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Case study - Implementation of flat rate on income of companies (Estonian CIT) in a limited liability company operating in the real property sector

A customer that MDDP Outsourcing has been providing services for since 2017 conducts business activity involving investments in the segment of high street retail commercial properties.

From the beginning of its operations, the company focused solely on the market in Warsaw (Poland). So far, the said strategy allowed for reaching a rental ratio of over 95% and achieving high returns on investments. Consequently, the Customer is constantly growing, continuously expanding their resources by acquiring new, attractive commercial properties in Warsaw.
At the beginning of 2022, the company decided to change the form of taxation of its income to flat rate on income of companies, the so-called Estonian CIT.

Before it happened, the Customer (in cooperation with MDDP Outsourcing) had do carry out a detailed analysis in order to determine whether they are entitled to choose the said form of taxation. The verification involved checking whether the Company meets all the necessary conditions allowing it to apply flat rate on income of companies.

The verification process of the possibility of choosing Estonian CIT as the preferred form of taxation in Poland

Pursuant to the Polish Act on corporate income tax, in its applicable version as of 1 January 2022, the flat-tax rate can be utilized by a taxpayer who meets all of the following conditions:

  1. They are subject to a tax obligation on all of their income in Poland, regardless of the location of its generation.

The Customer has a registered office in Poland and is subject to corporate income tax on all of their income, regardless of the location of its generation. As a result, the said condition is met.

  1. Less than 50% of revenue on its operations in the previous fiscal year along with the payable VAT originates from:
    • receivables,
    • interest and profits on any type of loans,
    • the interest portion of the leasing rate,
    • sureties and guarantees,
    • copyrights or industrial property rights, including disposal of such rights,
    • disposal and realization of rights on financial instruments,
    • transactions with related entities pursuant to Art. 11a section 1 point 4 – in situations when, as a result of such transactions, no added value is generated in economic terms or such a value is negligible.

With the support of MDDP Outsourcing, the company analyzed their revenue in 2021 and more than 50% was constituted by revenue on operating activities i.e., real estate trade and rental. Thus, those do not constitute the so-called passive revenues mentioned above. Consequently, the condition specified in this point is fulfilled. In the upcoming years, the Company along with MDDP Outsourcing will verify, whether the condition is still being met.

  1. The taxpayer:
    • employs at least 3 people under contracts of employmentin full time equivalent units, provided that such people are not partners of the said taxpayer, for the period of at least 300 days in a fiscal year, and in a situation when the fiscal year is a period other than consecutive twelve calendar months – for at least 82% of days falling within the fiscal year, or
    • incurs monthly expenditures in an amount of at least three times the average monthly remuneration in the corporate sector for the payment of remuneration in favor of the employees under a contract other than a contract of employment (i.e. other civil law agreements) for at least 3 natural persons who are not the partners of the taxpayer, provided that due to the payment of the said remunerations the taxpayer must withhold advance payments for the personal income tax and social insurance contributions.

In the said period, the Customer employed 3 people under a contract on employment on a full-time basis for over 300 days in the fiscal years (both in 2020 and 2021). The calendar years equals to the fiscal year of the Company which means that the above-mentioned condition is met. The company should continue the employment of 3 employees under the rules described above for the period in which the flat rate is applied or meet the a/m condition in a different way. The monitoring of the said condition is carried out in parallel both by the Customer and MDDP Outsourcing.

  1. Conducts business activity in form of a limited liability company, a joint-stock company, a simple-joint stock company, a limited joint-stock company, where, respectively, the shareholders, stockholders or partners consist solely of natural persons without property rights related to receiving a benefit as the founder or beneficiary of a foundation, trust or another entity or a legal relationship of fiduciary nature.

Our Customer’s Company conducts business activity in form of a limited liability company with only two natural persons as the partners. The said persons do not have any property rights related to receiving a benefit as the founder or beneficiary of a foundation, trust or another entity or a legal relationship of fiduciary nature. Thus, the above-mentioned condition is met. In the upcoming years, it will be necessary to verify whether the said condition is still being fulfilled.

