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Despite the deglobalization crisis triggered by the coronavirus pandemic, cross-border transactions between economically cooperating countries continue to play a key role in trade. This applies to the flow of goods, products, services, and intangible benefits as well as to capital flows. This includes, in particular, foreign investments in developing countries, which tend to contribute more rapidly to increasing the market value of capital groups than investments in economically developed countries. Due to the higher growth rate of capital flows, which results from shorter payback periods for the invested capital, such investments are economically justified. Furthermore, in times of an energy crisis and the resulting supply shortages and high energy costs, foreign investments will continue to support globalization processes and, consequently, the search for investment opportunities abroad.
Why does Europe still have a chance?
For companies based in Europe, there are natural opportunities for development and investment in other European countries. European companies implement sustainable development strategies far more effectively than Asian countries, where production is cheaper. In contrast, Europe is prepared to meet the highest ESG standards. Furthermore, shortening supply chains significantly reduces transportation costs and thus lowers the carbon footprint. There is even a hypothesis that highly specialized European products based on technology and know-how could become increasingly important, making them more price-competitive compared to goods and products from China. The European Union’s common trade policy is accompanied by relevant regulations on the protection of personal data and tax provisions that facilitate trade.
Despite common guidelines stemming from European regulations, each country implements its own regulatory frameworks, which not only ensure economic competitiveness but also safeguard the maintenance of capital sources to finance structural investments or—a factor of growing importance in recent times—defense.
Thorough planning is the key to success
Given the growing influence of the state on businesses and consumers due to rising costs—such as energy costs and tax liabilities—every international structure should be planned with local regulations in mind.
One of the most important regulations that must be anticipated and adapted to is, of course, tax legislation. The structure of relationships among international corporate groups can often make it difficult for tax authorities to determine the jurisdiction where the income and profits of affiliated companies are taxable.
However, tax authorities are prepared to identify such structures using available tools, including the exchange of information between countries. This exchange is made possible by Directive 2011/16/EU (DAC) and its amendments, such as Directive (EU) 2021/514 (DAC7). These directives improve cooperation among the tax authorities of EU member states and regulate the exchange of information for tax purposes, including reporting on sales and services provided via digital platforms. The ongoing development of regulations governing the protection of capital sources facilitates trade on the one hand, while creating a series of obligations on the other that should be appropriately anticipated.
Tax on the Income and Profits of Foreign Companies
One of the most rapidly evolving areas of tax law is withholding tax (WHT). Although international agreements represent one of the most stable sources of law and take precedence over national legislation, the national guidelines governing their practical application are subject to constant change. It is important to note that this is a tax that must be anticipated and planned for and often aligns with guidelines regarding the procurement and provision of relevant documents, as it primarily pertains to passive income, such as the payment of dividends, interest, royalties, intangible services, or profits.
The basis for levying this tax is the determination of the country of the source of payment. When calculating and collecting this tax, it is essential to refer to the relevant international agreement with the country of the company with which the transaction is conducted.
Therefore, when planning cash flow within a corporate group—for example, dividends—one should not only estimate the appropriate rate and amount of withholding tax in the country of origin from which the payment is made, but also the procedure for a possible refund—such as payment of the tax by the payer (so-called payment and refund procedures).
The general principle of bilateral agreements is to avoid double taxation. Therefore, a taxpayer who pays the tax in the country where they receive the payment (dividend) can expect that they will no longer have to pay it in the source country. However, the rules governing the collection of withholding tax in the country from which the payment is made are independent of the regulations in the recipient’s country.
For example, if you wish to reduce the withholding tax on dividends paid by a subsidiary resident in Poland, you can utilize a number of available tools. For example, under the agreement between the Republic of Poland and the Federal Republic of Germany for the avoidance of double taxation with respect to income and capital taxes, the standard tax rate is 15% and the preferential tax rate is 5%, with the assumed threshold for the share in the capital of the distributing company being 10%. The Polish Income Tax Act provides for a standard rate of 19% on dividends (distribution of capital gains) (20% for other securities mentioned above) and simultaneously stipulates that additional conditions must be met to qualify for a lower rate or an exemption.
Statement on the Application of Preferential Rates
One way to avoid the mandatory WHT refund mechanism is to obtain an opinion on the application of preferential treatment. This allows the payer to withhold no tax on payments exceeding 2 million PLN within a 36-month period. This ruling has provided protection since January 1, 2022, and applies to tax exemptions or reduced tax rates under double taxation treaties. The application for this ruling may be filed by the payer or their representative and requires numerous documents as well as their certified translations. As part of the review process, the tax authorities verify the transparency of the group’s structure and its relationships.
The first option for avoiding the mandatory WHT refund mechanism—i.e., withholding tax in the source country—is the ruling on the application of preferential treatment. This allows the payer to refrain from withholding tax on payments exceeding 2 million PLN within a 36-month period. The application, prepared on the appropriate form, must be accompanied by numerous documents regarding the taxpayer, as well as their certified translations. As part of the ruling procedure, the tax authorities verify the transparency of the group’s structure and relationships by reviewing, among other things, the following:
- Registration data
- Group structure plans
- Contracts
- Dividend resolutions
- Annual financial statements (including consolidated financial statements)
- Certificate of tax residency, etc.
Under certain circumstances, the authorities may refuse to issue the requested opinion. However, because the opinion on the application of preferential treatment can effectively influence the optimization of cash flows within the capital group by preventing them from being frozen until they are returned, it serves as a tool that encourages payments (before they are made) while simultaneously ensuring the security of the transaction.
Refund Procedure
The procedure for refunding the tax paid differs depending on whether the tax amount paid is up to the limit of 2 million PLN or above that limit. As with applications for tax relief, supporting documents must be attached to the application in this case as well, and the tax authorities also have the right to request additional explanations during the processing of the application.
The WHT collection procedure generally applies to payers subject to due diligence. The application of the tax rate resulting from the double taxation treaty (i.e., lower than the tax rate applicable under national regulations) or the non-collection of the tax is possible if the taxpayer proves their tax residence by providing a certificate of residence and a corresponding declaration.
In line with the implications of tax competition between countries, it should be noted that the tax authorities conduct post-transaction audits and collect taxes retrospectively. This affects the ability to determine whether the recipient of the payment was not the actual owner of the receivables received. Mechanisms that allow for review by the tax authorities prior to the payment date, as well as prepared due diligence procedures, offer protection against potential consequences.
Although the issue of withholding tax is not particularly complicated, it can entail formal complications. Further changes to tax regulations in connection with the significant events we have observed—which result from changes in the European Union’s policies and strategies and will have further consequences related to the armed conflict in Ukraine—are difficult to predict. Especially under such circumstances, the area of representations and safeguards should be given special priority within the organization—not only to protect you from adverse consequences in the future but also to enable you to define transparent structures and freely manage international flows. Solid companies that form capital groups on a reliable foundation are the cornerstone of any strong economy.
