Hidden dividend and tax on pass-through income

June 8, 2022

Tax changes planned under the Polish Deal are aimed at tightening the tax system. We are facing changes in the Corporate Income Tax Act. These include, among others, hidden dividend and taxation of the so-called pass-through income.

Hidden dividend

The payment of dividends is a permanent part of corporate culture in the financial market. In this way, entrepreneurs form an appropriate relationship with investors. Dividend for the company is a cost of using the capital contributed to the company, while for the investor it is an income, which is granted to him due to the risk of providing the capital. The tax rate for dividends is 19%. The concept of the so called “hidden dividend” was introduced within the framework of the Polish Deal to prevent situations where profit is paid out by an entity in a different way, e.g. for intangible services, so far classified as tax deductible costs. The changes, which were to come into force in 2022, were postponed until 1 January 2023. Point 15b was added to Article 16, section 1 of the CIT Act. This provision is to read as follows:

The following shall not be regarded as tax deductible costs

We can speak of a hidden dividend when it meets at least one of the following conditions:

• the amount or deadline for such costs depend on the achievement of profit or the amount of profit
• the taxpayer incurs costs or higher costs that a rational taxpayer would not incur when comparing a service provided by non-related parties. In determining the amount of these costs the transfer pricing rules apply accordingly;
• costs which include remuneration for the right to use assets owned or co-owned by the partner and other related parties before the taxpayer was formed.

The above terms constitute a hidden dividend and are not deductible. The exception is the amount of the “hidden dividend” that is less than the gross profit. In this case, it is included as a deductible expense.

Tax on pass-through income

Another change concerning corporate income tax is the regulation of Art. 24aa of the CIT Act, which provides for the introduction of another source of revenue, in the form of the so-called pass-through income. These costs include costs incurred directly or indirectly for the benefit of an entity related to the taxpayer, which constitute receivables of this entity. The act specifies two more conditions that must be met in order to recognize costs as passed-through income, i.e:

• The tax must be at least 25% less than the amount of income tax. This applies to the related entity’s payment of tax in the year of receipt in its country of residence;
• Costs must be at least 50% of the value of the revenue that the entity earned.

The pass-through income is taxed at the same rate as the basic corporate income tax rate, i.e. 19%. However, in order to apply this rate, it must be remembered that the so called pass-through income constituted 3% of the sum of all KUP.

It is important to mention that the rules on taxation of the pass-through income do not apply to entities that lie within an EU or EEA country.

In summary, in 2023, special attention should be paid to transactions with related parties in the context of the hidden dividend provisions. If there is a risk of such costs meeting the conditions set out in the Act and they exceed the amount of gross profit, the entity should decide to change the settlement model. Another change introduced as part of the Polish Deal is the tax on pass-through income, i.e. costs incurred directly or indirectly for the benefit of a related party that meet two conditions outlined in Article 24aa(2). An exception applies to entities from a country located in the EU and OEG that conduct substantial real economic activity in that country that is taxable

Author: Natalia Rzempowska

Tags hidden dividend, podatek od przerzucanych dochodów, tax on pass-through income, ukryta dywidenda