The restrictive approach of the Supreme Administrative Court regarding the application of withholding tax preferences by holding companies

Polski

The Supreme Administrative Court in judgments that were announced at the end of 2023 (cases: II FSK 27/23, II FSK 28/23, II FSK 29/23) dismissed three cassation appeals in cases resolved by the Voivodeship Administrative Court in Lublin to the detriment of taxpayers, and agreed with the court of first instance in its refusal to issue an opinion on the application of withholding tax (WHT) preferences. In February 2024, the Supreme Administrative Court published written justifications for these judgments. The conclusions drawn from their analyzes confirm the unfavorable position of the tax authorities regarding the possibility of using the WHT exemption by holding companies and investment funds.

Background to the dispute with the tax authorities

The CIT Act provides that when paying dividends, interest or license fees exceeding PLN 2 million per year to foreign related entities, the payer is obliged to collect the withholding tax (due to the existence of the so-called "pay and refund" mechanism). However, the Polish regulations allow for the possibility of not collecting WHT in certain situations. One of them is obtaining an opinion on the application of withholding tax preferences by the taxpayer or by the tax remitter.

However, the tax authority may refuse to issue such an opinion when the conditions for exemption provided for in the CIT Act or the relevant double taxation treaty are not met, or when there are justified doubts as to the compatibility of the documentation attached to the application, or of the taxpayer's declaration that he is the beneficial owner of the payment, with the actual state of facts. The authorities may also refuse to issue such an opinion when there are reasonable suspicions that the transaction is aimed at tax avoidance, or when there is a reasonable suspicion that the recipient of the receivable does not conduct an actual business activity in the country of its residence.

Supreme Administrative Court judgments

The case finally considered by the Supreme Administrative Court under reference number II FSK 27/23 concerned the refusal to issue an opinion on the application of WHT preferences with respect to the dividends paid to a holding company located in the Netherlands. The refusal was related primarily to the tax authority's assumption that there were justified doubts as to the correctness of the taxpayer's declaration about not benefiting from the exemption from income tax on all of his income, regardless of the source of such income, and, as a result, there were doubts as to the fulfillment of the formal condition for the application of the exemption (resulting from directly from Article 22(4)(4) of the CIT Act).

The Supreme Administrative Court emphasized that the construction of an opinion on the application of preferences requires the entity applying for it to demonstrate and justify that the conditions for exemption have been met. In a situation where a foreign company receiving dividends from Poland does not declare or pay any tax in its place of residence (the dividend obtained is exempt from taxation) and the explanations and documentation provided by the applicant do not indicate what circumstances resulted in the lack of such taxation, the tax authority is not obliged to make additional findings in this respect and obtain evidence justifying this situation. If the lack of taxation results from objective reasons, such as the utilization of losses from previous years, such explanations should be included and described in detail in the application for an opinion. If they are missing and there are justified doubts, the authority has the right to refuse to issue a WHT preferences opinion.

Apart from the controversial issue, which was the lack of effective taxation of the Dutch company in the country of its registered office, the authority's refusal was also justified by the assumption that the taxpayer does not conduct an actual business activity and that anti-abuse provisions (resulting from Article 22c of the CIT Act) apply to the structure. This resulted in particular from the low amount of paid-up initial capital and the value of assets, lack of employees’ costs on the part of the foreign company, low costs of running the office, lack of management costs, small profits from operating activities while incurring only the costs of advisory services, and the transfer of received dividends in the same amount to the sole shareholder (non-EU company).

The other two judgments issued by the Supreme Administrative Court on the same day in joined cases (reference numbers II FSK 28/23 and II FSK 29/23) also concerned appeals on the refusal to issue an opinion on the application of WHT preferences in relation to the loan interest and dividends paid to a Luxembourg company, operating in a structure with an open investment fund based in Luxembourg.

Similarly to the previous judgment, the Supreme Administrative Court stated that for the purposes of considering an application for an opinion on the application of preferences, it is sufficient to examine whether there are justified doubts as to the status of the beneficial owner of the receivable; it is unnecessary for the tax authority to further determine whether the taxpayer is the beneficial owner of the receivable under the conditions indicated in the CIT Act. In this respect, the authority is not obliged to make factual findings on principles similar to those during a tax proceeding.

