The government’s draft bill provides for granting corporate income tax (hereinafter also referred to as CIT) status to limited partnerships and, in certain cases, to general partnerships. According to representatives of the Ministry of Finance, this draft is intended to civilise and simplify Polish tax law in the area of corporate income tax. These changes are announced as beneficial, but will the taxation of entities whose income was previously taxed at the level of their partners, and not the company itself, lead to the ‘extinction’ of limited partnerships?

Limited partnership

A limited partnership is one of the partnerships in the Polish legal system, the purpose of which is to run a business under its own name. It is not a legal person, but an organisational unit without legal personality, to which the law grants legal capacity, which means that it can sue, be sued, incur liabilities, acquire ownership of property and rights, etc. A limited partnership differs from a general partnership in the characteristics of its partners. At least one of the partners in a limited partnership must be a general partner and at least one must be a limited partner. For readers who are not lawyers, it should be noted that a general partner is a partner who is liable with all their assets if enforcement against the company proves ineffective, while a limited partner is liable to a certain limited extent, known as the limited partnership sum.

As a brief description of the concept, I would also like to touch upon historical issues. The origins of limited partnerships date back to medieval times. In the 11th century, accomanditaria agreements were concluded in Italy. Wealthy landowners and rich merchants operating on land entrusted their funds to sea merchants, who operated the entrusted capital during their voyages. Upon their return from their voyages, they settled accounts with the persons who had entrusted their assets to them. This agreement became so popular that over time it was also used in land-based trade. This is how limited partnerships were created, in which one partner contributed their assets to the partnership but remained inactive, while the other partner contributed primarily ideas, activity and management skills.

As indicated at the outset, currently in the Polish legal system, limited partnerships do not have the status of an income tax payer, because this status is held by its partners, and it is they who pay tax on the partnership’s profits. The partnership’s profits are distributed in varying proportions among all partners, depending on the content of the partnership agreement. It should be noted that it is not possible to completely deprive a partner of their right to profit in the company, which results from Article 51 § 1 in conjunction with Article 103 of the Commercial Companies Code, but it is permissible to exempt a partner from sharing in losses. A limited partnership therefore has the advantage that its profits are not subject to double taxation. This is a significant advantage compared to capital companies. The second advantage of a limited partnership is that its partners do not have unlimited liability in a situation where the general partner is, for example, a limited liability company. It is only important that the management board of the limited liability company, which is the general partner, remembers to file a petition for bankruptcy at the right time, obtain a decision to open restructuring proceedings or a decision to approve an arrangement, or announce in the Court and Economic Monitor the opening of simplified proceedings for the approval of an arrangement, as a result of which the arrangement was approved, or the opening of rehabilitation proceedings or the filing of a simplified petition for bankruptcy. (see K. Wojciechowski, Commentary on the judgment of the Supreme Administrative Court of 5 December 2018, II FSK 1686, Review of Tax Case Law, Vol. 5, pp. 371-377 and Article 25 of the Act on subsidies for bank loans granted to entrepreneurs affected by the effects of COVID-19 and simplified proceedings for the approval of an arrangement in connection with COVID-19). In other words, it is entirely possible and permissible under the law that the partners of a limited partnership will not be liable for its obligations. Probably, such a construction by the legislator seemed too favourable to entrepreneurs and therefore, apart from the obvious desire to increase tax revenues, it decided to grant a limited partnership the status of a corporate income tax payer, even though it is not a legal person.

Limited partnership as a corporate income tax payer

Moving on to the crux of the matter, it should be noted that the government’s draft stipulates in Article 1(3)(1) that the provisions of the Corporate Income Tax Act will also apply to limited partnerships having their registered office or management in the territory of the Republic of Poland. Furthermore, point 1a of the aforementioned provision stipulates that the Act also applies to general partnerships with their management or registered office in the territory of the Republic of Poland, if their partners are not exclusively natural persons. Nevertheless, even such general partnerships may acquire the status of a corporate income tax payer [hereinafter referred to as a CIT payer] if they meet the reporting and information requirements specified in the Act before the beginning of each financial year.

Returning, however, to limited partnerships, it should be noted that they will therefore pay corporate income tax on the level of profit achieved by the partnership itself, and then the partners will pay income tax. The income tax rate is 19% or 9%. Limited partnerships will be subject to the provisions of Article 4a(10) of the Corporate Income Tax Act, i.e. the regulation on small taxpayers (Article 2(3) of the draft).

Different situation of general partners and limited partners

A general partner (legal or natural person) will be able to reduce their income tax on dividends received from the profit of a limited partnership by the tax paid by that partnership. This means that, as a rule, the general partner’s profit will continue to be taxed once. However, it may happen that a general partner of a limited partnership, which is a limited liability company, has the status of a small taxpayer, as the value of goods or services sold does not exceed EUR 2,000,000 million in the financial year, and therefore it will pay 9% CIT. On the other hand, a limited partnership in which this limited liability company is a general partner may no longer have the status of a small taxpayer, as it has exceeded the statutory threshold of EUR 2,000,000 million. In this case, the limited partnership will pay 19% income tax, while the limited liability company will not pay any tax at all, but the limited partnership will pay twice as much as the limited liability company, and this example illustrates the scale of the financial consequences of the changes introduced.

