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Application of double taxation conventions by residents and non-residents

Taxable persons earning income from abroad are faced with the obligation to tax such income correctly. In other words, they must apply the provisions of double taxation conventions.

What is double taxation? How can it be prevented, and what issues are governed by such conventions?

According to the income tax laws, taxable persons that have their place of residence or registered office in Poland are taxable in Poland on their entire income, including that earned abroad. However, such income may also be taxable in the country where it is earned. We deal with double taxation in a situation where two states levy the same or similar taxes on income or assets (capital) obtained under the same arrangements by the same taxable person in the same period.

Such phenomena are very harmful. That is why the interested states take measures that are designed to prevent their occurrence or at least mitigate their effects.

These measures are included in bilateral double taxation conventions. The rules contained in such conventions determine how to tax income or assets (capital) if a person having their place of residence or registered office in one state earns income in the other contracting state.

Pursuant to the Constitution of the Republic of Poland, international agreements become generally applicable sources of law once they are ratified and published in the Journal of Laws. Therefore, double taxation conventions concluded by Poland with more than 80 countries are applied directly in order to decide how to tax foreign income.

Double taxation conventions are usually formulated in accordance with the model developed by the Organisation for Economic Co-operation and Development (OECD). The model is known as the Model Tax Convention on Income and on Capital. Another widely accepted model of such conventions is the UN Model Double Taxation Convention between Developed and Developing Countries.

Both models have a similar structure and include similar definitions and methods for elimination of double taxation.

The interested states that intend to sign a double taxation convention are not obliged to use any of these models. As a rule, however, they do. The interested states are of course free to modify individual provisions included in the models.

Conventions entered by Poland are based on the provisions of the OECD Model Convention. The Model Convention is supplemented by the Commentary, which explains how the signatory states understand and interpret its stipulations.

Neither the OECD Model Convention nor the Commentary are the sources of law in Poland, but Poland – as a member country of the OECD – is obliged to apply the Convention and the Commentary, and the tax authorities should refer to the Commentary in both the application and interpretation of double taxation conventions in order to ensure a uniform application of the law.

Individual conventions based on the Convention are addressed to persons that have a place of residence or a registered office in one of the states, and relate to income and property taxes that are levied by both contracting states.

Double taxation conventions resolve how to tax the following categories of income and assets (capital):

- income from immovable property;
- business profits;
- profits from international transport;
- profits of associated enterprises;
- dividends;
- interest;
- royalties;
- profits from alienation of property;
- income from liberal professions;
- profits from dependent personal services;
- directors' fees and remunerations of supervisory board members;
- remuneration of artists and sportsmen;
- pensions;
- salaries of government service;
- income of students;
- other income.

In addition, individual conventions include provisions concerning methods for elimination of double taxation.

In the conventions entered by Poland, we can find two methods for elimination of double taxation:

exemption with progression and the principle of credit.

Double taxation conventions also include the provisions concerning equal treatment of citizens of both states by tax jurisdictions of such states, procedures for the exchange of information and mutual assistance of tax administrations, and specific provisions (if any).

In order to ensure a proper taxation of their foreign income, a taxable person should in the first place use a relevant convention to decide which state they are a resident of (in this state they will be subject to taxation on their entire income). Then, they should determine which taxation method is provided for by the convention in respect of their income. In a situation where the convention specifies that the income in question may be taxed both in the country of residence (registered office), and in the country where the income was earned (the source country), then to the taxation of such income in the country of residence one should use an appropriate method for elimination of double taxation. To the income which, in accordance with the convention, is subject to taxation in Poland, one should apply the provisions of Income Tax Acts.

The oldest and still effective double taxation conventions were signed by Poland back in the 1970s. For many years, the conventions have only applied to a handful of people. Poland's accession to the European Union and opening up of foreign labour markets have transformed the conventions into truly universal legal acts the knowledge and appropriate application of which becomes simply essential.

