A major tax reform was launched in Poland on 1 January 2022 under the sobriquet of the New Polish Deal (‘the Reform’), which seemed at first to be a game changer – also at the cost of real estate investors.
As always, the devil’s in the detail. With a few weeks of operating under the new rules, our fair assessment on its actual impact on real estate investors is ‘it depends’ … and mostly on the business model and strategy of the investor. And, you can take action to mitigate the potentially adverse effects of the Reform. In sum, we believe the Reform will not dampen growth, nor the attractiveness of Polish property, nor investor appetite. That said, we’ll have to keep a close eye on the Reform and especially developing tax practice, and act accordingly.
We have set out below a summary of the key elements of the Reform that may affect activity on the Polish real estate market.
Under the amended CIT regulations, tax depreciation write-offs of entities qualifying as real estate companies as defined by the Polish CIT Act in respect of non-residential buildings (such as warehouses, shopping malls, office buildings) cannot exceed in a given tax year depreciation write-offs made in accordance with accounting regulations charged in that tax year to the financial result of the entity. In other words, real estate companies cannot recognise as tax-deductible costs the excess between tax depreciation write-offs and accounting depreciation write-offs. This change is important for companies that recognise such buildings for accounting purposes as investment assets under the fair value model (not under the cost model). Thus, they should review their situation / consider adjusting their accounting practices.
Under the amended CIT Act, it is no longer possible to make tax depreciation write-offs in respect of residential buildings and residential apartments. However, interim regulations allow for tax deprecation in 2022 of the residential buildings/apartments that were put into use by the end of 2021. This change is important for investors investing in PRS. Still, it should be noted that generally the annual tax depreciation rate in respect of residential buildings/apartments is only 1.5% (it is generally 2.5% p.a. for other types of commercial properties). From what we’re seeing, this change is generally not hitting investor appetite for Polish residential real estate.
These changes may impact ongoing cash flows (annual rates of return), but costs of acquisition of residential and non-residential buildings may still be recognised for tax purposes (lowering taxable income) when selling. Thus, for some projects these changes to tax depreciation may just amount to a timing issue (which in respect of non-residential buildings can sometimes be managed by appropriate accounting policies).
Tax deductibility of debt financing costs
Under the amended CIT regulations, it is no longer possible to argue that the annual limits of tax-deductible financing costs shall be established as 3,000,000 złotys plus 30% of tax EBITDA over that amount and only the higher amount is allowed for tax purposes (limitation equal to 3,000,000 złotys or 30% tax EBITDA whichever is higher). Moreover, taxpayers are not allowed to recognise as tax deductible the costs of debt financing obtained from related parties in the part in which they were allocated directly or indirectly to equity/M&A transactions.
Tax on ‘diverted profits’
The Reform includes a new concept of taxation of so-called ‘diverted profits’ which amounts to 19% of the tax base.
The tax base includes fees paid by Polish tax residents directly or indirectly to affiliated parties for certain intangible services (also fees for the use of IP rights, transfer of the risk of debtor insolvency, or provision of debt financing). Such costs constitute taxable income for the company that makes such payments (with 19% CIT) ‘diverted profits’ only if two conditions are jointly met: (i) the actual level of taxation of the affiliated recipient is 25% lower than the tax that would be paid in Poland by a Polish tax resident recipient, and (ii) the share of the amount of the above fees in the taxable revenues of the affiliated entity is at least 50%. It will be possible to reduce this tax by the withholding tax levied in Poland on the fees paid to affiliated entities and by the amount compensating for the application of tax deductibility limitations concerning debt financing costs and fees for intangible services.
Tax on diverted profits will not be paid by taxpayers whose share of costs included in the tax base, but paid to both related and unrelated entities, does not exceed 3% in the total amount of costs of that taxpayer.
Moreover, the tax on diverted profits will not apply to fees paid to a related party which is a tax resident in an EU/EEA country and conducts “genuine and material economic activity” in that country.
The goal of the regulations on diverted profit tax is to combat profit-shifting between group entities in different jurisdictions. Those regulations will apply mostly to back-to-back structures with limited or no business substance. Thus, it should not affect many structures with proper substance. Still, to be on the safe side, companies operating on the Polish real estate market should check whether these regulations may apply to them.
Removal of the EBITDA based rules limiting tax deductibility of payments for certain intangible intra-group services / new type of minimum tax
The Reform eliminates EBITDA-based rules limiting the deductibility of intangible intra-group services above the threshold of 5% tax EBITDA plus 3,000,000 złotys. It also introduces a new tax, known as ‘minimum income tax’.
The new minimum tax covers among others real estate companies that (i) incurred a loss from a source of income other than capital gains, or (ii) whose taxable income represents less than 1% of their revenues (other than from capital gains). The regulations clarify that certain types of costs (such as tax deprecation concerning fixed assets) and revenues are not included in the calculation of the loss and income-to-revenue ratio.
The minimum tax rate is 10% of the tax base composed of (a) 4% of operating revenues (other than from capital gains), plus (b) excessive debt financing costs incurred to related parties (generally exceeding 30% of the tax adjusted EBITDA), plus (c) the value of deferred income tax resulting from the disclosure of intangible assets (not amortised for tax purposes to date) in tax settlements to the extent that it results in an increase in gross profit or a decrease in gross loss, plus (d) costs of intangible services and/or royalties incurred to related parties, exceeding 5% of the tax adjusted EBITDA plus 3,000,000 złotys.
Exemptions and deductions may apply. For example, minimum tax does not apply to taxpayers for their first three years of operations.
The amount of minimum income tax payable may be reduced by the regular CIT due for the same tax year. Minimum income tax can be deducted from regular CIT over the next three consecutive fiscal years.
It looks as if most real estate companies operating in Poland should not be affected by the minimum tax, as their taxable income-to-revenue ratios should be higher than 1%.
The Reform (a) narrowed the scope of the new WHT ‘pay and refund’ regime (which was suspended until 1 January 2022) to interest, dividends and royalties paid out to related parties within the meaning of the transfer pricing rules, (b) changed the definition of beneficial owner, (c) extended the scope of the opinion on the application of the exemption (which allows taxpayers to apply preferential WHT treatment straight away and not withhold the tax) (d) changed the definitions of the so-called ‘due diligence’ that should be applied by Polish tax residents when making payments to non-residents.
WHT aspects have been on the radar of the Polish tax authorities for quite some time. Most clients have already analysed and adjusted their structures in respect of new WHT requirements in Poland, while others should still review whether their current structures may benefit from preferential WHT treatment.