1. Definition

The term Controlled Foreign Company (hereinafter: ‘CFC’) is used in the context of regulations which provide for the obligation to include in the tax base of a Polish tax resident, a natural person and a legal person, the income obtained by a controlled foreign entity fulfilling the conditions specified in the act.

The CFC regulations are an instrument whose purpose is, according to the explanatory memorandum to the draft amendments to the Personal Income Tax Act (Journal of Laws 2022.2647 as amended) (hereinafter ‘PIT’), the Corporate Income Tax Act (Journal of Laws 2022.2587 as amended) (hereinafter: ‘CIT’), and the Law on Lump Sum Income Tax on Certain Income Earned by Natural Persons: to secure the fiscal interest of the state by establishing regulations, counteracting tax avoidance practices, which have a direct impact on the functioning of the internal market.

In addition, it was pointed out that the purpose of creating these regulations was to tighten the income tax system to ensure that the amount of tax paid was linked to the actual place of revenue generation by large companies, especially international ones.

2. Conditions for qualification as a CFC

Under Article 30f(3) of the PIT Act, a foreign controlled entity is an entity:

• having its registered office in a “tax haven” or
• having its registered office or management in a country with which neither Poland nor the EU has ratified an international double taxation treaty.

In addition, the regulations presuppose the formation of a CFC upon the occurrence of one of three situations:

1) The following three conditions are met cumulatively:

• In this entity, the taxpayer with residence or registered office and management in the territory of the Republic of Poland holds, directly or indirectly, 50% of the shares in the capital, voting rights in the controlling bodies, more than 50% of the right to participate in profit or exercises effective control.
• The income tax actually paid by the entity is at least 25% lower than the CIT the entity would pay if it were a Polish taxpayer.
• At least 33% of the entity’s income is derived from dividends, from the disposal of shares, from receivables, rent, lease, guarantees of investment fund titles, from warranties and guarantees, from copyrights or industrial property rights and many others listed in the Act.

Or

2) The second version of the conditions that must be met cumulatively:

• In this entity, a taxpayer with residence or registered office and management in the territory of the Republic of Poland holds, directly or indirectly, 50% of the shares in the capital, voting rights in the controlling bodies, more than 50% of the right to participate in profit or exercises effective control.
• The income tax actually paid by the entity is at least 25% lower than the CIT the entity would pay if it were a Polish taxpayer.
• And when the income is less than 30% of the sum of the value of the assets held in certain categories (inter alia, shares in a company, real or movable property, including those used under leases, intangible assets, receivables from passive income, as defined under the previous CFC premise), and these assets constitute at least 50% of the value of the entity’s assets.

Or

3) The third version of the conditions that must be met cumulatively:

• In this entity, a taxpayer with residence or registered office and management in the territory of the Republic of Poland holds, directly or indirectly, 50% of shares in the capital, voting rights in control bodies, more than 50% of the right to participate in profit, or actually exercises effective control.
• The income tax actually paid by the entity is at least 25% lower than the CIT the entity would pay if it were a Polish taxpayer.
• The income exceeds the income calculated according to the formula given in the provision (a+b+c)*20%

Where:

“a” = carrying value of assets,

“b” = annual employment costs, and

“c” = total depreciation and amortization to date], less than 75% of the entity’s income is derived from transactions with unrelated parties but originating from the same country.

As can be seen, in each of these three cases of qualifying a company as a CFC, the amount of tax paid by the entity is repeated, as well as the ownership, directly or indirectly, of 50% of the shares in the capital, voting rights in the controlling bodies, more than 50% of the right to participate in profits or the exercise of de facto control. What differs is the third condition that the entity must meet.

However, the criteria for the individual conditions are not clear-cut. Therefore, they are subject to interpretation by the tax authorities.

An example of an interpretation concerning the manner of verifying the individual conditions for qualification as a CFC is the individual interpretation of the Director of the National Tax Information Service (hereinafter: “DKIS”) of February 20, 2023 (mark: 0115-KDIT1.4011.851.2022.2.MR).

