It’s a perfect example of using the so-called “boiling frog syndrome” in practice. What does it mean? If you suddenly put a frog into a pot of boiling water, it will try to jump out immediately. But if you gradually increase the temperature and bring it to boil slowly, the frog will stay in place and boil alive.
The Finance Ministry’s idea to tax Poles working abroad is based on the exact same principle.
The idea itself, however, isn’t new.
Tax law experts anticipated a similar situation already in July 2018 when, by signing the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI), Poland committed itself to amending 78 bi-lateral treaties on eliminating double taxation. Poland was among the first signatories to ratify the convention.
It was the exact moment when the pot full of water was put on the stove and the knob started to turn.
Tax-relief on foreign income
Currently, when a Polish citizen earns something abroad, in most cases, the income isn’t subject to taxation (the earned amount only determines the effective tax rate necessary to calculate taxes due from income earned in Poland). Thus, if the amount of money earned in Poland equalled PLN 0, no income tax applies.
Convenient? Very much so.
It’s called the exemption with progression method, and it’s about to change now. Drastically.
The MLI Convention changes the principle used to settle taxes with all signatory countries who ratified the treaty, replacing the exemption with progression method with the less convenient credit method.
Put simply: the credit method means that income earned abroad is taxed in Poland, but the tax paid abroad is deducted from the tax due.
Where’s the problem then?
In practice, this method of avoiding double taxation makes it mandatory to pay income tax even if the taxpayer, working abroad, made no income in Poland.
Thus, tax-relief on foreign income serves as a protective mechanism against that procedure.
When a taxpayer works abroad for several months (whether under an employment contract, freelancing, or having his/her own business) and then returns to Poland for a short period of time, thanks to tax-relief on foreign income, he/she is exempt from paying an additional tax in Poland.
The Ministry of Finance had just announced its plans to abolish tax relief on foreign income, even though about 67.000 Polish citizens working abroad benefit from it every year. A draft bill is said to be introduced anytime now, and the new legislation will enter into force starting January 01, 2021.
What will be the consequences of abolishing the tax relief?
In principle, whatever the amount of money earned abroad, it will be added to the income earned in Poland. Due income tax will then be calculated based on the entire sum. Of course, under the current legislation, the income tax paid abroad can be deduced.
- Foreign income is often so small that after deducing the tax-free allowance in the country where the income is earned there is little or no taxable amount left. Thus, the income tax Polish citizens end up paying abroad is either non-existent or very small. And yet, regardless of that, once the new regulation is passed, they will still need to pay their tax in Poland" – says Przemysław Hinc, tax advisor and a member of the board member at PJH Consulting.
- In Poland, the tax-free allowance is as little as PLN 3089. Given the relatively weak Polish zloty and high exchange rates, even a relatively low foreign income (e.g. the minimum wage in the respective country where it was earned) can amount to considerable sums of money. This will then directly influence the taxable amount and the income tax due. We should also keep in mind that remembered that the 17% rate for personal income tax is paid only up to the amount of PLN 85 528 PLN. When exceeded, the tax rate jumps to 32%. - Hinc warns.
The lower the overall tax burden in the country of work, the more palpable the change. This trap can be easily illustrated in the example of the United Kingdom. There, in the fiscal year 2019/20, the tax-free allowance t was £ 12.500. Given an average exchange rate of PLN 4.90 PLN per pound, this already leaves us with PLN 61 250 PLN.
If someone working in the UK earned a little over 1000 pounds a month, that person didn’t have to pay any tax. However, in Poland, such income would already be subject to personal income tax.
- Starting this year, the agreement with the UK on avoiding double taxation (which is in many ways beneficial for Polish citizens), will be abolished and exchanged by the MLI convention. For the time being, the tax relief on foreign income is still applicable, but once it is abolished, a Polish citizen earning little in the UK will have to pay an income tax in Poland- says Hinc.
The MLI Convention already applies (from 2019 onwards) to foreign income earned in countries such as, for example, Austria and Slovenia, and it will gradually enter into force with regards to other countries too- see the table below.
So, if a country has not yet ratified the MLI, can I sleep peacefully then?
Not exactly and not always. Higher taxes, calculated according to the current tax rates in Poland, will have to be paid by all persons working in countries with which Poland had signed the treaty on double taxation using the credit method (e.g. Netherlands, Norway, Singapore, Belgium, the US).
It means that once the tax relief on foreign income is abolished, a person who earns an income in the Netherlands will have to be prepared to pay a painful tax in Poland.
Why is the Ministry of Finance trying to abolish it?
