Who are related parties to your business?
Generally speaking, if any person or business has at least 5% of shares in the another one or if there is any person that manages or takes part in management of two different businesses, then the two entities are related parties to each other.
In fact, the definition of “related parties” in the tax law reaches further than that. A “relation” in term of taxes exists if the other business is managed by – for example – your spouse, sister, brother, son, daughter or your brother/sister in law. Also the capital participation doesn’t need to be direct in order to have consequences in taxes: it is enough if the two entities have the same common shareholder(s) or the company shares are held via a “proxy” company, that is owned by one entity and simultaneously holds shares in the other one.
Tax consequences for related parties
While not illegal, the transactions between related parties have long drawn attention of the tax administration as they were pretty often used to transfer profits to countries with mild tax policy. For the last few years you can see an increasing trend in the European Union, and Poland is no exemption from that, to put this kind of transactions under control and to make the law more stringent for businesses that try to escape the taxes.
The mechanism is quite simple: as soon as your transactions with a related party exceed in total a limit set in the Income Tax Act, you have to prepare a specific documentation (transfer pricing documentation) that proves your transactions with this entity are carried out on usual market conditions. The limits are low: EUR 30.000 for services and EUR 50.000 for sale of goods (unless the transaction volume doesn’t exceed 20% of your share capital – then this limit is set at EUR 100.000).
What happens if…
What happens if you don’t have this documentation despite of having made transactions with a related party that exceed the limits set in the Income Tax Act? Apart from the liability for a tax offence, the pure financial consequences for the business may be also serious. The profit gained from these transactions will be assessed once again by the tax administration according to the official conception of “usual market conditions” and using methods defined in the Income Tax Act. Should the re-calculated profit be higher than the amount reported originally by the business, the difference is taxed with a panalty rate of 50% income tax (especially foreseen for such cases). The same procedure is also applied if the transfer pricing documentation prepared by the company is insufficient or not compliant with the requirements of the law.