On 22 May of this year the Polish Family Foundation came into effect. We have discussed the significant benefits of the new institution extensively in articles and on Wealth Advisory – Anna Maria Panasiuk YouTube channel. This time, I point out the risks of the Polish family foundation when this institution is used outside the framework which determines the purpose of its creation.
The Polish Family Foundation as a Tax Planning Vehicle: Limits and Risks
This vehicle allows assets to be separated from the founder, but only for the purpose of accumulating property, managing it in the interests of the beneficiaries, and fulfilling obligations to the beneficiaries. The founder, while operating within the scope of general goals, may establish in the articles of association a specific goal for the establishment of a family foundation.
Therefore, in practice, the objectives will mainly be:
- Multi-generational succession planning,
- Securing and effectively managing family assets,
- And, attention please… Tax planning.
Yes! The institution of the Polish family foundation can serve as a tax planning vehicle, but only if the main purpose is to secure assets to pay benefits to the beneficiaries in the future. A family foundation cannot be used for aggressive tax optimisation. It cannot be part of an artificial structure owing to which you will not pay tax in Poland.
It should be noted that, although the first family foundations in Poland will most likely serve the purpose of reinvestment and it is from these entities that we will learn the function of the family foundation in the business, legal and tax environment, there are already questions at this stage to which practice does not yet know the answers. These unknown areas must be first identified and secured.
Business Operations of the Polish Family Foundation: Permitted and Restricted Scopes
First of all, it is worth noting to what extent a family foundation may conduct business. Originally, a model was considered in which a family foundation could not conduct business, because, in principle, the institution serves other purposes. However, it was recognised that these purposes, that is, primarily safeguarding assets for beneficiaries, can be carried out by conducting business, or at least to a certain extent. In practice, this means that we are dealing with the so-called “permitted operations” and “restricted operations”. In the scope of “permitted operations”, a family foundation enjoys income tax exemption, while “restricted operations” are subject to a special CIT rate of 25%.
One of the scopes within which a family foundation can conduct business operations is the sale of assets unless the assets were acquired solely for the purpose of further sale. Thus, the scope of a family foundation’s operations is subject to limitations, such as the exclusion of the possibility to conduct real estate development operations (envisaging the commercialisation of investments in the form of real estate sales). Therefore, is it true that the acquisition of real estate by a family foundation to protect the assets from inflation will be an area of disputes with the fiscal authority? Will there not be a presumption that the real estate was acquired for resale?
The exemption of dividends related to participation in commercial law companies and partnerships, as well as interest on loans from taxation may also appear problematic. Will dividends be a gain resulting from “business operation consisting in joining commercial law companies and partnerships”? Given the legislator’s general and rather vague articulation of this issue, this area may be subject to potential disputes with the fiscal authority and generally pose a tax risk.
Are you considering setting up a POLISH FAMILY FOUNDATION? This eBOOK is for you – a number of risk areas are addressed in it and some solutions related to the Family Foundation Act are proposed – check it out.
VAT and the tax on civil law transactions (henceforth TCLT): Analysis of Consequences for the Polish Family Foundation
The regulations governing the family foundation do not introduce any lex specialis in the context of VAT and TCLT, either. While the contribution of assets to a family foundation is not subject to income tax, both on the part of the family foundation and the funder, each time this activity should be analysed in terms of the emergence of VAT and TCLT tax obligations. The situation may become further complicated if the funders consider contributing not individual assets, but their organised groups. Then the classification and tax settlement of such an operation may raise many doubts.
Therefore, special care should be taken when contributing real estate to a family foundation from a sole proprietorship. This is so because such an operation will not benefit from VAT exemption.
Hidden Profits and CIT: Risks and Limitations
The first version of the legislation introducing the institution of the Polish family foundation aroused enthusiasm in the context of the tax optimisation of investment vehicles, as it allowed for solutions in which tax might de facto never arise, both at the level of the beneficiary and the family foundation. There appeared ideas in the public space that the family foundation would own the assets, and the beneficiary would benefit from those assets even before the time of benefit payment… on top of that, the payment of benefits might never be realized, resulting in no taxation.
The legislator countered these ideas and created a catalogue of the hidden profits of a family foundation, in other words a set of operations that will result in CIT obligation on the part of a family foundation at a rate of 15%. Hidden profits will include, among others:
- interest on a loan granted to the foundation by the beneficiary, founder or an entity affiliated with them;
- benefits to the beneficiary, the founder, or an entity affiliated with them – from, for example, consulting services, accounting services, or those involving market research;
- loans granted by the foundation to its beneficiaries (with the provision that only long-term and irredeemable loans will be subject to taxation on hidden profits).