In the factual situation which is the subject of the aforementioned interpretation, a Polish tax resident was the founder of a foundation in Liechtenstein, which in turn held 100% of the shares in the company “X” sp. z o.o. in another country. The applicant, argued the inability of his foundation to qualify as a CFC, due to the lack of income. Lack of revenue means PLN 0 tax both in Poland and in the country of the company’s registered office. In view of this, the tax actually paid abroad would not be less than 25%, the income tax to be paid in a similar situation in Poland.

However, the authority argued that in the explanatory memorandum to the draft law amending the PIT, CIT and certain other laws of October 29, 2021. (Journal of Laws of 2021, item 2105, print 1532), two additional criteria were added to the catalogue of entities forming a CFC, in order to prevent tax avoidance by creating a ‘shell company’. The authority considered that the applicant, meets this condition due to the disproportion between the assets and the passive income it derives from its shares. In this situation, the authority assumed income representing 8% of the value of the assets. Then, there is a 25% tax differential. 

They are characterized by having inequalities showing, in the assets held, to little or no income generation. If income is determined to be at least 8% of the value of the assets, this also qualifies the entity as a CFC. In other words, a tax base of 8% or more of assets becomes the equivalent of income. 

This interpretation makes it clear that a foreign entity, even where there is no income at all – thus not achieving a tax liability of less than 25%, can be considered a CFC, due to the type of interpretation and the conditions stated in the legislation, resulting in taxation applicable to foreign controlled entities.

3. Tax consequences of the recognition of an entity as a CFC by a tax authority

When a company is recognized as a CFC, in addition to the tax paid by the company in its country of residence, in addition the partner must pay income tax in its country of residence. In Poland, the tax rate in this case is 19%.

The complication with CFCs is that the amount of this tax must be self-declared. If the taxpayer fails to do so, or incorrectly calculates the amount of CFC income and the resulting tax, it may result in committing an offence or a fiscal offence and, under certain conditions relating to the lack of records, also in the assessment of income.  

In addition to the 19% tax on the company’s income, additional administrative obligations are imposed on the CFC partner in relation to the keeping of records, registers and filing of separate tax returns.

4. Opportunities for an entrepreneur deemed to be a foreign controlled entity

The legislation provides for an exemption when a company with a CFC charter conducts a real economic activity (hereinafter: “RDG”) in its country of residence. The possibility to benefit from this exemption is limited to member states of the European Union and the European Economic Area (Norway, Iceland, Liechtenstein, Switzerland). The prerequisites for conducting an RDG are listed in Article 24a(18) of the CIT Act and it is an open catalogue. Some of the premises are:

• independence of the entity in the activities performed,
• the existence of commensurability between the possessed infrastructure, personnel and the scope of activities,
• revenues from the conducted activities prevail among the entity’s total revenues. 

Proving the operation of an RDG can be burdensome at the time of a fiscal inspection, as the burden of proof is on the taxpayer. This means that, at the time of the inspection, the taxpayer must show any evidence to support the thesis of running an RDG.

The second option is to deduct from the income of the CFC the gain from the sale of shares in that company or the dividend received from a company with CFC status. This possibility is to prevent double taxation of CFC profits at the level of the Polish taxpayer.

5. Summary

Every entrepreneur with a company abroad should keep a close eye on the changes to the in the regulations on foreign controlled entities, as a small change in a provision may determine whether the company will be considered a CFC by the tax authorities. Similarly, as in the case of the interpretation discussed here, a foreign entity may be deemed to be a CFC even if it does not earn any income and therefore, also if its income were taxed in Poland, it would not pay tax. This situation is quite exceptional as far as income tax regulations are concerned, nevertheless it should be kept in mind when approaching the subject of foreign companies in the context of CFC regulations.

Given the increasing complexity of CFC regulations and the relatively harsh consequences for failing to properly comply with these obligations, many entrepreneurs operating internationally may face this problem. In these circumstances, it may be worth considering to ask professionals to conduct a thorough review of the entrepreneur’s business structure in terms of CFC obligations.

If you have any doubts or questions, the experts at Nexia Advicero will help to address your concerns regarding foreign controlled entities.