Rules for determining tax residence

Place of residence

Double taxation conventions do not contain own definitions of the place of residence.

According to the conventions, the term “resident of a contracting state” means any person who, under the laws of that state, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature. So, if for example Polish regulations recognize that a person has a place of residence in Poland, then on the basis of a double taxation convention, the person will be considered to be a person who lives in Poland.

Determination of the place of residence should therefore start from reviewing Polish regulations that govern this issue.

Pursuant to Article 3 para. 1a of the Personal Income Tax Act:

“A person having their place of residence in the territory of the Republic of Poland is understood as an individual who:

1) has their centre of personal or economic interests (centre of vital interests) in the territory of the Republic of Poland, or
2) stays in the territory of the Republic of Poland for more than 183 days in a tax year”.

Even if only one of these conditions is satisfied, it will mean that an individual will be considered a Polish resident in accordance with the Polish legal regulations.

The first of these conditions refers to the “centre of vital interests”, which consists of a centre of personal or economic interests. The conjunction “or” in this provision means that it is sufficient to have at least one of such centres in Poland to be considered a person living in Poland.

Example:

John goes to work in the Netherlands. Ha rents a flat there, opens a bank account, and stays in the country for more than 183 days in a year. He even joins a trade union in his Dutch plant. He has no assets in Poland.

So one could say that he has moved the centre of his economic interests to the Netherlands. However, John's wife and children stay in Poland and live in his parents' house. Therefore, John's centre of personal interests is still in Poland.

Consequently, he will be subject to the unlimited tax obligation in Poland. When his family leaves Poland to join him in the Netherlands, it will be possible to conclude that John's centre of vital interests is located in the Netherlands.

John's transfer of his personal interests to another country will be primarily proven by the fact that he lives with his family in that country. Other personal relations, such as: friends, hobbies, cultural or other activities are certainly not as tight as family relations. The transfer of economic interests is testified in the first place by the fact that a taxable person earns most of (and preferably the entire) income in a new country.

The second condition contained in the regulation provides that a person has their place of residence in Poland if they stay in the country for more than 183 days in a tax year. We should note here that it does not have to be an uninterrupted stay. In order to determine whether a taxable person is subject to the unlimited tax obligation in Poland, we have to count the days of their stay in the country.

In real life, it often happens that two states recognise a taxable person as a resident of their territory.

Example:

A Czech is delegated by his employer to work in Poland for a year.

Once his stay in Poland exceeds 183 days in a given tax year, he will become a person having a place of residence in Poland.

Most likely, however, the Czech legislation will consider him a resident in the Czech Republic.

This situation is a “residence conflict” – that is a case where two states consider the taxable person is their resident. Pursuant to double taxation conventions, an individual may have a place of residence in one state only, and can be subject to the tax obligation on their entire income in one state only too. Therefore, any “residence conflict” should be resolved in line with the provisions of double taxation conventions.

Resolving the issue of the place of residence on the basis of double taxation conventions

If, within the meaning of the applicable provisions of both contracting states, a person has a place of residence in both states, then their place of residence is determined in line with the following principles, as set out in double taxation conventions:

a) a person shall be deemed to be a resident only of the contracting state in which he has a permanent home available to him; if he has a permanent home available to him in both contracting states, he shall be deemed to be a resident only of the state with which his personal and economic relations are closer (centre of vital interests);
b) if the state in which he has their centre of vital interests cannot be determined, or if he has not a permanent home available to him in either state, he shall be deemed to be a resident only of the state in which he has a habitual abode;
c) if he has a habitual abode in both contracting states or in neither of them, he shall be deemed to be a resident only of the state of which he is a national;
d) if he is a national of both contracting states or of neither of them, the competent authorities of the contracting states shall settle the question by mutual agreement.

The above criteria should be applied in the order specified above, that is, if one is unable to resolve a given issue according to a), one should move to b) and so on.

