Following recent changes to the rules on foreign controlled entities (CFCs), CFC taxation may also apply to foreign foundations and foreign shell companies that have no income but have assets.
If, as a resident of Poland, you are a beneficiary of a company outside Poland, you may have to pay tax in Poland on the income of that company. This may come as a painful surprise to all owners of holding companies in Cyprus or Malta, trading companies in Dubai or Hong Kong, or shell companies in the Marshall Islands or LLCs in Delaware, which were intended to serve as safe custody of assets.
Polish regulations on foreign controlled entities, here, are complementary to the international regulations known as theCommon Reporting Standard ( CRS), which require financial institutions worldwide to collect information and report it to the relevant tax authorities.
The system was developed under the auspices of the Organisation for Economic Co-operation and Development OECD as an Automatic Exchange of Information (AEOI) tool on foreign tax residents. Banks are required to determine where their customers should pay taxes, and to do this they will use data they hold on customers and may also request missing information. If a customer is tax resident in a country other than the one in which his or her bank accounts are held, the bank will provide this information to the local tax authorities, who may then exchange this information with the tax authorities of the country in which the customer is tax resident.
This is why the Polish tax authorities will find out about your banking contacts abroad – not only those conducted for you as an individual, but also those relating to companies, trusts and foundations that you control or are a beneficiary of. You do not even have to personally be a proxy for the account in order for the bank to report you under the CRS as a beneficiary, and the Polish tax authorities to attempt to tax you under the CFC PIT on this basis.
Skarbiec Law Firm’s services include the following:
- verification whether the client’s foreign company, foundation or trust meets the criteria for recognition as a foreign controlled entity and what implications this has for the client’s ownership of a CFC entity;
- performance of duties related to the possession of a foreign controlled entity – determination of the financial result of the CFC in order to establish the tax base in Poland, assistance in the preparation of the CFC PIT (Statement on the amount of income earned from a foreign controlled company by a taxpayer of personal income tax);
- Representation in tax audits relating to the issue – foreign controlled entities CFC;
- Representation in tax audits relating to the issue of CFCs (foreign controlled entities);
- clarification of issues related to reporting of foreign bank accounts to KAS in Poland under the so-called Common Reporting Standard;
- monitoring changes in the law relating to foreign controlled entities CFCs.
Who is subject to the CFC?
A CFC is a foreign entity in which a Polish tax resident, alone or jointly with related parties or other Polish tax residents, participates to a certain extent in the profit or capital, or has voting rights or effective control over it.
Following a number of amendments relating to foreign controlled entities – CFCs (e.g. the Polish Governance reform), the term “controlled company” was replaced by “controlled entity” and thus, from 2019, the CFC regulations covered a broader group of entities, and so a foreign controlled entity may be:
- legal persons,
- capital companies in organisation,
- unincorporated organisational entities other than an unincorporated company,
- unincorporated companies, if they are treated as legal entities in their country of tax residence and pay tax on all their income,
- foundations, trusts or other legal entities/relationships of a fiduciary nature,
- tax capital groups or companies of such a group (provided that such a company, being outside the tax capital group, would itself pay tax abroad at an effective rate of no more than 14.25%),
- structurally or legally separated parts of foreign companies or other entities, whether incorporated or unincorporated
- a foreign permanent establishment of a foreign entity in any form.
Taxation of CFCs
In the event that a controlling, shareholder or beneficial owner of the profits of a foreign entity is a PIT or CIT taxpayer who is a Polish tax resident, it is obliged to calculate and pay CFC tax on the income of the foreign controlled entity. The CFC tax rate is 19 per cent, and the tax base is the income earned by the foreign entity during the period of its tax year in which it was controlled by a Polish tax resident.
It is also incumbent on the above entities deemed to be CFCs to prepare and deliver to the tax office an annual tax return on their CFC income, i.e. PIT-CFC or CIT-CFC, respectively. The deadline for the submission of the return, as well as for the payment of the tax, is set at 30 September of the year following the tax year covered by the return.
Tax on a so-called ‘shell company’
The intention of the legislator in increasing the scope of the subject matter of the CFC was to take measures to prevent tax avoidance by so-called “shell companies”. A shell company can be defined as an entity with large assets but little income. The category of shell companies also includes a company with large revenues but small assets.
In this case, a shareholder of an entity falling into this CFC category is obliged to pay 19% tax on 8% of the market value of its assets. In other words, the tax base of such an entity will be income understood as 8% of the market value of the assets of this foreign entity.
The 8% rate is to be applied when the profitability of the establishment is less than 30% of their value.
Tax in a CFC country versus tax in Poland
In order for a company to be considered a CFC, it is also important that the tax actually paid by that company in its country of residence is at least 25% lower than the income tax that would be payable by that company (using a 19% tax rate) if that entity were a Polish taxpayer. Prior to the amendment to the legislation, the key requirement was that the tax actually paid, in the state of residence of that entity, was less than 50% of the tax that would theoretically be due in Poland if the foreign controlled entity was a Polish taxpayer.
Record-keeping obligations
Controlling CFCs are required to maintain a register of their foreign controlled entities and CFC records through which it will be possible to determine the amount of the CFC’s income, The deadline for the obligation to have complete records was set no later than when the CFC return is filed with the tax office, i.e. 30 September of the following year. The income of the CFC is to be determined in accordance with Polish tax regulations.
Actual economic activity will exclude CFC tax
However, the key issue of a foreign controlled entity carrying on substantial and genuine economic activity still remains unchanged. Where an entity carries out such substantial and genuine activities, the CFC rules will not apply. However, the activity should be carried out in a country of the European Union or the European Economic Area. It is a condition that the foreign entity (in one of these countries) must be subject to taxation on its entire income.
The prerequisite of actual economic activity by the entity in question is significant in determining whether it has, for example, adequate premises with equipment, qualified personnel, whether there is commensurability between the scope of activity carried out by the foreign controlled entity and the premises, personnel or equipment actually possessed by the company, as well as whether the foreign controlled entity independently performs its core economic functions using its own resources, including the managers present.
Failure to comply with the obligations
If a taxpayer fails to comply with its above-mentioned record-keeping obligations, including if it keeps the required records in an improper manner that makes it impossible to determine the CFC’s income, there is a risk of a tax investigation or audit being initiated against it in order for the tax authorities to assess the CFC’s income based on the object of its business or the type of transactions undertaken. The above may imply tax arrears with interest.
The taxpayer may even be subject to criminal and fiscal liability for breach of the current CFC rules, failure to comply with the resulting tax rules, including calculation, payment and filing of the CFC return, as well as failure to provide CFC documents/records to the tax authority upon request.
In view of the numerous difficulties in making a proper classification of a foreign entity as a foreign controlled entity, taking into account also the necessity to constantly monitor changes in the law, as well as in the complicated process of creating and updating CFC documentation, we recommend using professional legal assistance in this respect.
Foreign controlled entities – publications of Skarbiec Law Firm
Over the course of the years 2013 – 2023, I have repeatedly commented on issues related to the regulations on foreign controlled entities, initially criticising their assumptions (2013 – 2016), then pointing out numerous loopholes in the existing regulations (2016 – 2018). As of 2018, it is difficult to speak of significant loopholes, especially as recently companies from countries where nominally there are high tax rates but it is actually not collected (e.g. Estonia) or is returned to the shareholder (e.g. Malta) have also been subject to this tax. This does not change the fact, however, that the CFC rules are complicated and unclear, change frequently and raise very serious doubts as to their compliance with the principles of legislative technique.
Robert Nogacki
