Guarantee fee payment without withholding tax. Tax remitter's due diligence when paying abroad
We are pleased to announce that we have obtained a favourable opinion of the Head of the National Revenue Administration for one of our clients from the construction industry regarding the lack of obligation to collect withholding tax on guarantee fees calculated as a percentage of the amount guaranteed by a foreign entity.
Case study
In order to raise funds for an investment (purchase of shares in a limited liability company with a registered seat in Poland), our Client applied for external financing. In order to secure the transaction, it was necessary to obtain a guarantee. The role of the guarantor was filled by a company based in Korea, the sole shareholder. The remuneration was determined as a percentage of the guaranteed amount. The Client's question concerned, in particular, the risk of qualifying the remuneration as "interest" under the double taxation agreement between Poland and South Korea (hereinafter: the Poland-Korea Agreement) and it being subject to 10% withholding tax in Poland.
The Head of the National Revenue Administration confirmed that the remuneration paid by our Client to the Korean company for the guarantee would not be subject to withholding tax in Poland, provided that our Client had had the certificate of residence of the Korean company in their possession at the moment of payment. In particular, the authorities emphasized that:
"The remuneration paid by the Applicant to the Related Entity is only a payment for the Related Entity's ability to provide financing. Thus, the remuneration paid by the Company to the Related Entity by virtue of the guarantee does not constitute interest within the meaning of Article 11 of the Convention [Double Taxation Agreement between Poland and South Korea - TIAS annotation]. (...) since, as indicated in the application, the Applicant holds the tax residence certificate of Company C, the remuneration obtained on account of the guarantee should be considered the profit of the enterprise within the meaning of Article 7 of the Convention. Such profits can only be taxed in the country of residence of the entity receiving such income (in the case at hand - on the territory of South Korea).
CIT Act and the Poland-South Korea Agreement with respect to the taxation of guarantees
It is worth mentioning that the Polish CIT Act stipulates that guarantees should be subject to withholding tax at the rate of 20%. However, it also indicates that this provision is applied taking into account the Double Taxation Agreement (DTA), and therefore, if the DTA with the country of residence of the entity granting the guarantee provides otherwise, the regulations of such an agreement will take precedence (in accordance with the Polish system of law sources). The double taxation agreement with South Korea (the Poland-South Korea Agreement) stipulates that the profits of the Korean company are subject to taxation in Korea, unless the company has a taxable permanent establishment in Poland and the profits in question are derived from operations of this permanent establishment (Article 7 of the Poland-South Korea Agreement). Our Client owns a taxable permanent establishment in the form of a branch in Poland, however the guarantee is provided by the headquarters in Korea, and the remuneration for the guarantee (guarantee fee) should be attributed to the Korean company and not to its Polish branch. Therefore, on the basis of Article 7 of the Poland-Korea Agreement, the guarantee fee would be subject to taxation only in Korea.
At the same time, however, given the percentage-based method of determining the guarantee fee and the content of the Poland-South Korea Agreement, Article 11 of this Agreement should be also taken into account. Article 11 provides for special rules for taxation of interest and the obligation to collect tax in the country of the tax remitter at the rate of 10%. This provision defines interest as income from debt claims of every kind, both secured and not secured by a mortgage or a right to participate in the debtor's profits, and in particular income from government securities, bonds, and debentures including premiums and prizes related to such securities, bonds, and debentures.
Although the word "guarantee" is used in the Polish version of that regulation, it must be noted that in the context of government guarantees, in the English version, which is decisive in the case of the Poland-South Korea Agreement, the term "government securities" appears. That term is also translated as "state securities" in other double taxation treaties, e.g., in the agreement with the Czech Republic and in the OECD Model Convention, and also as "government loans", e.g., in the agreement with China and Germany – thus, without any reference to the word "guarantee". In order to eliminate all risk of qualifying the percentage-based guarantee fee as interest, it is worth referring to the Commentary to the OECD Model Tax Convention on double taxation avoidance, which provides guidance on how to interpret the provisions of double taxation agreements. As indicated in the OECD Commentary, interest is defined as compensation paid for the amount borrowed. Therefore, it can be considered that the notion of interest applies only in the event that the debtor was provided with earlier access to the borrowed capital, which found confirmation in the tax ruling that we have managed to obtain from the relevant tax authority. : "only the remuneration for the actual provision of capital (particularly in the form of a loan) should be considered interest within the meaning of the double taxation agreement [the Poland - South Korea Agreement - TIAS annotation]".
Hence, the tax authority rightly stated that the remuneration paid for the guarantee by our Client to the Korean company is not classified as interest referred to in Article 11 of the Poland-South Korea Agreement, as it constitutes payment for the Korean company's willingness to provide financing to the Polish entity (which is not equal to compensation paid for the amount borrowed). Therefore, in accordance with Article 7 of the Poland-South Korea Agreement, the guarantee fee is subject to taxation in Korea (which means that there is no obligation to collect withholding tax in Poland), provided that the remitter held a tax residence certificate of the Korean company as of the remuneration payment date. We would also like to inform you that the absence of an obligation to collect withholding tax on the basis of a double taxation agreement does not exempt the remitter from fulfilling reporting obligations towards the tax authorities as well as the recipient of the receivables by submitting proper information on the IFT-2R form.
Due diligence
Moreover, the authority indicated that the Applicant, as a remitter exempt from withholding tax, is also obliged to perform due diligence in accordance with Article 26 Section 1 sentence 3 of the CIT Act, regardless of whether the sum of payments to one taxpayer exceeds PLN 2 million in a given tax year. Sentence 3 was added to the CIT Act along with the planned change in the withholding tax collection system from the current system of tax relief at source at the moment of payment (subject to certain conditions specified by the law) to the tax refund system, i.e. collection of tax upon payment and subsequent tax refund for amounts due over PLN 2 million to the same taxpayer. The effective date of the new withholding tax collection mechanism has already been postponed several times, and it is now scheduled for 1 January 2021.
However, the regulation referring to the remitter's due diligence requirement at the time of payment to the foreign counterparty is already in force and raises many interpretation issues. The current restrictive approach of the tax authorities requires that in order to perform due diligence, the remitter, regardless of the paid amount, shall verify whether the recipient of the receivables is the actual beneficiary and whether he is conducting a legitimate business activity. The authorities maintain that such verification is already mandatory and should be carried out by means of correctly prepared statements, data checks based on publicly available information sources, document collection in the case of payments to related parties, and, for the most significant amounts, expert opinions obtained from and auditor or tax advisor. Otherwise, in the case of failure to exercise due diligence, the authorities may revoke any benefits resulting from the application of double taxation agreements or EU directive-regulated exemptions and determine the tax liability using the standard rates stipulated in the CIT Act . For more information, we would like to refer you to our article on due diligence and current case law concerning this issue.
For further information, please refer to our article on the requirements of due diligence and current judicial decisions on this subject.
▶ Guarantee fee payment without withholding tax. Tax remitter's due diligence when paying abroad
As TIAS, we support our clients in:
- securing savings in the case of payments of an ambiguous nature allowing us to apply for an individual tax ruling,
- identifying payments made abroad that are subject to withholding tax,
- correctly settling cross-border transactions with respect to relevant tax regulations,
- properly documenting tax collection and fulfilling reporting obligations to the tax authorities,
- performing due diligence at the time of payment for evidential purposes (in case of potential audit, tax proceedings),
We follow and keep you informed about the latest judgements of administrative courts and decisions of tax authorities connected with withholding tax. If you would like us to assist you in that regard, please do not hesitate to contact us.
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