The first criterion that is used to resolve which country is a taxable person's place of residence is a permanent home. According to the Commentary to the OECD Model Convention, a permanent home is understood as a 'hearth and home', i.e. the place where a taxable person's family and personal life is concentrated. It does not matter whether a taxable person has a legal title to that place.

If a person has a permanent home in both contracting states (for example, they have two permanent homes and stay in each of them for part of the year), then the right of residence is granted to that country with which the personal and economic relations of the taxable person are closer, this being understood as the centre of vital interests. The concept of a centre of vital interests, which can be found in double taxation conventions, should be interpreted in the same way as it is interpreted pursuant to the PIT Act. It is therefore necessary to examine with which of the two countries the taxable person is bound with stronger personal and economic relations. A place of residence of the taxable person's immediate family (spouse, children) is of primary importance here.

Where a taxable person has no permanent home in any of the states concerned, and it is impossible to determine in which state they have a centre of vital interests (because they have personal and economic relations with both states), they shall be deemed a resident of the country in which they have a habitual abode.

By a “habitual abode” we mean staying in one state for longer than in the other one. If it cannot be resolved in which country a taxable person has a habitual abode (because they stay in both states or in neither of them), then the person shall be considered a resident of the country of which they are a national. Thus, citizenship is only a third-grade criterion in determining the place of residence.

If, however, this condition does not result in the final determination either (because a taxable person is a national of both states concerned or neither of them), then the taxable person's place of residence would have to be decided by the authorities of both states by mutual agreement.

In most cases, it is possible to determine the place of residence on the basis of the “centre of vital interests” criterion.

Registered office (permanent establishment)

According to the OECD Model Convention, the term “a person having their permanent establishment in a contracting state” means a person that, under the laws of that state is subject to the tax obligation in that state because it is their place of management or based on any other criterion of a similar nature.

If a person other than an individual has a permanent establishment in two contracting states, then it is believed that they are a resident of the contracting state in which it has a place of effective management.

The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the enterprise's business are made. The place of effective management will usually be the place where a person or group of persons holding the top functions (such as the board of directors) takes official decisions.

The Commentary to the OECD Model Convention recognizes that no exact standard can be specified on this subject, but all relevant facts and circumstances must be examined to determine the place of effective management.

An entity may have more than one place of management, but it can have only one place of effective management at any one time.

Tax certificate of residence

Pursuant to the above provisions, a taxable person's residence (i.e. the place of residence or registered office) is therefore determined by the facts rather than fulfilment or non-fulfilment of some formal requirements (for instance the mere fact of having the permanent registered address in Poland does not suffice to prove that the person has the place of residence in Poland).

However, in some cases, a taxable person may need an official confirmation of their residence. Then, at the taxable person's request, tax authorities issue a certificate stating the place of residence (registered office), known as a tax residence certificate.

According to the definition specified in the Income Tax Act, a tax certificate of residence is a certificate stating a taxable person's place of residence for tax purposes, issued by a competent tax authority in the taxable person's state of residence.

Issuance of a tax certificate of residence by the Polish tax authorities is regulated by Article 306l of the Tax Code, according to which a tax authority, at the request of a taxable person, issues a certificate stating their place of residence or registered office for tax purposes within the territory of the Republic of Poland.

Polish legislation does not indicate formal requirements to be met by a foreign tax certificate of residence, or state what information should be included in the certificate. However, a certificate should be a document issued by the tax authorities of the country concerned, confirming that the person has a place of residence in that country and is taxable on their entire income in that country.

It happens that Polish tax regulations require that income of non-residents should be taxed in a different way than provided for by a double taxation convention.

In such cases, it will be possible to apply the provisions of the convention and not of the act (e.g. by a taxpayer collecting a tax or tax advance), if a non-resident submits a tax residence certificate issued by the other state.

