Do family foundations evade paying taxes?

FAMILY FUND MANAGEMENT POLSKA

11 September 2024

The draft amendments to the Family Foundation Act have not yet been published, but the motivations and scope of the changes under consideration, as reported in the press, are worrying.

First and foremost, the argument is being raised that family foundations are created for the purpose of tax avoidance. In principle, a family foundation is required to pay tax within the specified time limit, i.e. at the time of payment of benefits, the foundation pays CIT at a rate of 15% of the tax base, and in addition, beneficiaries are required to pay PIT according to the scale, in accordance with their tax status (0%, 10% or 15% of the tax base). Furthermore, in the case of activities not included in the list of activities specified in the Act (Article 5), the family foundation should pay CIT at a rate of 25% of the tax base. At the same time, the family foundation is not able to reduce the tax base by the costs of obtaining income, as the tax base is the benefits paid out.

Therefore, family foundations that carry out transactions involving their assets, e.g. in the case of the sale of shares or stocks in a company, do not tax the income from the sale and do not settle the costs of obtaining income. However, the benefits paid are taxed. CIT is charged to the family foundation and PIT is charged to the beneficiaries. Taxpayers belonging to the group of entities subject to a zero rate benefit from a special exemption. This group includes: the founder, his or her spouse, ascendants (parents, stepfather, stepmother of the founder), descendants (child, stepchild of the founder) and siblings. It should be added that these are the same persons who have been granted tax relief on donations and inheritances under the law on inheritance and donations.

Therefore, we are not dealing with tax avoidance or non-payment of taxes by family foundations, but rather a kind of ‘deferral’. A family foundation is obliged to pay taxes within the time limit specified in the Act.

It should be emphasised that the terminology used in the public sphere, not only among administrative bodies, but also among legal, tax, accounting and business advisors, is inappropriate. It wrongly causes a negative attitude towards existing legal solutions. Proper terminology is important because incorrect terminology creates inappropriate connotations. And so, according to press reports, the application of the provisions of the Act by family foundations has begun to arouse negative feelings, expressed by terms ranging from ‘tax reduction’ and ‘tax avoidance’ to ‘tax fraud’.

However, the application of legal provisions allowing for the payment of tax in the amount and within the time limit specified by law should not be referred to as ‘avoidance’ or “exploitation” or ‘aggressive exploitation’ of tax regulations.

The same applies to the use of the term ‘prohibited activities’ in relation to activities not listed in the Family Foundation Act (Article 5 of the Act). Such activities are not prohibited by law. They are taxed at a higher rate, i.e. 25% of the tax base (Article 19 of the CIT Act). Therefore, they are permitted, but they are subject to a higher tax, which can be called a penalty tax, because that is its nature. The inclusion in the regulations of the obligation to pay a higher tax effectively discourages entrepreneurs from undertaking activities within the framework of a family foundation that are not listed in Article 5 of the Act.

However, if a family foundation were to undertake an activity not listed in the statutory catalogue, that activity would be valid and effective in the eyes of the law. The regulations do not provide for sanctions for the failure to maintain such an activity in business transactions. However, the legislator has, in a sense, ‘priced’ the penalty, stipulating that 25% tax must be paid to the State Treasury in such cases. Every founder who establishes a family foundation agrees to this kind of ‘contract’ and either refrains from undertaking certain activities or pays tax that is disadvantageous to the family foundation.

It should be emphasised that when legal provisions are applied in accordance with their wording, there can be no question of ‘bad intentions’ on the part of taxpayers. There are specific grounds in law, including under the current tax regulations, on the basis of which it can be determined whether a taxpayer's actions lead to ‘tax avoidance’. Each specific case of tax evasion or avoidance should be subject to decisive sanctions. However, the use of general, negative terms is not only unfair to those who act in accordance with the law, but also, more importantly, undermines the already fragile trust of citizens in the stability of the law and, thus, in the creation of a vehicle – a family foundation.