  1. Does not own any shares (stocks) in the capital of another company, participation units in an investment fund or an institution intended for mutual investments, all rights and obligations in a company that is not a legal person or other property rights related to receiving a benefit as the founder or beneficiary of a foundation, trust or another entity or a legal relationship of fiduciary nature.

The Company does not own shares (stocks) in other companies, participation units in an investment fund or an institution intended for mutual investments, all rights and obligations in a company that is not a legal person or other property rights related to receiving a benefit as the founder or beneficiary of a foundation, trust or another entity or a legal relationship of fiduciary nature. Thus, the above-mentioned condition is fulfilled. In the upcoming years, it will be necessary to verify whether the said condition is still being met.

  1. Does not prepare financial statements for the period of taxation with flat rate in accordance with the IAS under Art. 45 sections 1a and 1b of the Polish Accounting Act.

The Company draws up financial statements under the Polish Accounting Act. It is in line with the above-mentioned condition. Throughout the period of applied flat rate, the Company will not be able to prepare financial statements based on the IAS.

  1. Submits a notification regarding their choice of flat-tax rate according to the established template to the head of the Polish tax office by the end of the first month of the first year in which they want to be subject to flat-tax rate.

With the support of MDDP Outsourcing, the Company fulfilled its notification duty and timely prepared and filed to the tax office the notification, required by provisions of law, on selection of flat rate on income of companies.

The analysis of entities’ exemptions – continued preparations for the change of taxation form

Before making the decision on the choice of the Estonian CIT as the form of taxation, it was necessary to conduct an analysis regarding the entities’ exemptions referred to in Art. 28k of the Polish Act on CIT.

It was necessary because the flat-rate taxation does not apply to:

  1. Financial undertakings referred to in Art. 15c section 16 of the Polish Act on CIT and lending institutions pursuant to Art. 5 point 2a of the Polish Act of 12 May 2011 on consumer credit.

The Company is not a financial undertaking pursuant to the Polish Act on CIT or a lending institution in light of the Polish Act on consumer credit. Thereby, the entities’ exemption indicated in the above-mentioned provision does not apply to the Company.

  1. Taxpayers generating income on business activity conducted within the territory of Special Economic Zones or the Polish Investment Zone under an acquired decision on support.

The Customer does not generate income on business activity conducted within the territory of Special Economic Zones or the Polish Investment Zone. The entities’ exemption indicated in the above-mentioned provision does not apply to the Company.

  1. Taxpayers declared bankrupt or put into liquidation.

The Company is not declared bankrupt or put into liquidation. In the end, the above-mentioned exclusions do not apply to the Company’s situation.

  1. Taxpayers established:
    • as a result of merger or division, or
    • by legal persons, natural persons or organizational units without legal personality that contribute, in form of contributions-in-kind in favor of the taxpayer, assets acquired by such persons or entities as a result of liquidation of other taxpayers, provided that the said persons or entities held shares (stocks) in such other liquidated taxpayers, or
    • by legal persons, natural persons or organizational units without legal personality, provided that in the fiscal year in which the taxpayer was established or in the immediately following fiscal year, a previously ran undertaking, organized part of the undertaking or assets of such an undertaking with a value exceeding the equivalent in PLN of the amount of EUR 10,000 was contributed to its capital,
    • in the fiscal year, in which they started the operations or in the immediately following year, not less however than for a period of 24 months after the establishment.

The Customer’s Company was established in 2006 so in a period longer than 24 months from the planned choice of flat-rate taxation. Thus, the above-mentioned exclusion does not apply to the Company. The Company did not participate in the a/m reorganizations. When under flat-rate taxation, one needs to pay attention to the restrictions in scope of possible reorganizations.