The authority's refusal to issue an opinion in the analyzed cases was justified by the fact that the manner of operation of the Luxembourg company and the granting of a loan to the tax remitter by the taxpayer were artificial. In particular, the authority drew attention to the fact that a taxpayer granting a loan and obtaining income from dividends could not be considered the beneficial owner of payments received from Poland, i.a. due to the fact that the taxpayer himself was financed by related entities, including the sole shareholder (i.e. an investment fund based in Luxembourg), and the amount of the taxpayer's interest receivables and liabilities was similar. Therefore, there was a suspicion that the taxpayer was acting as an intermediary entity. The Supreme Administrative Court shared the tax authority's position that the specific nature of organizational connections, capital structure and financial flows between the tax remitter, the taxpayer and the fund constituted objective doubts in this case, allowing the refusal to issue a protective opinion.

Commentary

The content of the judgments published by the Supreme Administrative Court provides important conclusions for taxpayers.

First of all, in the case no. II FSK 27/23, the decision concerned an important issue: the interpretation of the condition arising from Art. 22 section 4 point 4 of the CIT Act, regarding non-exemption from income tax on all the income, regardless of its source, by a company obtaining income (revenues) from dividends. In particular, whether this condition should be understood equally with the obligation to effectively tax the taxpayer's income abroad.

The position presented in this matter by the tax authorities, and confirmed later by the Supreme Administrative Court, is an example of the restrictive line of interpretation and jurisprudence in this area. This is, for example, reflected in the justification presented by the Supreme Administrative Court, which clearly states that the mere ability to pay taxes at the place of residence, or being subject to tax liability, are not sufficient to apply the WHT exemption, if the taxpayer simultaneously applies exemption. Therefore, the fact that the taxpayer entitled to the dividend is subject to tax liability abroad and is able to obtain a tax residence certificate should not be perceived as a decisive factor.

The judgment does not clarify whether only a subjective exemption, or also an objective exemption of the dividend should matter. It would be reasonable to assume that the condition of not benefitting from the exemption from income tax on all of one's income, in the context of dividend exemption, should be related only to subjective aspects (i.e. without objective exemptions). Such conclusions come, among others, from the draft WHT clarifications of September 25, 2023 (more details:here) and the general purpose of the EU dividend directive.  

The Supreme Administrative Court has not decided whether a taxpayer's explanation regarding the reasons for the lack of tax payment abroad (here - being the result of settling losses from previous years) would be sufficient for the authority to recognize the condition resulting from Art. 22 section 4 point 4 of the CIT Act was met. However, in a situation where the tax authority has doubts regarding the facts presented in the application for a WHT opinion, it seems reasonable to ask the applicant to provide a detailed justification of such facts and evidence to support them. Otherwise, the purpose of the institution, which is an opinion on the application of preferences, may no longer fulfill its original assumptions, especially in situations where the authority may, for any reason, state the existence of doubts, not attempting to clarify them with taxpayers or tax remitter. Therefore, the Supreme Administrative Court seems to allow for a situation in which the grounds for refusing to issue an opinion on the application of preferences indicated in the CIT Act - i.e. the existence of "reasonable doubts" and "reasonable assumptions" - may be interpreted and applied broadly by the authority. Accepting the situation in which the tax authority examining the case bases the scope of WHT obligation on its intuition may, in our opinion, pose a serious threat to taxpayers' rights.

Another conclusion that comes from reading the discussed judgments is that the application of withholding tax preferences may raise difficulties even in uncontroversial factual situations. WHT remitters should exercise particular due diligence when verifying their foreign contractors and carefully document the compliance with the conditions for applying WHT preferences. Extreme caution should be maintained especially in cases of holding structures that generate mainly dividend income, where other operating activities are severely limited.

It is clear that the authorities and courts apply a rigid approach to entities that conduct typical holding activities, expecting that the way they operate will be similar to the entities conducting operational activities (such as e.g. sales or production). Thus, they tend to refuse issuing an opinion on the application of WHT preferences in a situation of low employment level and low  employee / management costs. The Supreme Administrative Court indicated the organizational, financial and personal connections between the taxpayer, the tax remitter and other payment participants, as well as the extent to which the taxpayer's activity elements related to: premises, personnel and administration are closely related to the entities from the group (e.g. whether these entities provide the taxpayer with elements necessary for its existence and undertaking activities in the form of a company of a Member State) as the factors that should be verified.

As a consequence of the discussed judgments of the Supreme Administrative Court, especially in the light of the statement that it is not the role of the tax authority to precisely determine the facts, because the facts are presented by the applicant in the application, both the taxpayers and the tax remitters should remember to always precede the submission of an application for an opinion on the application of WHT preferences with a very thorough analysis of the facts and all circumstances proving that the conditions for applying the WHT exemption are met, and the analysis of the current case law of tax authorities and administrative courts. Given the very demanding approach of the tax authorities, it seems crucial to gather convincing documentation and arguments to effectively defend one's position in a possible administrative court proceedings.