A family foundation is a vehicle. Just like other legal vehicles: capital companies, partnerships and even business activities. There were various reasons for introducing this particular solution. One of the important ones was (and if it was not, it certainly should have been) the desire to keep assets in Poland and prevent them from being transferred to other tax jurisdictions. This was to ensure that entrepreneurs in Poland would accumulate assets in the long term, pay taxes or cover other expenses related to the operational functioning of their assets. It is no secret that Polish entrepreneurs have long been practising the protection of family assets using foreign legal structures: Swiss, Luxembourgish, Cypriot, Maltese and others. From a business point of view, placing assets in foreign structures always carries a certain risk. Most often, this risk is related to, for example, the effective and rapid transfer of funds to Polish structures, the obligation to involve persons and institutions from a foreign legal regime in the decision-making process, or exposure to possible enforcement of the law by foreign authorities or courts. However, they decided to do so because, until recently, Polish regulations did not offer solutions ensuring succession and protection of the integrity of assets. Foreign regulations provided this possibility for Polish assets, while domestic regulations did not offer similar solutions. Wouldn't it be good for the largest assets to remain in Poland? Yes, it would. Shouldn't we try to bring them back to Poland or at least prevent further outflows? We should. It seems that this was the idea behind the Family Foundation Act, which came into force in May 2023. The Act was well written, but even then there were concerns that it would not survive, that it would be amended in such a way that its purpose would cease to be important, that there would soon be numerous changes and that we would ‘throw the baby out with the bathwater’.

It should be noted that there are people with large and very large fortunes who are holding off on setting up family foundations in Poland. They are waiting for the regulations to ‘settle down’. They suspect that changes may soon be made that will undermine the goal of building stable succession structures in Poland. Entrepreneurs value predictability and the ability to plan for the long term. They are reluctant to adapt solutions that carry risk, and our domestic legal solutions, especially in the area of tax regulations, are unfortunately subject to frequent changes, preventing such planning. The Family Foundation Act is just over a year old and has already been amended once.

One may wonder whether all the amendments, both those that have been made and those that have been proposed, are legally permissible at all. The legislator explicitly stated in the Act that the Council of Ministers should review the functioning of the provisions of the Act and submit to the Sejm and Senate information on the effects of its implementation, together with proposals for amendments, three years after its entry into force. Therefore, the first amendments will only be made after the review and only in May 2026 (Article 143 of the Act). This provision is in force and has not been amended or repealed.

Building stable family assets in Poland by enabling the creation of family foundations in our legal system seems to be a necessity. Compared to similar solutions available in other countries, such as Germany or Austria, which already have over 100 years of practice in this area, we have some catching up to do in this matter. Legislation allowing the establishment of family foundations is also present in many other countries, including Malta, Switzerland, Liechtenstein, Luxembourg, and, relatively recently, Hungary. Denmark is a particularly interesting jurisdiction. Most Danish family assets are managed in the form of family foundations.

Poland should not deviate from regulatory standards in Europe. Entrepreneurs should be encouraged to such an extent that it is not profitable to transfer assets outside Poland. Regulations should actively attract these assets to Poland, which is very difficult today. Founders already have structures in place abroad, transferred assets, defined and systematised relationships with beneficiaries, and experience in operation. I would like to emphasise that an important, though probably not the only, reason for organising assets outside Poland is , among other things, tax breaks (not abuses!). Polish legislators should offer regulations that are attractive and, above all, stable enough to ensure that founders do not leave, but rather return with their assets to Poland.

To achieve this, it is necessary to think beyond the level of the 2,000 foundations currently registered. The largest assets are probably already abroad. At the moment, family foundations with smaller and medium-sized assets are being established in Poland. Let us give them a chance to grow. In Poland.

These reflections arose after press reports: ‘I do not understand why wealthy individuals who are beneficiaries of family foundations should enjoy tax preferences that go far beyond the spirit of the law on family foundations,’ said the deputy minister. "Even the originators of family foundations admit that the tax regulations in this area have gone too far. We have examples from tax advisory websites that encourage the creation of foundations as a method of reducing taxes. There are already opinions that nearly half of the foundations created were established solely for the purpose of tax avoidance. We also have reports from the National Tax Administration that some foundations are being used for very aggressive tax optimisation," he added. According to Neneman, this requires urgent intervention by the legislator. And, as he emphasised, this intervention is necessary ‘primarily for the good of family foundations, so that they do not get labelled as vehicles for aggressive tax optimisation and are not associated with tax fraud.’