- It seems that without abolishing the tax relief on foreign income the MLI Convention completely loses its effectiveness. And since the government has been pushing to ratify the convention almost immediately after it was signed, its aim was clearly to increase the taxable amount and the tax itself. The relief stood in the way of doing that -says Hinc.
The Ministry of Finance explains that the convention is necessary because it prevents aggressive international tax optimizations schemes. So far, the regulation contained in bilateral double taxation treaties has been rather inconsistent, which only encouraged tax evasion and fraud- i.e. situations when the tax is not paid either in the place where the income is earned nor in the place of residence, in Poland.
Moreover, the Ministry explains, the tax relief on foreign income is used to establish personal partnership companies abroad and thus avoid paying taxes in Poland.
- Annually, the tax relief on foreign income costs Poland PLN 260 million. 80% of this amount concerns income earned in EU tax havens: for instance, in the Netherlands, Luxembourg, and Cyprus- the Deputy Minister of Finance, Jan Sarnowski, said in an interview with Polish Press Agency.
This raises the following question: why does the Ministry of Finance put fraudsters and regular, hard-working citizens into one bag?
The Ministry claims it acknowledges the problem and it will introduce a tax-free allowance for foreign income. Up to PLN 8.000 per year is to be settled under the old regulation.
The Ministry is also convinced that about 41.000 out of 67.000 people will fall under this bracket. The rest will have to pay more.
Should the tax relief on foreign income be abolished, tax law experts anticipate two potential scenarios:
One – to avoid paying higher taxes, many Polish citizens may choose to permanently move their center of vital interests from Poland to another country. Put simply: they’ll emigrate.
The new fiscal policy applies to Polish tax residents. If a Polish citizen resides in another country for at least 183 days in a given year, has his/her home and family there, and is linked to Poland only by a passport, that person no longer needs to pay a personal income tax in Poland and becomes subject only to the law of the new country of residence.
In that case, the person does not have to file a tax return and pay taxes to the Polish tax authorities.
And scenario number 2 – people working abroad for a couple of months a year to earn some extra money might simply decide to do it illegally. They will look for employers who can pay them under the table.
When does the MLI start to apply in Poland? A list of country-specific timelines
Taxable periods begin only after the MLI has entered into effect. Below, please find a country-specific list of timelines:
1. Austria – date of entry into force: 01.01.2019.
2. Slovenia - date of entry into force: 01.01.2019.
3. United Kingdom - date of entry into force: 01.04.2019.
4. New Zealand - date of entry into force: 01.04.2019.
5. Serbia - date of entry into force: 01.04.2019.
6. Switzerland - Pursuant to Article 35(7) subparagraph a) of the Convention, Switzerland has reserved its right to extend the date on which the Convention enters into effect until it has completed its internal with respect to the specific Covered Tax Agreement.
7. Slovakia- date of entry into force: 01.07.2019.
8. Japan - date of entry into force: 01.07.2019.
9. France - date of entry into force: 01.07.2019.
10. Israel - date of entry into force: 01.07.2019.
11. Australia - date of entry into force: 01.07.2019.
12. Lithuania - date of entry into force: 01.07.2019.
13. Malta - date of entry into force: 01.10.2019.
14. Singapore- date of entry into force: 01.10.2019.
15. Ireland - date of entry into force: 01.11.2019.
16. Finland - date of entry into force: 01.12.2019.
17. Luxembourg - date of entry into force: 01.02.2020.
18. United Arab Emirates - date of entry into force: 01.03.2020.
19. India - date of entry into force: 01.04.2020.
20. Belgium - date of entry into force: 01.04.2020.
21. Norway - date of entry into force: 01.05.2020.
22. Ukraine - date of entry into force: 01.06.2020.
23. Canada - date of entry into force: 01.06.2020.
24. Iceland - date of entry into force: 01.07.2020.
25. Denmark - date of entry into force: 01.07.2020.
26. Russia - date of entry into force: 30.11.2020.
27. Latvia - date of entry into force: 01.08.2020.
28. Qatar - date of entry into force: 01.10.2020.
29. Saudi Arabia - date of entry into force: 01.11.2020.
30. Cyprus - date of entry into force: 01.11.2020.
31. Portugal - date of entry into force: 01.12.2020.
32. Indonesia - Pursuant to Article 35(7) subparagraph a) of the Convention, Indonesia has reserved its right to extend the date on which the Convention enters into effect until it has completed its internal procedures with respect to the specific Covered Tax Agreement.
33. Czech Republic - date of entry into force: 01.03.2021.
34. South Korea - date of entry into force: 01.03.2021.
(based on information provided by the Ministry of Finance: https://www.podatki.gov.pl/podatkowa-wspolpraca-miedzynarodowa/konwencja-mli/stosowanie-mli/)
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