The regulations regarding the so-called Estonian CIT (flat-rate tax on company income) came into effect in Poland from January 2021, introducing a new form of tax settlement. The main idea behind this approach is to shift the taxation point to the time of profit distribution from the company.

In the traditional CIT, income is defined as the difference between taxable revenues and the tax deductible costs. In the case of Estonian CIT, different business events are taxed, understood as the distribution of earned profit.

Additionally, the tax rates differ from the standard CIT. For Estonian CIT, the rate is 20% or 10% for small taxpayers and newly established businesses.

Starting from January 1, 2023, the list of entities eligible for Estonian CIT has been expanded. Currently, the list includes limited liability companies, joint-stock companies, simple joint-stock companies, limited partnerships, and limited joint-stock partnerships.

During the validity of the regulations, significant doubts arose regarding the new tax option. In this article, we present the key issues which have recently been subject of taxpayers’ interest and tax authorities’ decisions.

Choosing Estonian CIT during the tax year  

Individual Interpretation of the National Tax Administration dated November 28, 2023, reference number 0111-KDIB1 2.4010.561.2023.1.MK

In the course of 2023, significant uncertainties arose regarding companies opting to change their tax status to Estonian CIT during the tax year. Several judgments, including one from August 29, 2023 (case reference III SA/Wa 1335/23), suggested that a company should prepare financial statements and submit a notification of choosing the flat-rate tax before the end of the first month of the tax year in which the transition to Estonian CIT occurs.

However, in one of the recent tax interpretations, it was confirmed that such a stance is not justified, and the company has a much longer deadline for preparing financial statements.

According to Article 28j(5) of the CIT Act, “The taxpayer may choose a flat-rate tax even before the end of its adopted tax year if, on the last day of the month preceding the first month of flat-rate taxation, it closes its accounting books and prepares financial statements in accordance with accounting regulations.”

The director of National Tax Administration, despite initially stating that financial statements must be prepared first and then a notification (ZAW-RD) about choosing Estonian CIT submitted, changed the position, acknowledging that a company can effectively choose flat-rate taxation during the year, provided the ZAW-RD notification is submitted before preparing the financial statements.

Withdrawal of money from the company

Individual Interpretation of the National Tax Administration dated February 24, 2023 – reference number 0114-KDIP2-2.4010.291.2022.2.ASK

The Applicant was both a general partner and a shareholder in a limited partnership with shares. Due to his role as a shareholder, according to the company agreement, he had the obligation to perform specific regular non-monetary activities, such as acquiring new suppliers, quality control of goods, and updating the company’s website. Additionally, he received compensation for managing the company’s affairs as a general partner.

Due to this dual role, the Applicant approached the tax authority with a question whether the received compensation could be considered hidden profit (note: hidden profit refers to monetary or non-monetary benefits, paid or unpaid, partially paid, made in connection with the right to share in profits, other than shared profits, where the beneficiary is a shareholder). The company argued that it does not constitute hidden profit and should not be treated as the basis for flat-rate income taxation.

It is worth noting that Estonian CIT encompasses the effective distribution of profits from the company to the shareholder, and besides dividends, it also includes other forms of distribution, such as hidden profit.

The tax authority’s response aligned with the Applicant’s position. The authority confirmed that the paid compensation does not constitute hidden profit. According to the tax authority, when the compensation is linked to specific duties related to both managing the company and providing recurring non-monetary services, it should not be treated as hidden profit but rather as a justified cost for the business.

Settlement of passenger cars – mixed use

Judgment of the Supreme Administrative Court dated July 11, 2023, case reference II FSK 93/23

Another interesting aspect addressed in one of the judgments was the settlement of passenger cars used for both business and private purposes. In one case, the company provided its passenger cars to both partners with employment contracts and other full-time employees for mixed purposes.

The director of the National Tax Administration concluded that the company should pay Estonian CIT on both benefits for partners and expenses related to the use of cars by employees. He argued that whatever partners and shareholders receive during flat-rate taxation is subject to taxation as hidden profit, regardless of whether they are employees of the company. The tax should cover half of the expenses and depreciation deductions, following the relevant provisions of the CIT Act.

In the context of this position, the Administrative Court in Gdansk (case reference I SA/Gd 917/22) and the Supreme Administrative Court only partially agreed with the tax authority. The company should pay Estonian CIT on income from hidden profits related to the use of cars for mixed purposes by partners, but not on expenses related to employees who are not partners or shareholders, as in 2022 there was no specific provision justifying such imposition of Estonian CIT.

It is important to note that in this judgment and previous judgments by the Administrative Court, particular attention is given to the legal status prevailing until the end of 2022. From January 1, 2023, 50% of deductions and costs related to company cars used for mixed purposes are subject to taxation under Estonian CIT. This applies to both situations where partners use them privately and employees who are not partners. For partners, these expenses are still treated as hidden profits, while for individuals outside the circle of partners, such as employees, they are considered expenses not directly related to business activities.

Sale of cryptocurrencies

Judgment of the Administrative Court in Gdansk dated July 11, 2023, case reference I SA/Gd 342/23

The taxation of income from the sale of cryptocurrencies by limited liability companies subject to Estonian CIT has been a source of many uncertainties. The key question revolved around the scope of taxation for these incomes – whether they should be subject to the flat-rate income tax for companies, in accordance with Article 28m(1) of the CIT Act, or to the tax on income derived from the paid disposal of virtual currencies, in accordance with Article 22d of the same act.

