Hidden dividend: how the Polish Deal complicates withdrawing funds from a company.

As part of the tax changes introduced by the so-called Polish Deal, a new, legally defined category of expenses will be created, which cannot be included as tax-deductible costs under the CIT (corporate income tax). This concerns the content of the new Article 16(1)(15b) of the CIT Act, according to which costs incurred by a taxpayer that is a company in connection with services rendered by an entity directly or indirectly related to the taxpayer, or to a shareholder (or stockholder) of the taxpayer, shall not be deductible if those costs constitute so-called hidden dividends.

According to the proposed Article 16(1d) of the CIT Act, hidden dividends are defined as costs of the company being the taxpayer if:

1. the amount or timing of incurring them is in any way dependent on the taxpayer’s profit or the amount of that profit; or
2. a reasonably acting taxpayer would not have incurred such costs, or would have incurred lower costs, in the case of performing a comparable service by an unrelated entity; or
3. these costs include remuneration for the right to use assets that were the property or co-property of a shareholder (or stockholder) or an entity related to the shareholder (or stockholder) before the taxpayer’s establishment.

It is worth noting that the concept of “services to the shareholder or related entity” has not been further specified, so the tax authorities’ interpretation of this term may be very broad. It cannot be ruled out that all transactions with related parties, even if carried out at market prices, will be subject to scrutiny regarding the above criteria. Although the planned changes primarily aim to prevent unjustified transfers of funds from the company to shareholders and artificial generation of tax costs for the company, they may complicate settlements between related entities within the previously accepted market practices.

The justification for the Act states that the construction responds to “distribution of profits to shareholders carried out in a way that reduces the taxpayer’s income by including such amounts as tax-deductible costs. This leads to an economic distribution of profits, which is formally not classified as dividends.”

According to the draft justification, “hidden dividends may take various forms:
– payments unrelated to conducted business activities,
– transactions of a non-market nature,
– excessive indebtedness of the taxpayer under various titles towards related entities within a capital group,
– use by the taxpayer of assets belonging to a shareholder or related entities, which originally belonged to the taxpayer.”

The draft also includes a provision establishing exceptions from the hidden dividend rule – if the sum of costs incurred in the tax year by the taxpayer classified as “hidden dividends” is lower than the gross profit as understood under accounting regulations, generated in the financial year in which those costs were included in the taxpayer’s financial result.

According to the latest information provided by the Ministry of Finance, the proposed provisions are planned to come into force in 2023. The government reserved the right for their final wording to still change before that date.

Taxpayers fear that expenses such as a company’s rental payments under a lease agreement with a shareholder could be deemed hidden dividends, even if such a transaction has an economic justification. Critics of the draft highlight that excluding from deductible costs rationally justified expenses (due to the broad definition of hidden dividends) could have catastrophic consequences for businesses.