Taxation of selected sources of revenue in accordance with double taxation conventions

Dividends

According to the OECD Model Convention, dividends paid by a company which is a resident of a contracting state to a resident of the other contracting state may be taxed in that other state.

However, such dividends may also be taxed in the contracting state of which the company paying the dividends is a resident and according to the laws of that state, but if the beneficial owner of the dividends is a resident of the other contracting state, the tax so charged shall not exceed:

- 5% of the gross amount of the dividends if the beneficial owner is a company (other than a partnership) which holds directly at least 25% of the capital of the company paying the dividends;
- 15% of the gross amount of the dividends in all other cases.

So the regulations allow for taxation of dividends in both states. Double taxation is eliminated in such a way that a taxable person may deduct the tax paid in the source country from the tax due in the state of residence.

Royalties

Royalties arising in a contracting state and beneficially owned by a resident of the other contracting state shall be taxable only in that other state.

The term “royalties” means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films or tapes for the radio or TV, any patent, trade mark, design or model, plan, secret formula or process, as well as for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience.

Income from dependent personal services

In accordance with the provisions of double taxation conventions, salaries, wages and other similar remuneration derived by a person having their place of residence in Poland in respect of dependent personal services shall be taxable only in Poland, unless such independent personal services are rendered in the other state. If such services are so rendered, such remuneration may be taxed in that other state.

This principle means that remunerations are generally subject to the tax in the country where the services are rendered. Conventions also allow for taxation of labour income in the state of residence, but in this case, an appropriate method for elimination of double taxation should be employed.

Of course, every rule has an exception, and so has this one.

Remuneration derived by a resident of Poland in respect of dependent personal services rendered in the other state shall be taxable only in Poland, if all three conditions are satisfied:

a) the employee is present in the other state for a period or periods not exceeding in the aggregate 183 days in any 12-month period commencing or ending in the fiscal year concerned;
b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other state;
c) the remuneration is not borne by a permanent establishment which the employer has in the other state.

If the above conditions are satisfied, then the remuneration of an employee working abroad will still be taxable in Poland, so no double taxation will occur. If one or more of the above conditions is not met, the employee's remuneration will be taxable in the country in which they render services.

a) Remuneration will be subject to the tax abroad, if the period of work exceeds 183 days:

In most cases related to posting of employees to work abroad, the place of taxation for remunerations will be determined based on the employee's period of stay abroad.

Example:

Henry is employed at a Polish construction company. Starting from 1 April 2012, he is posted to work at a construction site in Estonia. During the period of secondment his remuneration is paid by the company in Poland. He comes back to Poland on 1 August 2012, and starting from 1 March 2013 he is posted again to Estonia where he works until 31 August 2013.

As a result, in the 12-month period between 1 April 2012 and 31 March 2013, his stay in Estonia was 153 days (i.e. it has not exceeded 183 days), but during the 12-month period calculated backwards from the date of return, i.e. from 31 August 2013 to 1 September 2012, his stay in Estonia was 184 days.

A double taxation convention signed with Estonia provides that a remuneration shall be taxable in Estonia, if an employee stays in Estonia for a period or periods exceeding in the aggregate 183 days in any 12-month period commencing or ending in a given tax year. Therefore, for the period of work between 1 March 2013 and 31 August 2013, the employee will be subject to the tax in Estonia.

The Commentary to the OECD Model Convention provides a simple method to determine the length of the employee's stay in the other country. So, in order to determine the number of days of stay in the other country, one should count “days of physical presence”, as the employee is either present in a given country or not. We must therefore take into account the following elements: part of a day, day of arrival, day of departure, and all other days spent inside the state (weekends, holidays, days of sickness, etc.).

b) Remuneration is paid by, or on behalf of, an employer who is not a resident of the other state:

Remuneration of an employee posted to work abroad may be taxable in that country regardless of the employee's length of stay. Such a situation will occur where the employee's departure to work at a foreign counterparty will involve a change of the employer.

