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Why a Limited Liability Company (spółka z o.o.)?

The limited liability company is the most popular form of business activity in Poland. It’s no surprise. This business form allows limiting the entrepreneur’s personal liability (a shareholder is not liable with private assets), it can be established with a low financial outlay (the minimum share capital is just 5,000 PLN), and it enjoys greater prestige – such a business is perceived as more professional than a sole proprietorship. Another advantage is the possibility of setting up the company online, although this has some limitations.

The biggest advantage of a limited liability company is definitely the limitation of shareholders’ liability. Thanks to this, a shareholder does not have to worry about financial failure, because in case of bankruptcy, as a rule, they are not liable with their own assets. Exceptions apply to shareholders who are also members of the management board and who do not meet the requirements specified in the Commercial Companies Code.

Limited Liability Company as a Separate Taxpayer

All these advantages do not change the fact that a limited liability company is not tax transparent. What does that mean? The company earns a certain income and pays corporate income tax (CIT) on it. The money does not yet belong to the shareholder, but to the company. To enjoy the profit, the shareholder must first withdraw the profit from the company, e.g., in the form of a dividend, which also requires paying tax, this time not by the company but by the shareholder. This results in a kind of double taxation of the profit — first at the company level, then at the shareholder level. Generally, the company pays CIT at a rate of 19% or 9% (if it has the status of a small taxpayer). The 9% rate does not apply to income from shares in the profits of legal persons (for example, if a limited liability company is a shareholder of another limited liability company). Then, the shareholder pays income tax on the withdrawal of funds from the company (e.g., in the form of dividends, a 19% flat income tax applies).

For tax optimization purposes, shareholders choose different ways of withdrawing funds from a limited liability company.

Ways of Withdrawing Funds from a Limited Liability Company

1) Dividend

The most classic way of profit distribution. It involves the shareholders of the limited liability company adopting a resolution on profit distribution and allocating it for dividend payment. Additionally, before paying the dividend, the company’s financial statement must be approved. Dividends are taxed at a 19% PIT rate. This is the safest, although not always the most optimal, way to withdraw money from the company. There is also the possibility of paying advance dividends during the tax year. However, the payment of advances requires meeting additional conditions and is subject to lower limits. It is important that neither dividends nor advances constitute deductible expenses for the company (so the company pays CIT on a higher amount). Dividends are not subject to health or social insurance contributions.

2) Remuneration for Appointment

Another way to pay remuneration to a shareholder may be to grant remuneration for serving as a member of the management board. Of course, this requires that the shareholder also serves as a board member. Granting remuneration to a board member requires a shareholders’ resolution. This solution has an advantage over dividends in that the remuneration of the board member can be recognized as a deductible expense for the company, reducing the amount on which the company pays CIT. The remuneration is subject to a 9% health insurance contribution but is not subject to social insurance contributions.

Board member remuneration is taxed progressively — at 12% up to PLN 120,000 per year, and 32% above that threshold. A tax-free amount of PLN 30,000 applies.

3) Employment Contract

Shareholders often also decide to conclude an employment contract with the company. Such a contract has similar tax and social security consequences as remuneration for appointment. It is also taxed progressively — at 12% up to PLN 120,000 per year, and 32% beyond that. A tax-free amount of PLN 30,000 applies. The company can include this remuneration as a tax-deductible cost.

However, there is a difference in contributions compared to remuneration for appointment. Employment remuneration is subject to social security contributions. Therefore, this option is most often chosen by shareholders who also run sole proprietorships and have overlapping social insurance coverage. This arrangement generally allows paying social insurance contributions only on the employment contract with the company (often covering minimum wage to minimize the contribution base). However, it should be noted that concluding an employment contract with a company in which one is a shareholder always carries risks depending on the number of shares held and possible functions in the company’s management board. We recommend consulting an expert in this regard.

4) B2B Contract with the Company

A shareholder who also runs a sole proprietorship may decide to provide paid services to the company. The remuneration paid to the shareholder-service provider may be recognized as a tax-deductible expense for the company. On the shareholder’s side, the remuneration is taxed according to the taxation form of their business (general rules, lump sum, or linear tax). Depending on the type of services, VAT taxation may also apply (and the company may deduct the input VAT). Income from the services generally affects the entrepreneur’s health insurance contribution, although details depend on the selected taxation form. Additionally, the entrepreneur pays social insurance contributions under general rules.

This solution is not without risk, especially if the shareholder simultaneously serves on the company’s management board. An example of ineffective tax optimization in this respect are the popular “management contracts” among entrepreneurs, which involve providing management services under a business activity contract. Regardless of the chosen taxation form, these contracts are subject to tax on general rules, i.e., progressive scale. Before providing any services to a company where one is a shareholder, it is best to consult a specialist. Tax authorities carefully analyze this solution regarding avoidance of dividend taxation and often question the services provided as fictitious or overlapping with activities carried out as a board member. The terms of service (especially remuneration) should be set at market level since these are transactions between related parties.

5) Recurring Non-Cash Contributions by Shareholders

The last of the mentioned methods of withdrawing funds from the company to shareholders is based on Article 176 of the Commercial Companies Code, which gained popularity shortly after the introduction of the so-called Polish Deal tax reform. According to this provision, the company’s articles of association may impose on a shareholder the obligation to provide additional, recurring contributions to the company. These obligations should be specified in the articles of association, and their introduction requires the shareholder’s consent. Examples of such contributions may be providing tools or materials to the company, making equipment available, or providing specific services. The contribution must be recurring, i.e., the shareholder must provide it regularly and for remuneration (which is the point of this solution).

Income of the shareholder from recurring non-cash contributions is taxed progressively. This remuneration is not subject to social insurance contributions nor – unlike remuneration for serving as a board member – to health insurance contributions. A tax-free amount of PLN 30,000 applies. The company can include this remuneration as a tax-deductible expense.

The biggest advantage of this solution — exemption from health and social insurance contributions — is also its greatest risk. Unfortunately, more and more ZUS (social insurance authority) interpretations indicate alleged abuses in the use of recurring non-cash contributions, qualifying them as service contracts or contracts of mandate subject to contributions. Before deciding to use this solution, the type of contribution should be analyzed and it is best to consult a professional.

Summary

Above are the most common ways of withdrawing funds from a company, through which shareholders try to optimize their income tax-wise and contribution-wise. As you can see, there is a whole range of methods to plan profit extraction. Each involves a certain degree of risk but also a certain degree of benefit. Dividends, although the “default” form of payout, require the company to show profit and are subject to a “fixed” tax rate. Alternatives that provide greater tax benefits and do not require the company to show profit or formalities related to approving financial statements require taxpayers to exercise greater caution to avoid accusations of tax avoidance or non-market transactions between related parties. The most advantageous result often comes from combining several of the above methods, which however entails even greater diligence in case of tax authority inspections. To reduce risk and develop the best strategy in a given case, we recommend contacting the team of specialists at ATL LAW Anna Błaszak law firm, who will analyze the company’s situation and propose the most effective solution.