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Companies and wealthy individuals in Poland are scrambling to reallocate assets after the Polish government abruptly imposed corporate income tax on closed-end mutual funds investing in tax-transparent partnerships late last year.
In December, some 8.3 billion zloty ($2 billion) left Poland’s non-retail investment funds, which are largely made up of closed-end mutual funds—one of the largest capital outflows in the 25-year history of the country’s capital markets, according to Michal Duniec, chief executive officer and director of the analysis and fund research department of Analizy Online, a Warsaw-based think tank that monitors and analyzes Poland’s capital market.
And this may just be “the beginning of possible turbulence in the non-retail segment of the market as you are not able to close the structures in a couple of weeks of one month,” he told Bloomberg BNA in a Jan. 16 telephone interview. “We are not able to estimate anything, but we can say that this is not the last picture. It can be the beginning of closing not all of funds, but of those that are not profitable for non-retail investors.”
Closed-end mutual funds were originally conceived as passive investment vehicles. But companies and wealthy individuals in Poland quickly realized that they can use the funds’ corporate income tax-exempt status for optimization purposes, particularly as tax-transparent partnerships made it possible to bring virtually any type of business activity under the funds’ management.
Late last year, the Polish government decided to crack down on the practice, believing it deprives the state budget of as much as 2.5 billion zloty ($610 million) in annual income. But the abruptness of the move—it was proposed by a group of parliamentary deputies with only two months left in the year and no advance notice—rattled the investor community.
“It was a total surprise,” Marta Pabianska, a senior manager and tax adviser with PwC Poland in Warsaw, told Bloomberg BNA in a Jan. 16 telephone interview. “The changes were presented on Oct. 31, 2016, and nobody expected those changes. There were not even rumors of a plan to change the taxation of the funds.”
“Investors had no time to prepare for the change, there was no vacatio legis,” she added, referring to a period of time between a law’s formal enactment and the law’s effective date. “So this all made for a not very good climate, and I think this resulted in a quick evaporation of assets from the funds.”
And although the original proposal to treat all closed-end mutual funds as regular corporations for the purposes of corporate income tax was subsequently watered down to only taxing revenue streams related to tax-transparent partnerships, it has left few options for those with assets in the funds.
According to Pabianska, one option is for investors to restructure portfolios to bring all assets under the direct ownership of funds, which guarantees a continued exemption from corporate income tax.
“If the fund holds the property directly, the fund retains the exemption, and all income generated by the fund from real estate, from leases and from sales is tax-exempt,” Pabianska said, speaking specifically of the real estate sector, where the use of closed-end mutual funds is popular among investors.
The problem is that “provisions of the investment law are very strict, and it’s not easy to hold assets directly by the fund, in fact it’s very difficult,” she added. “There are regulations on leveraging of the funds, the fund cannot freely invest into assets that are mortgaged, and the investment law also provides strict diversification rules, which in practice means that a fund cannot invest in a single or very few assets.”
Another option is for investors to shift assets to a different jurisdiction, which, however, means that the government will miss out on its stated goal, that of bringing in more tax revenue, according to Duniec of Analizy Online.
“Instead of Polish optimization, they will just change to Luxembourg or Maltese funds because they are wealthy and they will always look for some kind of tax optimization,” he said. “And because the funds [in Poland] will be closed, there will be no profit for the budget.”
A third option, at least when it comes to real estate investments, is to wait for Poland to adopt legislation that will make it possible for investors to invest via real estate investment trusts. But that is still at least a year away, Pabianska said.
Under the new regime, which was passed by the Polish parliament late last year and came into force Jan. 1, closed-end mutual funds will be taxed at the corporate income tax rate of 19 percent only on revenue streams that relate to tax-transparent partnerships.
These streams include:
Open-end mutual funds retain a full tax-exempt status.
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