One of the consequences of the pandemic and the resulting economic crisis may be the need for some taxpayers to discontinue projects. Do the Polish tax regulations allow for settlement of expenses incurred for discontinued projects under the CIT Act? Will the taxpayer have to make an adjustment of input VAT on expenses incurred in the course of work on such projects?
Definition of a project
Pursuant to the Corporate Income Tax Act of 15 February 1992, projects (inwestycje) are defined as fixed assets under construction within the meaning of the Accounting Act of 29 September 1994. The Accounting Act, in turn, states that fixed assets under construction are classified as fixed assets during the period of their construction or assembly, or improvement of an existing fixed asset. Thus, a project is a certain economic effort to create or increase the taxpayer’s fixed assets. The catalogue of projects can be very broad, depending on the type of activity conducted by the taxpayer.
Project expenditures as a tax-deductible cost
According to the general rule, tax-deductible costs are costs incurred to earn revenue from a source of income or to maintain or secure a source of income. A consequence of this principle is the necessity for taxpayers to assess and qualify each expenditure. An exception is when the CIT Act expressly indicates that a certain cost belongs to the category of tax-deductible costs or excludes the possibility of deducting it. This means that for the legal classification of a given cost, the purpose for which it was incurred is relevant. An expense will be treated as a tax-deductible cost if there is a causal link between its incurrence and creation, increase or possibility of income. The burden of proof on the existence of such a causal link lies with the taxpayer.
Pursuant to the CIT Act, project expenditures are not expressly included in tax-deductible costs at the time they are incurred, but increase the value of the ongoing project. Thus, this affects the future initial value of the fixed asset created upon completion of the project. In principle, these expenses will become deductible costs through depreciation write-offs made from the initial value of the generated fixed asset.
Discontinuation of project due to COVID-19 pandemic
Undoubtedly, it may happen that a taxpayer carrying out a project will not be able to complete it as planned and thus there will be no fixed asset generated from which it will be able to make depreciation write-offs. Many taxpayers whose activities have been affected by the COVID-19 pandemic and who will be forced to discontinue ongoing projects may face such a situation. However, they do not need to look for beneficial solutions in newly passed laws, i.e. the successive versions of the Anti-Crisis Shield. Art. 15(4f) of the CIT Act, in force for years, provides that if a project is discontinued, costs related to it are deductible on the date of disposal or liquidation of the project.
As indicated in the legal literature, discontinuation of a project results from permanent cessation of project tasks due to the lack of subsequent project activities, arising from the taxpayer’s decision to refrain from continuing the project (P. Małecki & M. Mazurkiewicz, CIT: Commentary—Taxes and accounting (Lex, 10th ed. 2019)).
There is no indication of the cause of discontinuation; therefore, it should be assumed that nothing stands in the way of acknowledging that permanent discontinuation of a project caused by the COVID-19 pandemic entitles the taxpayer to recognise expenses incurred on the project. At the same time, according to the wording of the provision, a condition which will have to be met is the sale or liquidation of the project.
What does “liquidation of a project” mean?
While “disposal of a project” does not seem to be a controversial and difficult term to decode, “liquidation of a project” may raise some doubts. In the absence of a legal definition of this term, its common meaning and interpretation by the tax authorities and administrative courts should be considered.
It is accepted that the liquidation of a discontinued project must be of a permanent nature, which should result from relevant documents, such as a report or decision of the company’s management board or shareholders’ meeting. A discontinued project cannot be considered liquidated when the taxpayer has indeed decided to discontinue the project but the project is still carried in the taxpayer’s books (individual interpretation by the director of National Treasury Information of 26 October 2018, ref. 0114-KDIP2-3.4010.231.2018.1.MC). As stated by the Supreme Administrative Court, when analysing the essence of liquidation as an economic process, it should be regarded as an irreversible and permanent action, and a condition for recognising these expenditures as tax costs is that the effect of expenditures incurred on the discontinued project cannot be used in the future. The definitive nature of the decision to discontinue the project, which is a condition for the possibility of recognising the expenses incurred for its execution as tax-deductible costs, means that none of its elements can be used in any other way in other activities of the taxpayer (Supreme Administrative Court judgment of 13 December 2017, case no. II FSK 3046/15).
Therefore, taxpayers who have discontinued a project in connection with the COVID-19 pandemic should be aware that if the discontinuation is only temporary and the project will continue later, Art. 15(4f) of the CIT Act will not apply.