Transfer Pricing: Impact on the Polish Family Foundation and Affiliated Persons
Due to the emergence of changes concerning hidden profits, also the issue of valuating transactions was addressed. Because of that, the way in which hidden profits are defined may lead to a foundation not necessarily being interested in board members such as beneficiaries, founders or entities affiliated with them or with the foundation itself holding functions for remuneration. On the other hand, the fact that these members perform a function without remuneration may give rise to some consequences on the grounds of transfer pricing rules. Additionally, on the part of the family foundation, revenue from unpaid service could be generated.
Family members are treated as affiliated entities. A family “business”, in turn, does not always equate maintaining market conditions. And then, the temptation to apply “special pay rates” to the closest ones emerges. For these reasons it is important that people deciding to start or already running a family foundation bear in mind the regulations on the required documentation of transactions concluded with affiliated entities. Transfer pricing tax obligations will arise if a family foundation concludes transactions with the founder’s family members and their companies, and the annual value of these transactions exceeds the statutory thresholds, i.e.:
- PLN 10M nett – in the case of commodity and financial transactions, or
- PLN 2M nett – in the case of a service transaction and other transactions.
The limits should be applied to transactions of one type, separately to the expenditure and revenue side. In accordance with the regulations, thresholds are determined for every homogeneous transaction regardless of the number of affiliated entities with which a transaction is made.
The Polish Family Foundation in the Context of International Structures: Taxation Issues and CFC
In the case of a Polish family foundation receiving passive revenue from abroad (e.g., dividends or interest), the family foundation may be effectively subject to withholding tax in other countries. If the country in which a foreign company holds residence apply the withholding tax on the revenue paid, international double taxation agreements concluded by Poland may be helpful, with relevant agreement usually limiting the withholding tax but not eliminating it.
A note on CFC for Family Foundations
Additionally, while the regulations for the Polish family foundations define subjective exemption in the scope of CFC, the regulations also stipulate that the founder may be subject to CFC because of having indirect effective control over the entity, which is formally owned by a family foundation. Thus, one should be especially cautious when acquiring investments outside the territory of Poland.
On the one hand, CFC in the context of the founder is interesting – but the situation of the beneficiaries of the Polish foundation being residents of other countries is yet another noteworthy issue. According to local regulations, many countries may acknowledge a Polish family foundation as a so-called foreign controlled entity and may effectively tax its current income as allocated to the beneficiary. Therefore, the situation will require analysis before the group of a Polish family foundation beneficiaries is determined.
Contribution of foreign real estate to a Polish Family Foundation
Moreover, contribution of foreign real estate will not be taxed in Poland, but it may be taxed in a foreign jurisdiction – e.g., on the basis of the sale of real estate – attention must be paid to the double taxation agreements between Poland and the country where the real estate is located(!)
Risks of the Polish Family Foundation – a summary
Summing up, while using the Polish family foundation as a means of financing new investments, paying attention to the following aspects is required:
- Fuelling a Polish family foundation with loans is not tax-efficient.
- It is crucial to ensure that the transactions made by and for a Polish family foundation are set at the market level.
- It is essential to schedule loans repayments to beneficiaries flexibly in order not to allow the situation where a repayment will not be made on the agreed date; a loan agreement should be concluded for no more than 10 years.
- It is essential to identify “permitted” and “restricted” business operations of a Polish family foundation.
- In the cases when a Polish entrepreneur uses foreign foundations, intends to contribute foreign assets to a Polish family foundation or when non-residents become the beneficiaries of a Polish family foundation, they should first analyse legal and fiscal consequences of such actions.
Establishing a Family Foundation in Poland offers certain benefits, in addition to creating certain traps. Even though a foundation may serve as means of tax planning, some risks associated with the abuse of the foundation for other purposes exist and it is necessary to identify and secure unknown areas. The economic activity of the foundation is subject to certain restrictions and must comply with the regulations, especially when it comes to the sale of assets or granting a loan. While contributing assets to the foundation, one should consider tax consequences associated with VAT and TCLT. Hidden profits – this was already pointed out by the legislator (!), exercise caution.
A Polish family foundation must also take into account the regulations concerning transfer pricing in the case of transactions with affiliated entities. If such a foundation receives passive revenues from abroad, it may be effectively subject to taxation in other countries and the founder may be subject to CFC regulations. In the case of beneficiaries residing abroad, local provisions may require taxation of the current income from the foundation. Contributing foreign real estate may be associated with various fiscal consequences. If you own assets outside the territory of Poland and you want to use the institution of the Family Foundation, remember to select a good consultant who will not only set up the structure of your foundation, but who is also familiar with the tax law of the countries in which you conduct operations, own assets or have other affiliations included in your Family Foundation.