With regard to limited partners, the Act stipulates that 50% of the income earned by a limited partner from participation in the profits of a limited partnership having its registered office or management in the Republic of Poland is exempt from income tax, but not more than PLN 60,000 of such income earned in a tax year, separately from participation in the profits of each such limited partnership in which the taxpayer is a limited partner. Therefore, limited partners will unfortunately not benefit from the same exemption as general partners. The exemption from taxation of limited partners’ dividends is only partial and additionally limited in amount, as the limited partner will only benefit from this ‘partial exemption from dividend taxation’ up to PLN 60,000 in a tax year. It is assumed that the effective taxation of limited partners (assuming that they are natural persons) will be approximately 22.5%.

The draft further indicates that this exemption does not apply in the following situations:

The exemption referred to in paragraph 4e does not apply to a limited partner of a limited partnership having its registered office or management board in the Republic of Poland who:

1. directly or indirectly holds at least 5% of the shares in a company with legal personality or a capital company in organisation which is a general partner in that limited partnership, or
2. is a member of the management board of: a) a company with legal personality or a capital company in organisation which is a general partner in that limited partnership, or b) a company which directly or indirectly holds at least 5% of the shares in a company with legal personality or a capital company in organisation which is a general partner in that limited partnership, or
3. is a related entity within the meaning of Article 11a(1)(4) to a member of the management board or a partner in a company holding directly or indirectly at least 5% of shares in a company with legal personality or a capital company in organisation which is a general partner in that limited partnership.

It can therefore be noted that in many cases, revenues in currently popular family limited partnerships and limited liability companies, in which the limited partners and members of the management board of the limited liability company being the general partner of that limited partnership are the same persons, will be double taxed.

How to solve the problem of double taxation

Double taxation of income in a limited partnership can be limited, among other things, by establishing a limited liability company as a partner that will meet the requirements of a small taxpayer under Article 4a(10) of the CIT Act. After adjusting the partnership agreement in such a way that most of the profit goes to the general partner, i.e. the limited liability company, we may be dealing with a single taxation of income at a rate of 9%. However, if the limited partnership does not have the status of a small taxpayer, the effective tax rate will reach as much as approximately 19%.

Another idea is to transform the limited partnership into a limited liability company. This will undoubtedly be the safest solution in terms of liability. Although a limited liability company will not immediately have the status of a small taxpayer, this will be possible after two incomplete tax years if, for example, we decide to partially divide our business. However, if we transform a limited partnership that meets the criteria of a small taxpayer into a limited liability company, the income tax rate for it will be 9% (Article 19(1a)(1)(2) of the CIT Act).

Another solution, which seems simpler but slightly less secure in terms of liability for obligations, is to transform a limited partnership into a general partnership. A limited liability company may remain a partner in a general partnership so that part of the profit generated by the company is taxed at 9%. In order to maintain a lower tax rate, a second limited liability company may additionally join as a partner in the general partnership. The remaining partners may, but do not have to be, natural persons with as small a share in the profit as possible.

Another option may be to transform a limited partnership, in which we have assets in the form of real estate or significant valuable fixed assets (e.g. machinery), into a general partnership, in which the partners will be limited partners of the general partnership. A limited liability company that was a general partner in a limited partnership may be dissolved, remain a partner in a general partnership, or transfer all rights and obligations in the limited partnership to one of the partners. It may be reasonable to establish a new limited liability company, without assets but with significant share capital. The limited liability company will take on the main burden of the business, and the general partnership or the partners of that company who are natural persons will lease or rent its fixed assets (movable and immovable).

The latter proposal may be of interest to new entrepreneurs who intended to set up a limited partnership (sp. z o.o.), but have now withdrawn from this idea. A sole trader can, at almost no cost, remove from the fixed asset register individual significant assets necessary to conduct business, and then make these assets available on the basis of lease and rental agreements to a newly established limited liability company, which will be used to conduct the most important and largest part of their business. In this way, by using lump sums and the small taxpayer institution, we can obtain an effective income tax rate of around 9-11% with no liability, as it is the company that will de facto conduct business activity using fixed assets owned by another entity.

Summary

It is difficult to agree with the Ministry of Finance’s position that the proposed changes are in fact beneficial to taxpayers, as these changes directly increase the level of public burdens on limited partnerships.

Subsequent changes in regulations force restructuring and tax advisors and legal counsels to advise and create increasingly secure and, above all, more tax-efficient forms of business activity for entrepreneurs. Although all of the above proposals are of a ‘hybrid’ nature, they are not difficult to implement in practice. They only require appropriate adjustment of the legal aspects of conducting business in legally permitted forms and reliable bookkeeping.

Many entrepreneurs are currently concerned about the future of limited partnerships, but as I have shown above, sometimes a simple amendment to the partnership agreement is enough to significantly reduce double taxation. Nevertheless, there will undoubtedly be situations in which a change in the form of business will bring many more benefits, including tax benefits. However, in such operations, it is important to remember that they should not be carried out solely for the purpose of obtaining tax benefits, as the anti-tax avoidance clause in Article 119a of the Tax Ordinance, known as GAAR, is increasingly being applied by tax authorities. Therefore, any changes should be made in a manner that is permitted and legally justified, with the involvement of practitioners.