Deduction of VAT on goods and services acquired in connection with discontinued project
Unlike the CIT Act, the VAT Act of 11 March 2004 contains no definition of a project or specific regulation on discontinuation of projects. Therefore, doubts concerning the taxpayer’s right to deduct input tax on goods and services acquired in connection with a project that has not been completed should be resolved under general principles.
Art. 86(1) of the VAT Act indicates that a taxpayer has the right to deduct input tax to the extent that the purchased goods and services are used to perform VAT-taxed activities. Therefore, a condition for the right of deduction is a close link between an expenditure on goods and services and performance of activities subject to VAT. Unfortunately, the VAT Act does not specify whether the taxpayer retains the right to deduct input tax even if the project has not been completed and therefore no VAT-taxable activities have been carried out using the project.
In this context, the definition of a taxpayer under the VAT Act is relevant. It indicates that a taxpayer is an entity performing its own business activity, regardless of the purpose or result of the activity. Therefore, it is not necessary for the business activity to bring the taxpayer any positive results or benefits generating an increase in the taxpayer’s business income.
Right to deduct VAT under CJEU case law
The issue of the right to deduct input tax in the event of discontinuance of a project has been the subject of judgments by the Court of Justice of the European Union, which in C-110/94, Intercommunale voor Zeewaterontzilting (INZO), and C-110/98, Gabalfrisa SL, pointed out that even the first project expenses incurred for the purpose and with the intention of setting up operations must be regarded as business activity. The court held that for business activity to be considered as initiated only when the project began to generate taxable income would conflict with the principle of neutrality. Otherwise, according to the CJEU, the taxpayer would carry the burden of VAT in the course of its business, and an arbitrary distinction would be created between expenditures incurred before actual use of the project and expenditures incurred during the use of the project.
In C-37/95, Ghent Coal Terminal NV, the Court of Justice held that a taxpayer is entitled to deduct input tax on the purchase of goods and services in connection with a project which will be used in VAT-taxable activities, and stressed that the taxpayer does not lose the right to deduction in cases where, for reasons beyond the taxpayer’s control, the purchased goods and services are never used to conduct business subject to VAT.
As a result, in light of the CJEU case law, it should be assumed that if the project was discontinued for reasons beyond the taxpayer’s control, the taxpayer does not lose the right to deduct input VAT on goods and services acquired in connection with the discontinued project, and therefore is not obliged to make input tax adjustments. Undoubtedly the COVID-19 pandemic should be regarded as a cause beyond the taxpayer’s control. Therefore, it must be concluded that if an entity discontinues a project in connection with the pandemic, it will not be obliged to make an adjustment to input VAT.
The tax authorities’ position
The Polish tax authorities also indicate that if the decision to discontinue the project is due to circumstances beyond the taxpayer’s control, the taxpayer retains the right to deduct input tax on goods and services acquired in connection with the unrealised project. In their view, a change in the project conditions or the economic situation over a certain period should be treated as an external circumstance, objectively independent of the taxpayer’s will. In such a situation, abandonment of a project is caused by circumstances for which the taxpayer is not responsible. Random events not attributable to the taxpayer preventing the project from being completed or rendering it unfeasible should also be considered a reason independent of the taxpayer.
On the other hand, the tax authorities indicate that the taxpayer loses the right to deduct input tax in a situation where it could have foreseen that the project would not be completed due to the high economic risk associated with the project. This approach was adopted by the director of the Warsaw Tax Chamber in an individual interpretation of 8 March 2016 (ref. IPPP2/4512-1272/15-4/MJ), holding that when a project was started because a customer declared that it would increase its orders, but the project was discontinued because the customer withdrew from the indicated orders, that is a reason the taxpayer could have foreseen when planning the project and analysing the economic risk associated with the project. As a result, the tax authority denied the taxpayer’s right to deduct input tax, as it considered that the project was not discontinued due to reasons beyond the taxpayer’s control.
For these reasons, retaining the right to deduct input tax on goods and services acquired in connection with a project discontinued due to the COVID-19 pandemic should not raise doubts. It can be firmly stated that the pandemic is an event caused by external factors beyond the taxpayer’s will and control—a random, nonculpable event the taxpayer could not have foreseen.
Sandra Derdoń, tax adviser, Mateusz Rowiński, Tax practice, Wardyński & Partners