According to the director of the National Tax Administration, these profits should be taxed under the principles applicable to income derived from the paid disposal of virtual currencies.

In the final decision, the court supported the tax authority’s position, dismissing the taxpayer’s complaint. A taxpayer subject to flat-rate taxation, earning income subject to separate taxation principles not mentioned in the content of this article, is subject to taxation in accordance with the principles governed by separate provisions of the CIT Act. Referring to Article 22d of the CIT Act, which defines the principles of taxing income derived from the paid disposal of virtual currencies, the court unambiguously stated that income from the sale of cryptocurrencies by flat-rate companies should be taxed in accordance with this provision.

Withdrawal of a limited partner from a limited partnership, transformation of the limited partnership into a limited liability company

Protective Opinion dated November 29, 2023, case reference DKP1.8082.2.2023

The Head of the National Tax Administration issued a protective opinion regarding the planned reorganization of the company. The objective of this reorganization was to transform the limited partnership into a limited liability company, along with making changes to the shareholder structure and opting for flat-rate income taxation for companies.

The Head of the National Tax Administration acknowledged that the proposed course of action by the parties is not artificial and is justified for economic reasons. It was also determined that achieving a tax benefit is not in conflict with the purpose of tax law.

It was emphasized that the transformation of the limited partnership into another legal form is not inconsistent with the legislative intent, and obtaining a tax benefit is permissible to that extent. The reorganization aims to adapt the organizational structure to changing legal regulations, increase management flexibility, and mitigate business risks. The benefits associated with the possibility of reinvesting in business development were also highlighted.

Importantly, the opinion also took into account the issues related to flat-rate income taxation for companies, stating that the planned reorganization would allow for the utilization of this form of taxation, in line with the prevailing regulations.

Expenditures related to capital increase

Individual Interpretation of the National Tax Administration (DKIS) dated October 9, 2023, reference number 0111-KDIB2-1.4010.286.2023.2.AR

The applicant for the mentioned interpretation was a company that was planning to establish a new branch. For this purpose, the company passed a resolution on the increase of capital, incurring various costs such as notary fees, fees for extracting the notarial deed, civil-law transaction tax, registration fee, legal consultancy fees and fees for changes notification in the National Court Register.

The company considered these costs to be related to its business activities and believed that they should not be subject to Estonian CIT. The company sought confirmation of its position.

The director of the National Tax Administration stated that the described expenditures are not subject to Estonian CIT. According to Article 28m(1) of the CIT Act, income subject to Estonian CIT taxation includes, among other things, income from expenses unrelated to business activities or from hidden profits.

Interest on a loan granted before transitioning to Estonian CIT

Judgment of the Administrative Court in Wroclaw dated January 18, 2024, case reference I SA/Wr 516/23

The factual context involved a company engaged in real estate trading, management and leasing. Since 2023, the company opted for Estonian CIT, and shortly before that (in December 2022), it entered into a loan agreement with an affiliated entity in the form of a credit line for ongoing operations.

The agreement remains in force until the end of 2024 and the interest rates were established on arm’s length’s level. The first disbursement from the credit line took place in 2022 and in the same year, the company settled both the principal and the interest. As of December 31, 2022, the outstanding debt balance was, therefore, 0 PLN.

The taxpayer’s crucial question concerned the taxation of interest on funds accessed after transitioning to Estonian CIT. The company argued that the interest is not hidden profit because the loan agreement was concluded before the change in the taxation system. Earlier, in an interpretation dated April 21, 2023 (case reference 0111-KDIB1-3.4010.178.2023.1.JKU), the director of the National Tax Administration referred to Article 28m(3), point 1 of the CIT Act, according to which interest is considered hidden profit.

The director of the National Tax Administration also invoked Article 28m(4), point 3 of the Corporate Income Tax Act, stating that interest is not excluded from the definition of hidden profits. The Provincial Administrative Court in Wroclaw found no irregularities in this interpretation and found no grounds to overturn it. The taxpayer’s complaint was ultimately dismissed.

The court’s ruling confirms the position of the director of the National Tax Administration, assuming that interest on the credit line obtained after transitioning to Estonian CIT constitutes hidden profit subject to taxation according to the provisions of the CIT Act.

Expenditures on Contractual Penalties

Individual Interpretation of the National Tax Administration dated July 26, 2023, case reference 0111-KDIB1-2.4010.257.2023.1.END

A taxpayer from the timber industry, choosing Estonian CIT, requested a tax interpretation regarding incurred expenses related to contractual penalties for a contractor. The company, due to a decline in demand for wood, incurred contractual penalties associated with the non-receipt of contracted raw materials.

The taxpayer argued that contractual penalties are related to generating revenue and securing the source of income, allowing them to be classified as deductible costs. The taxpayer claimed that flexible responsiveness to market realities is a significant element of business activity. In response, the tax authority sided with the taxpayer, acknowledging that contractual penalties are economically justified and economically rational, and are related to the company’s core business activities.

The mentioned contractual penalties did not meet the criteria for being taxed under the flat-rate income taxation for companies.