Tax-consolidated groups – transfer pricing

Tax-consolidated groups (TCG) were often used as an aggressive tax optimisation tool. The lawmakers have recently taken measures aimed at limiting such optimisation mechanisms by, among other things, modifying the regulations governing the operation of tax-consolidated groups. In result of amendments to the regulations, transfer pricing has become an important aspect of TCG business since 1 January 2018.

Operation of tax-consolidated groups

A tax-consolidated group (TCG) is defined in the Corporate Income Tax Act (the "CIT Act"). TCG is a specific organisational structure intended for specific use, being a taxable entity formed solely to meet the corporate income tax purposes. There is no doubt that before the amendments to the regulations, TCGs were used for aggressive tax optimisation.

The beginning of 2018 saw the amending act which introduced essential modifications in the operation of TCGs in terms of taxes (the act amending the Personal Income Tax Act, the Corporate Income Tax Act and the Act on Flat Income Tax on Certain Revenues Earned by Natural Persons), which implements the Council Directive (EU) 2016/1164 (of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market (OJ EU L 193 p.1).

The lawmakers introduced a number of changes, not only in terms of formal conditions concerning the formation and operation of TCGs, but also in terms of the transfer pricing documentation obligation applicable to companies making up the structure of tax-consolidated groups.

Formation of a tax-consolidated group

The changes in formal conditions crucial for the formation of a TCG are beneficial to companies which are interested in setting up such a structure. Consequently, the required average share capital per each of the TCG companies was reduced (to PLN 500,000), and the percentage share of the dominant company’s share capital in related parties was decreased to 75%.

Further changes concerned the operation of tax-consolidated groups – namely, the income-to-revenue ratio was reduced to 2% and companies belonging to a TCG are currently obliged to transact on arm’s length terms with associated enterprises from outside the TCG structure.

The most important changes relating to TCG concern the time when a TCG loses its taxable person status. The new regulations apply retroactively. If a tax-consolidated group loses its status of a taxable person, the TCG member companies will have to account for income tax separately for up to 3 years, as if TCG did not exist at that time. It means, therefore, that they will have to account for the tax on their own income retroactively. The aim of making it possible to asses transactions made within a tax-consolidated group in terms of taxes after the group has been dissolved is to limit the use of the TCG structure for aggressive tax optimisation purposes.

Tax-consolidated group and obligation to prepare transfer pricing documentation

Before the amendment to the regulations the obligation to prepare transfer pricing documentation did not apply to transactions made by companies belonging to a tax-consolidated group. The foregoing was governed by Article 11(8)(1) CIT Act which says that national relationships cannot be transposed to relationships between companies belonging to a tax-consolidated group.

Currently, the new regulation requires such transactions to be made in line with the arm’s length principle, repealing the article mentioned above. The new regulations provide for the possibility to analyse the transfer pricing rules used in transactions between TCG member companies for compliance with the pricing rules used by independent entities. In justifying the change, the lawmakers claim that a tax-consolidated group aims at enabling its member companies to set off income against losses, and not to exclude the transfer pricing regulations.

The lawmakers point directly to the obligation to prepare transfer pricing documentation on transactions between TCG member companies and associated enterprises, the latter not being part of the TCG structure (Article 9a(3e) CIT Act). Although the aforesaid regulation does not apply to transactions between TCG member companies, when justifying its introduction the lawmakers point to a desire to stress that the obligation to prepare transfer pricing documentation applies only to transactions with extra-group entities and that this obligation does not apply to transactions between TCG member companies.

As regards the changes, most important and at the same time controversial is the obligation to prepare transfer pricing documentation on transactions between TCG member companies whenever TCG loses its status of a taxable person. The regulations on retroactive consequences of accounting for income tax by companies formerly belonging to TCG do not govern the transfer pricing documentation obligation. The lawmakers say nothing about whether the aforesaid obligation becomes enforceable, and if it does – what legal status should be applied and what sales of the companies (for which years) should be taken into account in determining the transactional thresholds and the responsibilities.

Curbing aggressive tax optimisation

The changes with effect from 1 January 2018 aim, first of all, at curbing aggressive tax optimisation practices. According to the old regulations, TCG member companies were obliged to account for the corporate income tax only after TCG ceased to be a taxable person. As a result of the amended regulations, generating virtual losses by one of the member companies is no longer profitable in terms of corporate income tax.

Introducing the possibility to review whether transactions between TCG member companies comply with the arm’s length principle is expected to draw the companies’ attention to the intragroup tax accounting practices which can be used.