It should therefore be noted that since the term “employer” is not defined in the Convention, it is understood that the employer is a person having the right to conduct the work and bearing the associated risk and responsibility.

In case of international labour lease, these functions are largely performed by the user of the workforce. Therefore, when employees are leased, we may deal with the change of the employer within the meaning of double taxation conventions.

c) The remuneration is not borne by a permanent establishment which the employer has in the other state:

If a company has a foreign permanent establishment or a fixed place of business through which it conducts an important part of its business activity abroad, then the establishment becomes an entity that is subject to taxation in the country in which it is located. A permanent establishment may be a factory, an office, a branch or a construction site (provided that it exists for more than 12 months).

Since an establishment becomes the entity that is subject to taxation in a given country, in order to determine the establishment's income, we take into account the revenue that is generated by the establishment and the expenditure that is incurred by the establishment (or by the headquarters for the establishment's account). Thus, remunerations of employees working at the establishment will undoubtedly be the establishment's expenditure (even if the remuneration is paid by the headquarters and not the establishment).

At the same time, remunerations will be taxable in the state where the establishment is located. Of course, the mere fact of having an establishment in a given state does not mean that every employee who works in that state performs work for that establishment.

Example:

A Polish company has a factory in the Czech Republic, which produces sub-assemblies. Remunerations of employees employed in the factory are naturally subject to the tax in the Czech Republic. But the remuneration of an employee who have been seconded from Poland to a contractor in the Czech Republic for a period of 4 months in order to train local employees will be subject to taxation in Poland.

Remuneration of sailors

Remuneration in respect of an employment exercised aboard a ship or aircraft operated in international traffic, or aboard a boat engaged in inland waterways transport may be taxed in the state in which the place of effective management of the enterprise is situated.

Liberal professions (professional services) and other independent personal services

Pursuant to double taxation conventions, the term “liberal profession” (“professional services”) includes especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists and accountants.

Income derived by a person having their place of residence in Poland form a liberal profession (professional services) or any other independent activities is taxable only in Poland, unless that person usually has a permanent establishment in the other country for the exercise of their activities. If they have such permanent establishment, then their income may be taxed in that country, but only to the extent to which it may be attributable to that permanent establishment.

Taxation of income of members of corporate decision-making bodies

Directors' fees and other similar payments derived by a resident of a contracting state receives in his capacity as member of the board of directors or supervisory board of a company which is a resident of the other contracting state may be taxed in that other state (Article 16 of the OECD Model Convention).

In accordance with the above regulation, income in respect of a supervisory or managerial function in a company having their registered office in a given state will be taxed in that state (the source country).

If a person, apart from holding an executive position, performs other services for the company, for example, on the basis of a contract of employment, and receives remuneration for such services, then the above-mentioned rules will apply to that portion of remuneration that is paid for the provision of supervisory or managerial services.

Rules governing taxation of enterprise income

Profits of an enterprise of a contracting state shall be taxable only in that state unless the enterprise carries on business in the other contracting state through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits that are attributable to the permanent establishment may be taxed in that other state.

As we have already said, a permanent establishment is a fixed place of business through which an enterprise conducts a business activity in the other state. If a company has a permanent establishment, one should determine (on the market basis) the amount of the establishment's profits and tax them in the country in which the permanent establishment is situated.

Methods for elimination of double taxation

Where a resident of Poland derives income which may be taxed abroad (such as income from employment in a foreign company), then we deal with double taxation: such income is taxable abroad, while the person who has earned it, is taxable in Poland. As I have already mentioned at the beginning of the lesson, double taxation is a very harmful phenomenon. That is why the interested states take measures that are designed to prevent its occurrence. These measures are included in bilateral double taxation conventions.

In double taxation conventions that have been concluded by Poland, we deal in principle with two methods for elimination of double taxation: exemption with progression and the principle of credit.

