Taxation of a partial refund of capital share to partners in a partnership
A partner in a partnership may have his contribution to the partnership partially refunded by reduction of his capital share. The regulations which are currently in force do not specify detailed rules for taxation of payments made on that account to partners. This issue has become the subject matter of numerous individual binding rulings by the Minister of Finance as well as judgments of administrative courts (including the Supreme Administrative Court).
Tax authorities present a uniform assessment as regards taxation of a payment made to a partner in a partnership in connection with reduction of his capital share. According to authorities, in such case a partner in a partnership derives tax revenue. In binding rulings different is only the position as to the source of revenue for PIT purposes to which such revenue should be classified: either revenue from property rights (individual binding ruling no. ITPB1/4511-1247/15/HD by the Director of Fiscal Chamber in Szczecin of 2 March 2016 and individual binding ruling no. IBPB-1-1/4511-58/16/SG by the Director of Fiscal Chamber in Katowice of 18 March 2016) or to revenue from business activity (individual binding ruling no. IPPB1/4511-864/16-2/KS1 by the Director of Fiscal Chamber in Warsaw of 7 September 2016 or individual binding ruling no. IBPB-1-1/4511-436/16-1/ZK by the Director of Fiscal Chamber in Katowice of 14 October 2016). According to tax authorities, tax income from reduction of a capital share in a partnership should be determined in accordance with general principles, so as the excess of received revenue over tax deductible costs, while tax deductible costs in the case of reduction of a capital share are expenses incurred for the subject matter of such contribution, so the so called “historical costs”.
The case law of administrative courts on taxation of the reduction of a capital share in a partnership is not uniform, either. At present the following decisions are presented, stating that a payment made in connection with the reduction of a capital share:
should not be subject to tax, because according to the amendment of statutory provisions on income taxes as of 2011 all payments made by partnerships to their partners during the term of a partnership are neutral from tax perspective. Taxation of such payments should be deferred until a partner leaves the partnership or the partnership is liquidated, so until a taxpayer ceases to be a partner in the partnership. Taxation of the reduction of a capital share during the term of the partnership means that the same income is taxed twice: first when a payment in connection with the reduction is received, and next when a partner leaves the partnership or the partnership is liquidated. There is no provision which would regulate the possibility to reduce any later income, if any, by the amounts paid out in connection with the reduction of a capital share (e.g. judgment of the Supreme Administrative Court of 22 May 2014 (ref.no. II FSK 1471/12), judgment of the Regional Administrative Court in Kraków of 24 August 2016 (ref. no. I SA/Kr 813/16) and of 14 June 2016 (ref. no. I SA/Kr 469/16) and of the Regional Administrative Court in Wrocław of 29 June 2016 (ref. no. I SA/Wr 253/16)).
should be taxed in the same way as when a partner leaves the partnership. Hence, income on that account should be recognised in accordance with special principles envisaged for leaving the partnership, and in such case the tax cost is the value of a contribution to the partnership on the date on which it was contributed (e.g. judgments of the Supreme Administrative Court of 30 July 2014 (ref. no. II FSK 2046/12), of 6 June 2015 (ref. no. II FSK 1072/13), of 4 September 2015 (ref. no. II FSK 1656/13));
should not be treated as partial leaving the partnership and should not be subject to tax in accordance with general principles using the costs incurred by the partner for acquiring the subject matter of his contribution to the partnership, so taking into account the so called “historical costs”).
We want to draw your attention to tax hazards which may be faced by a partner in a partnership following partial refund of his contribution. In our opinion, there are reasonable arguments to claim that refund of a part of the contribution up to the amount of the partner’s contribution should be neutral from tax perspective because the partner does not receive any financial gain on that account.