What in the APA for a taxpayer?

by Radosław Ozimek, Łukasz Szczygieł

9 April 2020

An Advance Pricing Agreement (APA) can sometimes bring a number of benefits to a taxpayer. Above all, an APA ensures tax-deductibility of certain expenses above the statutory limit. In addition to reducing the taxable base, Advance Pricing Agreements substitute transfer pricing documentation and release enterprises from the obligation to prepare it.

It is no secret that many Polish taxpayers carry out (controlled) transactions with associated enterprises, which entail numerous obligations and limitations. If the value of a controlled transaction exceeds a statutory threshold, the taxpayer needs to draw up transfer pricing documentation plus a benchmarking study to confirm that the price of the controlled transaction is set as if the same transaction was carried out by independent enterprises. An Advance Pricing Agreement has a similar role to transfer pricing documentation because it confirms that the transfer price is at arm’s length. Once an APA is signed, the transaction concerned is so transparent for tax authorities that there is no need for further examination. So it was reasonable for the lawmakers to have concluded that such transactions give no potential for profit shifting between associated enterprises and, therefore, there is no point in limiting tax-deductibility of expenses referred to in Article 15e of the CIT Act. This may bring really big savings to many taxpayers.

Tax-deductibility above the statutory limit

The potential for the savings comes from the opportunity to avoid the limitation referred to in Article 15e of the CIT Act. That article lists expenses of limited tax-deductibility if they are paid to associated enterprises or entities based in tax havens. The limitation applies to:

• expenses for advisory services, market research, advertising, management and control, insurance, guarantee and surety services and similar;
• fees and amounts due for the use or the right to use intangible assets, e.g. licences;
• expenses for the transfer of the risk of debtor's insolvency under loans and similar facilities.

If a controlled transaction involves one of the above expenditures, its tax-deductibility will be limited by law. The limit equals the sum of 3 million zloty plus 5% EBITDA. EBITDA in this case means profit calculated for tax purposes using a specific formula:

EBITDA = (revenues from all revenue sources – interest income) – (tax-deductible costs – costs of amortisation/depreciation – interest expenses).

The following example may help to explain how to calculate the limit. A taxpayer has calculated EBITDA based on his accounting documents using the above formula at 10 million zloty. To find out the cap on expenses, the taxpayer adds 5% of the calculated amount (that is 500 thousand zloty) to the fixed limit of 3 million zloty. As a consequence, the taxpayer will be able to recognise up to 3.5 million zloty of expenses listed in Article 15e under tax-deductible costs. Please note that for the calculation of the limit, tax-deductible costs and interest expenses are recognised exclusive of thin capitalisation rules, i.e. without application of limited deductibility of debt financing costs.

The good thing about an Advance Pricing Agreement in the context of this limit is that it turns off this limit insofar as the APA confirms that the fee paid to the associated enterprise is correct. This means that expenses referred to in Article 15e of the CIT Act as part of the controlled transaction covered by an APA are tax-deductible without limitation. This makes life a lot easier for taxpayers who carry out high-value transactions with associated enterprises.

While calculating if it makes sense to reach an APA, it is important to remember that the limit under Article 15e of the CIT Act is cumulative for all expenditures listed in that article. So, a taxpayer should identify the highest value transactions which “use up” most of the limit and consider excluding them from that limitation.

Example

A company liable to CIT has calculated its limitation on the expenditures under Article 15e of the CIT Act at 5 million zloty. The company made 2 transactions with associated enterprises in a tax year: purchase of advisory services worth 10 million zloty and purchase of licences worth 2 million zloty. Following the limit, the company may deduct only 5 million zloty on both transactions. However, if the company had an Advance Pricing Agreement covering the purchase of services in that year, it could deduct all expenditures for those services. If the Advance Pricing Agreement covered only the purchase of advisory services, the company could also deduct all of the expenditures for licences because they would fit the limit of 5 million zloty.  Summing up the above example, without an APA the company could deduct 5 million zloty on both transactions, and with an APA – 12 million zloty. As a consequence, the company would disclose 1.33 million zloty less of CIT payable.

Moreover, it could reap the fruits of the APA also in the following years as an APA may be signed for up to 5 years. The APA’s lifetime may also be extended by another 5-year period if the elements have not changed significantly. Consequently, an APA may be bringing tax advantages for years.

No transfer pricing documentation obligation

In addition to the tangible benefits described above, we would like to mention exemptions from other obligations related to controlled transactions. For instance, Article 11k of the CIT Act stipulates that transfer pricing documentation has to be prepared for homogeneous controlled transactions exceeding the following value thresholds:

• 10 million zloty – for financial transactions or transactions in goods;
• 2 million zloty – for services and other transactions.

Yet, the CIT Act stipulates also exemptions from that obligation. One of them includes transactions covered by an Advance Pricing Agreement. Therefore, an APA substitutes the TP documentation and transfer pricing analysis, so the taxpayer does not need to prepare them and declare that the transactions terms have been set at arm’s length.

Reduced risk of a tax inspection in the future

An Advance Pricing Agreement represents a step towards more transparent cooperation with tax authorities. Please note that transactions covered by an APA are not disclosed in the new transfer pricing information return (TP-R form), so they will not be checked for profit shifting among associated enterprises. So, if a taxpayer decides to cooperate with tax authorities to confirm the correct accounting for transactions most prone to profit shifting, he will also reduce a risk of tax inspections of information disclosed in the TP-R form. 

If you are interested in obtaining the advantages described in this article by signing an APA, Rödl & Partner experts are at your service.