Settlement of tax losses after a merger by takeover | In Principle

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Settlement of tax losses after a merger by takeover

Under current regulations in Poland, in post-merger accounting, tax losses of the acquired company cannot be recognised. However, it is possible to settle tax losses of the acquiring company, although this is not always the rule. In determining whether the acquiring company is entitled to settle tax losses, it is necessary to assess whether the company’s actual principal business after the takeover is wholly or partially different from that before the takeover. What, in essence, is covered by the notion of “actual principal business”? When should the principal business be considered to have changed “in part”?

The regulation and its purpose

Under the provisions in effect since 1 January 2021, in determining taxable income under the Polish Corporate Income Tax Act, the losses of a taxpayer which has acquired another entity are not taken into account when as a result of the acquisition:

  • The taxpayer’s actual principal business after the takeover is different, in whole or part, from the taxpayer’s actual principal business before the takeover, or
  • At least 25% of the taxpayer’s shares belong to an entity or entities that did not hold shares in the taxpayer as of the end of the tax year in which the taxpayer incurred the loss.

The purpose of this provision was to curb tax optimisation in which taxpayers used another entity’s tax losses to reduce their own tax liabilities. As pointed out in the explanatory memorandum to the bill introducing this provision, the pre-2021 rule allowing a taxpayer to recognise losses it had incurred itself may have been abused by various types of restructuring operations aimed at recognising the taxpayer’s loss against the income earned by another undertaking. In particular, a loss-making entity with no prospect of generating income in subsequent years, against which it could apply its accumulated tax losses, could acquire another (profitable) company only to reduce its taxable income by the value of past losses incurred by the acquirer.

The drafters also gave an example of a profitable company, X, a manufacturer of specialised medical equipment. To reduce its tax liabilities, the shareholders of X acquire the shares of Y, a company manufacturing agricultural machinery, which has incurred significant losses in the previous years but does not promise to generate income in the future. Subsequently, Y acquires X, changes its name to the former name of X, and formally it is now Y—operating under X’s name—that is the manufacturer of specialised medical equipment (it no longer produces agricultural machinery). As a result of this “restructuring,” the income generated from manufacturing medical equipment is then reduced in Y by the tax losses incurred in the previous 5 years by Y when it manufactured agricultural machinery.

Is an analysis always necessary?

This example shows clearly the type of restructuring where the drafters sought to exclude the acquiring company’s right to settle tax losses. But not all mergers resemble this example in the relevant aspects. Taxpayers conduct mergers for a variety of reasons, and their aim is not always to unjustifiably settle tax losses. Regardless of the reasons for the merger, if the acquiring company has any tax losses it wants to claim, these provisions should be analysed in detail.

Actual principal business

The first condition excluding the right to recognise losses of the acquiring company is a change, in whole or part, in the principal business actually carried out by the acquiring company. The benchmark for examining whether a change has occurred is the actual principal business conducted before the takeover.

The CIT Act does not provide a legal definition of the notion of the “taxpayer’s actual principal business,” but it seems reasonable to assume that this should be understood consistent with the taxpayer’s de facto business, i.e. first and foremost taking into account the scope of the business in fact conducted by the taxpayer. The predominant activity stated in the commercial register should play only a supporting role in this regard.

Simply adopting the predominant activity disclosed in the commercial register would be inappropriate, since the parliament did not directly use this approach, but instead used the previously undefined notion of “principal business.” Thus this should be regarded as a freestanding concept, and the scope of the business actually performed should be taken into account, not just that disclosed in the register.

Partial change of business

For the taxpayer’s (acquiring company’s) right to settle losses to be effectively limited, the taxpayer’s actual principal business must change, wholly or partly, from its principal business before the takeover.

For a total change, this provision does not seem controversial. A change in the entire scope of the taxpayer’s actual principal business is relatively easy to identify.

But it is problematic to define what it means for the taxpayer to change its actual principal business “in part.” Will even the slightest difference require exclusion of the tax losses?

Again, since there are no relevant legal definitions, when determining the taxpayer’s actual principal business, we could refer to financial data and assume that if most of a company’s revenue (more than 50%) is generated from a certain type of business, then that would be considered its principal business.

Thus, if after the takeover of another company and the start of a new, additional activity in a different area, the revenue from the new activity accounts for, say, 10% of the company’s total revenue, and the revenue from the continuing activity accounts for 90%, it seems fair to conclude that there has not been even a partial change in the actual principal business conducted by the taxpayer. It can be argued that in this case the new activity is only a sideline.

The problem is in drawing the line. If the acquirer’s principal activity is continued on the same scale as before the merger and the revenue from the new, additional activity account for some 10% (or less), the claim of no partial change in the core activity should, in principle, be justified. But what if the revenue from the new, additional activity makes up 15% or 20% of total revenue? Can the taxpayer continue to claim that it is a sideline? What if the taxpayer’s core activity is conducted in two or more areas, and the newly added activity generates about 10% of its revenue—is that also significant?

There is certainly no simple answer to these and other such questions in the provisions. Each of these situations requires a separate analysis. It may also be helpful to apply for a tax ruling. Based on the practice of the tax authorities known to us, the authorities are inclined to favour the view that not every change in a company’s business after a merger is a change limiting the acquiring company’s right to settle tax losses.

Change of shareholder

The second condition which results in exclusion of the right to recognise losses of the acquirer is a change in its ownership structure. This involves a situation where at least 25% of the shares of the acquirer are held by an entity or entities that did not hold the shares as of the end of the tax year when the acquirer suffered a given loss.

In this case, the problem is not to decode the meaning of the provision, as it does not raise any particular doubts. The problem may be in applying this provision to downstream mergers, i.e. where a subsidiary acquires its own shareholder (shareholders of the target receive shares in the acquirer, i.e. the subsidiary). Thus, in most cases where this type of reorganisation is carried out, there will be a change in the ownership structure that precludes the possibility of settling the acquiring company’s tax losses.

Certainly not every downstream merger is performed solely for the purpose of tax optimisation and taking advantage of accumulated losses, but under the current law in Poland, any downstream merger precludes the possibility for the acquiring company to settle such losses. It does not seem acceptable to automatically apply this rule to all downstream mergers, in light of the purpose of the regulation, which was to limit abusive tax optimisation measures. After all, some downstream mergers are conducted for legitimate commercial reasons.

In the tax rulings known to us, the tax authority has rejected the position that the exclusion of losses should not apply when a downstream merger is performed for legitimate economic reasons because this would discriminate against downstream mergers. Nor did the authority uphold the position that in a downstream merger, when the existing shareholders are replaced by shareholders of the company being acquired who indirectly held 100% of the shares of the acquiring company, the exclusion to settle the tax losses should not apply.


When preparing for a reorganisation in which the acquiring company has unutilised tax losses, it is worthwhile to make a detailed analysis and consider applying for a tax ruling. With provisions that raise so many questions, failure to secure the taxpayer’s position in the form of a tax ruling runs the risk of later denial of the acquiring company’s right to recognise tax losses.

Sandra Derdoń, adwokat, tax adviser, Tax practice, Wardyński & Partners

Jakub Macek, attorney-at-law, tax adviser, Tax practice, Wardyński & Partners