  1. Taxpayers that:
    • were divided through spin-off, or
    • made a contribution to another entity, including contributions to the capital, in form of:
      • previously ran own undertaking, organized part of the undertaking, or assets of such an undertaking with a value exceeding the total equivalent in PLN of the amount of EUR 10,000, calculated according to the average exchange rate of EUR announced by the National Bank of Poland on the first working day of the month preceding the month in which such assets were contributed, rounded to PLN 1000. However, the value of the said components is calculated according to the provisions of Art. 14, or
      • assets acquired by the taxpayer as part of liquidation of other taxpayers, provided that the taxpayer holds shares (stocks) in such other liquidated taxpayers,
      • in the fiscal year, in which the division or the contribution was made and in the directly following fiscal year, not less however than for a period of 24 months from such a division or contribution.

In the last 24 months, the Company has not been subjected to division by spin-off and it has not made a contribution to another entity. As a result, the above-mentioned exclusion does not apply to the Company.

Bearing in mind the above, the Customer’s Company met the conditions provided for in the Polish Act on CIT for the application of flat-rate taxation. Moreover, the analyses proved that no entities’ exempts applied within the scope of flat rate indicated in the Polish Act on CIT.

Based on such a detailed verification, the Customer decided to shift to flat rate on income of companies i.e., the Estonian CIT starting from 1 January 2022.

System modifications after the implementation of Estonian CIT

The Customer’s decision on the change of form of taxation required certain modifications in the accounting records of the Customer. It was also necessary to fulfill additional settlement obligations connected with the flat rate.

So, the team of specialists of MDDP Outsourcing was obligated:

  1. As of 31 December 2021, to make a split-out in the Company’s equity by allotting:
    • the amount of distributed revenues and the amount of retained revenues that were recognized in capitals and generated in years preceding the first year of flat-rate taxation, and
    • amounts of uncovered losses that were incurred in years preceding the first year of flat-rate taxation.
  2. Carry out an initial adjustment as of 31 December 2021.

The said obligation results from Art. 7aa section 1 of the Polish Act on CIT and involves preparation of information on the income on transformation, in the amount that corresponds to the sum of surpluses of individual assets, determined for the net financial results in accordance with accounting regulations, as of the date of transformation, beyond their tax base determined for that date, along with the information on tax due.

The said information was drawn up as Attachment CIT/KW to the CIT 8 declaration for 2021.

  1. The change of rules in calculation of the advance income tax payment for 2022. Starting from 1 January 2022, the following components will be subject to flat-rate taxation at the Company:
    • income on net profit generated in the period of flat-rate taxation, in portion intended for distribution among partners or coverage of losses incurred in the period preceding the flat-rate taxation,
    • income on hidden profits,
    • income on expenses unrelated to the taxpayer’s economic activity,
    • income on revaluation of assets (in case of merger, division, transformation of entities or a contribution-in-kind made by a natural person to the undertaking or its organized part),
    • income on net profit in portion that was not divided or allocated to cover losses in the period in which the flat rate is applied – in case of a taxpayer who ended flat-rate taxation,
    • income on non-disclosed economic operations.

The modifications also needed to include the company account plan. Due to the special categories of income subject to taxation i.e., expenditures not related to economic activity or hidden profits, the Company withdrew from the use of temporary accounts dedicated to expenditures that did not constitute tax-deductible costs and they were replaced with off-balance sheet accounts corresponding to the said two special categories of income for the needs of flat rate on income of companies.

The said operation facilitates the calculation of the advance income tax payments.

In the end, the whole complicated process of change of the taxation form ended successfully. It was achieved mainly thanks to the effective preparation and in-depth analysis conducted by the Experts of MDDP Outsourcing. The new procedures had also to be reflected in the Customer’s accounting and financial systems but the necessary modifications were carried out seamlessly under the supervision of our Team. This was quite a challenge and we immediately knew that we would need to delegate additional resources for some time. Nevertheless, we are happy about the success and newly acquired experience. At the same time, we would like to thank our Customer for trusting us.

Author: Agnieszka Bojar, Accounting Department Manager at MDDP Outsourcing.