D. Sp. z oo had deducted interest expenses on intra-group loans and expenses related to intra-group services in its taxable income for FY 2015. The loans and services had been provided by a related party in Delaware, USA.
Following a inspection, the tax authority issued an assessment where deductions for these costs had been denied resulting in additional taxable income.
In regards to the interest expenses the authority held that the circumstances of the transactions indicated that they were made primarily in order to achieve a tax advantage contrary to the object and purpose of the Tax Act (reduction of the tax base by creating a tax cost in the form of interest on loans to finance the purchase of own assets), and the modus operandi of the participating entities was artificial, since under normal trading conditions economic operators, guided primarily by economic objectives and business risk assessment, do not provide financing (by loans or bonds) for the acquisition of their own assets, especially shares in subsidiaries, if these assets generate revenue for them.
In regards to support services (management fee) these had been classified by the group as low value-added services. It appeared from the documentation, that services concerned a very large number of areas and events that occurred in the operations of the foreign company and the entire group of related entities. The US company aggregated these expenses and then, according to a key, allocated the costs to – among others – Sp. z o.o. The Polish subsidiary had no influence on the amount of costs allocated or on the verification of such costs. Hence, according to the authorities, requirements for tax deduction of these costs were not met.
An appeal was filed by D. Sp. z oo with the Administrative Court requesting that the tax assessment be annulled in its entirety and that the case be remitted for re-examination or that the proceedings in the case be discontinued.
Judgement of the Administrative Court
The Court dismissed the complaint of D. Sp. z oo and upheld the assessment issued by the tax authorities.
Excerpt in regards of interest on intra-group loans
“The authorities substantively, with reference to specific evidence and figures, demonstrated that an independent entity would not have agreed to such interest charges without obtaining significant economic benefits, and that the terms of the economic transactions adopted by the related parties in the case at hand differ from the economic relations that would have been entered into by independent and market-driven entities, rather than the links existing between them. One must agree with the authority that a loan granted to finance its own assets is free from the effects of the borrower’s insolvency, the lender does not bear the risk of loss of capital in relation to the subject matter of the loan agreement, since, in principle, it becomes the beneficiary of the agreement. This in turn demonstrates the non-market nature of the transactions concluded. The lack of market character of the transactions demonstrated by the authorities cannot be justified by the argumentation about leveraged buyout transactions presented in the complaint (page 9). This is because the tax authorities are obliged to apply the provisions of tax law, which in Article 15(1) of the A.l.p. outline the limits within which a given expense constitutes a tax deductible cost. In turn, Article 11 of the A.l.t.d.o.p. specifies premises, the occurrence of which does not allow a given expense to be included in tax deductible costs. This is the situation in the present case. Therefore, questioning the inclusion of the above-mentioned interest as a tax deductible cost, the authorities referred to Article 11(1), (2), (4) and (9) of the A.p.d.o.p. and § 12(1) and (2) of the Ordinance of the Minister of Finance of 10 September 2009 and the findings of the OECD contained in para. 1.65 and 1.66 of the “Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations” (the Guidelines were adopted by the OECD Committee on Fiscal Affairs on […] and approved for publication by the OECD Council on […]). According to these guidelines: 1.65. – However, there are two specific situations where, exceptionally, it may be appropriate and justified for a tax administration to consider ignoring the construction adopted by the taxpayer when entering into a transaction between associated enterprises. The first arises when the economic substance of the transaction differs from its form. In this case, the tax administration may reject the parties’ qualification of the transaction and redefine it in a manner consistent with its substance. An example could be an investment in a related company in the form of interest-bearing debt, and according to the principle of the free market and taking into account the economic situation of the borrowing company, such a form of investment would not be expected. In this case, it might be appropriate to define the investment according to its economic substance – the loan could be treated as a subscription to capital. Another situation arises where the substance and form of the transaction are consistent with each other, but the arrangements made in connection with the transaction, taken as a whole, differ from those that would have been adopted by commercially rational independent companies, and the actual structure of the transaction interferes with the tax administration’s ability to determine the appropriate transfer price; 1.66. – In both of the situations described above, the nature of the transaction may derive from the relationship between the parties rather than be determined by normal commercial terms, or it may be so structured by the taxpayer to avoid or minimise tax. In such cases, the terms of the transaction would be unacceptable if the parties were transacting on a free market basis. Article 9 of the OECD Model Convention, allows the terms and conditions to be adjusted in such a way that the transaction is structured in accordance with the economic and commercial realities of the parties operating under the free market principle.
Bearing in mind the aforementioned guidelines, in the circumstances, it was legitimate to adjust the terms of the transaction for tax purposes in such a way as to result in a transaction that would correspond to market conditions, thus disregarding the arrangements by which the burden of paying interest was shifted to the Applicant.”
