholding tax collection” published on the 19th of June 2019. The explanatory notes are still in draft form, however, and, as such, in our opinion do not yet provide any reliable protection for the taxpayer. However, they constitute the only document (apart from individual tax rulings) containing guidelines from the Minister of Finance on understanding the new regulations, so complying with their content should be the safest solution from a fiscal point of view.
According to the Minister of Finance, the following circumstances should be taken into account when performing due diligence: 1. the nature and scale of the activities conducted by the taxpayer, 2. the relationship of tax remitter with the taxpayer, 3. actual possibility of obtaining information.
Performing due diligence consists primarily in:
- verification of the received documents in terms of their compliance with the factual circumstances (on the basis of publicly available information);
- verification of the tax residence of the recipient of the receivables (in that regard, attention should be paid to the risk of registering the company in one country and managing it from the territory of another country);
- verification of the status of the counterparty as a taxpayer, the beneficial owner of the paid receivables, including the actual business activity conducted by the entity.
The Minister of Finance indicates that, in the case of unrelated entities, obtaining an opinion (report) of an independent auditor or tax advisor on the activities of the recipient of the receivables may be considered as exercising due diligence in the case of the most relevant payments. Such an opinion for the purposes of the future refund procedure is considered by the Minister of Finance to be an important factor which may affect the efficiency of the proceedings and the refund process. The tax authorities as well indicate, by means of individual tax rulings, that being in possession of a report prepared by an independent auditor or tax advisor may constitute a confirmation of exercising due diligence. In our opinion it is highly advisable to possess such opinions in relation to the most important payments.
Related entities - higher requirements
The Minister of Finance sets higher standards of due diligence for payments made to related entities, i.e., the obligation for the tax remitter (company/entity having its registered seat in Poland) to obtain documents pertaining to:
- financial flows between entities in the group and the role of individual entities in its structure,
- the business substance of the recipient who has a registered seat abroad, e.g.: description of their business activity, their financial statements, organizational and management structure, job descriptions of the persons employed, local transfer pricing documentation (Local file).
Furthermore, according to the explanations of the Minister of Finance, a refusal to provide access to the above-mentioned documents by related parties is not a justification for lowering the standards of due diligence with regard to payments to those entities. Therefore, it seems that tax remitter in Poland always have to request the related entity to provide the above-mentioned documents. If the tax remitter, on the basis of the collected information, determines, for instance, that the recipient does not have proper infrastructure and personnel to conduct business, or that the purpose of the recipient's existence within the group structure is not a business but only a tax purpose, he may (or may even be required to) refuse to apply a preferential rate or exemption resulting from a double taxation convention or EU directives.
When making payments to related entities, parties should pay close attention to verifying the status of the recipient, also due to the provisions of the Tax Ordinance Act and the fact that the sole responsibility for not collecting withholding tax when making payments to related entities lies within the tax remitter. It is not possible to exclude a tax remitter from liability through the fault of a related taxpayer and to issue a decision on the liability of the taxpayer as it is the case with unrelated entities (§ 5a Article 30 of the Tax Ordinance Act).
Current status of due diligence in relation to payments of up to PLN 2 million
The current situation (i.e., before the entry into force of the regulations changing the withholding tax collection system) of tax remitters who make payments of up to PLN 2 million is definitely also worth noting in the context of due diligence. The Provincial Administrative Court (WSA) in Warsaw, in the judgment of 23 June 2020, case ref. III SA/Wa 2400/19, ruled that in the case of payments of up to PLN 2 million made to one counterparty for the provision of intangible services, the taxpayer is entitled not to collect withholding tax on the basis of the received certificate of residence, without the obligation to possess relevant statements from the recipient of the payment and to verify the prerequisites of Article 28b section 4 points 4-6 of the CIT Act, i.e., whether the recipient is the beneficial owner of the receivables paid and whether it conducts actual business activity. The Provincial Administrative Court in Kraków had a similar opinion on the matter in its ruling of 14 Jaunary 2020 case ref. I SA/Kr 1269/19, which was connected with remuneration for intangible services as well. It is the opinion of the court that there is no basis for verifying the prerequisites specified in Article 28b Section 4 points 4-6 of the CIT Act when making payments not exceeding PLN 2 million.
Thus, the courts are questioning the approach of the Minister of Finance as expressed in individual rulings and explanatory notes that each payment to a foreign counterparty already requires the tax remitter to exercise due diligence in compliance with the highest standards (i.a., verification of the beneficial owner, his actual business activity, followed by the process of verifying and obtaining statements from contractors). The tax authorities’ approach seems far too automatic, and it burdens the tax remitters with obligations which are not reflected in the currently binding regulations. It raises the question as to whether, under the current legal status, i.e., prior to the entry into force of the amended provisions concerning withholding tax collection system, it is not sufficient (and, at the same time, also correct) that even for amounts exceeding PLN 2 million, due diligence would only correspond with requirements verification for not collecting the tax, for the application of an exemption or a reduced rate under conditions resulting from double taxation conventions or provisions implementing EU directives. For example, in the case of remuneration for services which exceeds PLN 2 million and is paid abroad, where non-collection of tax is a consequence of qualifying the payment as business profit, due diligence should be limited to qualification of the income under Article 7 of the double taxation convention, and holding a certificate of residence of the foreign entity.
The Minister of Finance, by imposing the above-mentioned requirements on the tax remitters (the increased requirements for related entities in particular), assumes that the tax remitter has more knowledge and access to information on the related entity than on the unrelated entity. On the basis of our experience (and that of our clients’ as well), we know that the process of obtaining the documents or more detailed information is often met with confusion on the part of the foreign counterparty (even among related entities). This is often further reinforced by cultural differences and trade secrets. Therefore, obtaining information, even within the same group of companies, can prove quite challenging. In our opinion, the due diligence requirements should be proportionate and not overburden the taxpayers/remitters, which, we can only hope, will be taken into consideration by the legislators working on the changes to the new (not yet in force) withholding tax collection system.
As TIAS, we make sure that our clients:
- know exactly which of their payments abroad are subject to due diligence,
- properly document due diligence at the time of payment for evidential purposes (potential audit, tax proceedings),
- can, with regard to the most important payments, always rely on the opinion of an expert tax advisor within the scope of the business activity of the recipient.
- are always kept up to date on the decisions issued by administrative courts and tax authorities.
We follow and participate in the work of the Ministry of Finance on changes concerning withholding tax.
If you would like us to assist you in that regard, please do not hesitate to contact us directly.
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