Tax optimization through tax capital groups: on the radar of tax authorities
On June 26, 2017, the Ministry of Finance issued a warning against the use of tax capital groups (PGK) for aggressive corporate income tax (CIT) optimization. The Ministry of Finance recognized a common trend among PGKs that involved the disposal of key assets, such as developed commercial real estate, combined with the donation of the entire proceeds from the sale to an affiliated company. Such transactions were accompanied by additional operations including an exchange of shares, followed by the formation of a tax capital group (PGK), and then the sale of those acquired shares resulting in the dissolution of the PGK. As a result of these operations, made within a short period of time, the proceeds from the sale of assets were not subject to CIT. According to the Ministry of Finance, this type of optimization in transactions totaled several billion zlotys nationally.
Mechanism of aggressive optimization
Initially, a Polish or foreign holding company with shares in Company A would intend to dispose of A’s assets, such as a shopping center, from which sales would be subject to 19% CIT. Typically, A would have financed the acquisition of its assets (e.g. the shopping center development) by taking out a bank loan.
Step 1: Share Exchange
The first preparatory stage would include a change in the shareholding structure with the introduction of Company B through an exchange of shares: Company B would receive shares in Company A (share contribution) from the holding company (Shareholder); in exchange, Company B would raise its share capital and issue shares to a foreign entity, the value of which shares would correspond to the value of Company A, whose main asset was the shopping center.
Under the applicable laws, an exchange of shares is neutral in taxation; thus, Company B will not be taxed until A’s shares are sold. In the event of the above mentioned divestment, however, Company B would have the right to include the value of its own shares, issued to the holding company, as a tax deductible cost as it was the „price” of the acquisition of Company A’s shares. In effect, Company B would be able to recognize the cost of the share exchange (based on the value of Company A’s assets) in their accounting records, which costs it would then be able to write off once A’s shares were actually sold.
Step 2: Forming PGK and Sale of Assets
The second stage would include the creation of a PGK after the share transfer by Company A and Company B with Company B acting as the leader of the group (managing company). The laws governing PGKs allow for the consolidation of Company A’s and B’s taxes and also provide for some documentation simplification; however, PGKs do not benefit from any special tax exemptions. Under the law, a PGK must be formed for a minimum of 3 years and consist of at least two companies.
Step 3: Selling assets combined with an obligation to donate
The third stage would include (a) Company A selling all of its assets to another entity (Buyer) combined with (b) an obligation to donate to Company B the funds obtained by Company A from such sale. The donation would reduce Company A’s income from the sale and consequently Company A would not be effectively taxed on the transaction. As a result of the asset sale and donation, Company A would dispose of all its assets and became a „shell company.” Thus, in effect, Company A’s donation would transfer to Company B all of Company A’s income.
Step 4: Sale of shares to another company
The fourth stage would consist of Company B’s sale of Company A’s shares to another entity (Company C), most often the Shareholder’s subsidiary. Because at this moment Company A would be a shell company, its value would be small (maybe even close to zero). Company B would then sell Company A’s shares at a very low price (e.g. PLN 1). Taking into account the high cost of acquiring Company A’s shares in the past (resulting from the exchange of shares at the first stage when Company A had significant assets), Company B would then be able to realize a huge loss from the sale of Company A’s shares, which loss it would then be able to use to offset Company B’s revenue resulting from the donation it had received from Company A. As a result, Company B, despite receiving a donation, the source of which was the sale of Company A’s assets, was not subject to tax; Company A was also not subject to tax.
The above described stages would have been implemented over the course of several months. For example, the PGK could have been formed and then, as a result of Company A divesting its shares in stage 4, dissolved within three months of formation. The individual steps described within each of the four stages (e.g. real estate sales, donations, divestments of Company A’s shares) could have even been made over the course of a few days. In many of the cases analyzed, when the Shareholder (holding company) was a foreign entity, the financial resources Company B obtained from the donation would then be transferred to the Shareholder subject to a tax exemption intended for dividends.
The above-mentioned publication is an English version of a warning against the use of tax capital groups (PGK) for aggressive corporate income tax (CIT) optimization issued by the Ministry of Finance on June 26, 2017 (source: www.mf.gov.pl)
Written by Magdalena Zalewska and the TPA experts of Poland
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