Exemption with the progression method

This method for elimination of double taxation is provided for in the majority of conventions concluded with European countries, including: Albania, Croatia, Cyprus, Czech Republic, Estonia, France, Germany, Greece, Italy, Latvia, Lithuania, Portugal, Romania, Slovakia, Slovenia, Sweden, Turkey and the UK.

If this method is used, it means that foreign income is tax-exempt in Poland.

However, in order to determine the tax rate on the remaining income – i.e. the income earned in Poland – one applies the tax rate that is appropriate for the entire income, i.e. including the income earned abroad.

Example

Let us assume that a taxable person in 2012 earns income in Germany in the amount of 79,000 PLN (converted into PLN) and in Poland in the amount of 40,000 PLN (we do not take into account the social security (ZUS) and health contribution).

To the taxable income (i.e. that earned in Poland), we apply the percentage rate that would be applicable if the German income was not tax-exempt.

We calculate the rate as follows:

1. We calculate the tax on taxable and exempt income:

40,000 PLN + 79,000 PLN = 119,000 PLN,

(119,000 PLN – 85,528 PLN) x 32% + 14,839.02 PLN = 25,550.06 PLN;

2. We divide the tax by the sum total of income and multiply the result by 100:

25,550.06 PLN / 119,000 PLN x 100 = 21.47%

(we round the rate to two decimal places);

3. We apply the calculated percentage to the taxable income:

40,000 PLN x 21.47% = 8588 PLN

So the tax will be 8588 PLN.

Credit method principle

This method is provided for in conventions concluded, among others, with: Belgium, Kazakhstan, the Netherlands and Russia.

If this method is used, it means that foreign income is taxable in Poland, but the tax paid abroad is deducted from the tax due. However, this deduction must not exceed the amount of the tax chargeable in proportion to the income earned abroad.

Example:

Let us assume that a taxable person in 2012 earns the same income as in the previous example, except that in a different country: in the Netherlands in the amount of 79,000 PLN and in Poland in the amount of 40,000 PLN (we do not take into account the social security (ZUS) and health contribution). We assume that the tax paid abroad amounted to 7907 PLN.

So the total (Polish and Dutch) taxable income will be 119,000 PLN.

1. We calculate the tax on the total income:

40,000 PLN + 79,000 PLN = 119,000 PLN,

(119,000 PLN - 85,528 PLN) x 32% + 14,839.02 PLN = 25,550.06 PLN;

2. We deduct the tax paid abroad from the tax. However, this deduction must not exceed that part of the tax that is chargeable in proportion to the income earned in the Netherlands. Income earned in the Netherlands (79,000 PLN) represents 66.39% of the taxable income, so we can deduct a maximum amount of:

25,550.06 PLN x 66.39% = 16,962.68 PLN;

3. Since the tax paid in the Netherlands amounted to 7907 PLN, we can deduct it in full:

25,550.06 PLN – 7907 PLN = 17,643.06 PLN.

Consequently, the tax due in Poland (rounded off to the nearest whole zloty) amounts to 17,643 PLN.

Summary

Double taxation conventions are aimed at resolving issues that may arise in the case of overlap of tax regulations of two states. The fact that income is earned abroad does not mean that it will not attract the attention of the Polish tax authorities, yet owing to a relevant double taxation convention we will not have to pay the tax twice on the same income.

Tax scale for personal income tax

 

Income up to 85 528,00zl – 18% minus the tax reduing amount 556zl 02gr

 

Income above 85 528,00 zł - 14 839 zł 02 gr + 32% surplus over 85 528 zł

 

Minimum employee wage 2015r.

 

1 750,00 zł

 

Important deadlines

 

On the 15th day of each month – immovable property tax payment by legal persons

 

On the 20th day of each month – income tax advance payment by employers and their employees, income tax advance payment by legal persons

 

On the 25th day of each month – VAT declaration submittal, VAT payment

 

On the 30th of each April – annual income tax return submittal, tax payment