“In this regard, the authority is correct that the explanations submitted by the Company dated […]. set out the transactions and liabilities the settlement of which required external financing in the form of loans. It was explained that “as a result of the agreement for the sale of the Company’s shares, […] P. was obliged to pay remuneration to both the […] fund and the receiver for servicing the Company’s receivables. The purchase of the shares from P. was financed in three instalments by loans which were granted by […] US to […] P. […] P. H. made repayments to the trustee for the servicing of the receivables of Fabryka […] and […] Sp. z o. o. (…) At the end of 2011. […] P. H. did not have the funds to cover the liability to the receiver. Therefore, […] P. on […]. took out a loan in the amount of USD […] in order to settle the instalment to the receiver in the amount of PLN 16,270 thousand, at the end of December 2011.” The tax authority of the first instance excluded from the tax deductible costs of the audited year, devoid of the attribute of market value, the interest on “intra-company debt instruments” created to finance its own fixed assets in the form of the purchase of shares in the share capital of […] spółka z o. o. Accordingly, based on the material collected, adjusted interest amounts were calculated. In the case of the loan from […] and […], the differences in the amount of interest related to the portion of the loan amounts intended for purposes other than the purchase of the shares of […] or the repayment to the trustee. With respect to the remaining loan agreements, the percentage of the adjusted interest amount is 100% of the original interest amount, as the value of the purchase of the shares […] or the repayment of the receivables to the Receiver is greater than or equal to the loan amount. In view of the above, the Company’s allegations that the interest on the loan amounts was unjustifiably excluded from the tax deductible costs should be regarded as unfounded.”
Excerpt in regards of intra-group services – management fees
“As regards this issue concerning management services, it should be recalled that the issue of classifying expenses as tax costs is regulated in Article 15.1 of the VAT Act, from which it follows that such costs are all costs incurred with the purpose of obtaining revenue or maintaining or securing a source of revenue, with the exception of those enumerated in Article 16.1 of the cited Act. The wording of the cited provision indicates that it is based on the so-called general clause, which does not mean, however, that all expenses not expressly listed in Article 16(1) of the A.P.C. may be classified as tax deductible costs. In order to recognise a given expense as a tax deductible cost, a taxpayer must demonstrate: the fact that the expense was incurred, its connection with the conducted business activity, the purpose of incurring it, which is to achieve revenue and the connection of the expense with the obtained or intended revenue. It is also necessary to properly document the expense in order to be able to examine the existence of all the above prerequisites conditioning the inclusion of the cash expense as a tax deductible cost. At the same time, taxpayers recognising an expense as a tax-deductible cost, and thus obtaining an advantage consisting in the reduction of taxable income, in addition to the invoice and proof of payment, should have evidence that the specific expense is not only an economic cost, but also a tax cost. A party claiming that such expenditure was incurred is therefore obliged to indicate the circumstances and evidence necessary for the tax authority to verify the expenditure incurred. The possibility of classifying a particular expense as a tax deductible cost depends, inter alia, on the total satisfaction of the prerequisites, i.e. the definite incurrence of the expense by the taxpayer, the fact that the expense is connected with his business activity, the existence of a causal link between the expense and the revenue obtained and proper documentation of the expense. It should also be emphasised that the tax authorities are authorised to assess the relationship of the incurred costs with revenue, which they do on the basis of documents, including those required by law. In tax law, the need to duly document the incurrence of certain expenses, reflecting the actual course of economic events, is therefore a condition for the taxpayer to derive certain entitlements for itself from such fact. The Income Tax Act adopts the principle that certain revenue should be recognised as due and costs as incurred only when such a factual or legal event actually occurs. It should also be added that intangible services, such as consultancy and management services, also require other material evidence than just an invoice to confirm their performance …
In the Court’s opinion, the Applicant has not presented credible evidence as to the “shareholder’s expenses”, and the circumstance of incurring at the same time significant costs for analogous services purchased from other entities indicates duplication of expenses. Consequently, it is not possible to verify whether the disputed management services were performed at all. In the administrative court judicature, the view has already become firmly established that intangible services, due to their nature, should be documented in a manner which allows their performance to be identified without any doubts (e.g. the judgment of the Supreme Administrative Court of 13 December 2012, case file No. I FSK 188/12; of 24 August 2004, case file No. FSK 356/04, of 7 December 2007, case file No. II FSK 1425/06, of 30 April 2010, case file No. II FSK 2178/08). In the case of this type of services, it is the taxpayer who must take care of the material evidence confirming the fact of their provision. It is the taxpayer who bears the burden of proof in this respect…”