Classification of an income tax exemption as state aid entails a number of consequences extending far beyond tax issues.
Where to locate an investment is usually determined by weighing numerous factors, and one factor that can play a major role is state aid. This explains the huge popularity of Poland’s special economic zones. SEZs offer advantages including an exemption from income tax on operations in the zone. But the consequences of treating an income tax exemption as a form of state aid extend far beyond tax issues alone.
State aid to businesses operating in zones
State aid to businesses operating in SEZs is regarded as a permissible form of “regional aid,” intended to encourage the economic development of regions where living standards are unusually low, or regions where there is a serious shortage of jobs.
Income tax exemption
State aid to businesses operating in SEZs in the form of an exemption from income tax is granted on the basis of the Special Economic Zones Act of 20 October 1994, pursuant to a permit to operate in one of the zones.
Under Art. 12 of the SEZ Act, income earned on economic activity conducted in the territory of the zone pursuant to an SEZ permit by legal or natural persons is exempt from income tax. Regional aid in the form of tax exemptions may be received for the costs of a new investment or creation of new jobs.
Forms of regional aid other than income tax exemption
In addition to exemption from income tax, businesses in special economic zones may also benefit from other forms of regional state aid, specifically exemption from:
- Real estate tax, under Art. 7(3) of the Act on Local Taxes and Fees, on the basis of a resolution of the commune council
- Betterment levies, pursuant to the Real Estate Administration Act of 21 August 1997
- Fees for removal of land from agricultural production, pursuant to the Act on Protection of Agricultural and Forest Land of 3 February 1995.
Limits on state aid
Classification of aid received by businesses in SEZs as state aid has far-reaching consequences, because it requires them to comply with numerous regulations concerning state aid, in particular rules limiting the available state aid. For example:
- These rules disqualify from state aid expenses incurred in connection with commencement of the investment process prior to obtaining a zone permit. Because regional aid is supposed to provide an incentive to invest, if the recipient begins the investment process before obtaining a permit, it does not qualify for an award of state aid. Beginning the investment process is understood to mean more specifically the purchase of machinery and equipment, conclusion of an investment agreement, or hiring employees.
- The executive regulation on the rules applicable to businesses operating in SEZs contains a fixed list of expenditures that may constitute qualified costs, which are the basis for determining the available pool of public aid. It also specifies the conditions that must be met for a given expenditure to be regarded as a qualified cost. This has to do for example with retaining ownership of assets, maintaining the investment after project completion, and in the case of large businesses, a requirement that the fixed assets qualifying for aid are new.
- The rules limit the pool of available state aid for investments in SEZs. Generally the expenditures that may be regarded as qualified costs are totalled and this value then provides the basis for calculating the available pool of state aid. Then these costs are discounted to present value as of the date of obtaining the SEZ permit. This value for qualified costs is then adjusted using a percentage factor for the maximum intensity of aid for the given region. During the period from 1 July 2014 through 31 December 2020, the intensity factors provided by the Regulation of the Council of Ministers of 30 June 2014 on Establishment of the Regional Aid Map for 2014–2020 range from 15% in Warsaw (10% from 1 January 2018) to 50% in the provinces of Warmia-Mazuria, Podlasie, Lublin and Podkarpacie. Moreover, aid to small enterprises is increased by 20 percentage points and medium-sized enterprises by 10 pp. (This does not apply to enterprises operating in the transport sector.)
Inspection after inspection
Aid granted by the state to investors in special economic zones must be monitored and audited. Oversight of the operations conducted in an SEZ may be exercised in several areas. This makes the scope of inspections and the set of authorities entitled to conduct them much broader than in the case of businesses not operating in an SEZ.
The subject matter of inspections of SEZ businesses includes more specifically:
- Oversight of the correct use of state aid awarded in the form of tax exemptions (conducted by the tax authorities and tax audit offices)
- Monitoring of performance of the conditions of the zone permit. Under Art. 18 of the SEZ Act, this authority rests with the Minister of Economy, but in practice it is delegated to the operator of each zone. Under Art. 19(3) of the SEZ Act, a permit may be withdrawn by the Minister of Economy if the business has ceased to operate in the zone, has grossly violated the conditions set forth in the permit (e.g. by failing to invest the minimum amount of money, create or maintain the minimum number of jobs, or complete the investment project on time), or has failed to cure irregularities found during the course of an inspection under Art. 18 of the act within the time specified by the Minister of Economy.
Moreover, under §5(2) of the Regulation of 10 December 2008 on state aid to businesses operating under an SEZ permit, a business in an SEZ is required to:
- Maintain ownership of the assets. Businesses enjoying an SEZ exemption are required to maintain ownership of the assets connected with the investment expenditures for 5 years (in the case of large enterprises) or 3 years (for SMEs) from the date they are entered in the books as fixed assets. This does not apply to instances where it is necessary to replace obsolete items as a result of rapid advancement of technology.
- Maintain the investment. Businesses enjoying an SEZ exemption are required to maintain the investment for which they received the permit in the given region for a period of 5 years (large enterprises) or 3 years (SMEs) following completion of the investment project.
Under Art. 17(5) of the Corporate Income Tax Act, if a permit to operate in an SEZ is withdrawn, the taxpayer loses the right to the tax exemption and is required to pay income tax for the entire period of use of the exemption (except for withdrawal of a permit issued before 1 January 2011, in which case the holder is required to pay income tax only for the period after the circumstances arose that were the grounds for withdrawal of the permit). Therefore withdrawal of a permit to operate in a special economic zone could mean that the business must reclassify income earned within the previous 5 years (based on the general statute of limitations on tax obligations) from tax-exempt income to taxable income. In this case, however, the tax obligation does not become time-barred because the obligation with respect to the previously tax-exempt income does not arise until the permit is withdrawn, and thus the 5-year statute of limitations under Art. 70 of the Tax Ordinance begins to run when the permit is withdrawn.
In addition, the European Commission monitors compliance of the aid with the rules of the internal market. If the Commission suspects that the aid awarded to a business is unlawful or is not being used for its intended purpose, it may inspect the beneficiary directly. If the Commission finds that the state aid is not being used for its intended purpose, it may take any necessary measures to reclaim the aid from the beneficiary. The Commission’s authority to claw back state aid is subject to a 10-year statute of limitations, starting from the date the aid was awarded to the beneficiary.
An investor in an SEZ must therefore operate under the risk of possibly having to refund the state aid under EU regulations governing improperly awarded state aid.
And who decides?
The dispersal of oversight and decisional competencies across various authorities may cause practical problems, for example in determining the authority ultimately responsible for interpreting the permit to operate in the zone.
Because state aid to businesses operating in SEZs takes the form of an exemption from income tax, many of them have applied to the Minister of Finance for an individual interpretation of tax law concerning their own tax calculations, the scope of the exemption and the specific conditions. But these conditions are set forth in a permit issued by the Minister of Economy, who has the power to amend or withdraw the permit.
Consequently, an individual tax law interpretation issued under the authority of the Minister of Finance may not offer much protection in practice. This is because if the Minister of Economy withdraws the SEZ permit held by the taxpayer, this changes the state of facts presented by the taxpayer in its application for an individual interpretation, and an individual interpretation is binding only with respect to the facts presented by the applicant, and not under any other state of facts.
It is therefore in the interest of businesses operating in special economic zones to consult decisions they plan to take with the authorities responsible for issuance and withdrawal of SEZ permits.
Joanna Prokurat, Tax Practice and State Aid Practice, Wardyński & Partners