Table of contents:
- What are undistributed profits of a civil partnership?
- Are distributions from the partnership after transformation subject to taxation?
Undistributed profits of a civil partnership, which after transformation into a limited liability company are reflected in the equity of the company and subsequently distributed to partners, will not be subject to taxation. This is because the partners of the civil partnership have already paid personal income tax (PIT) on the income derived from the partnership activities in the past, proportionate to their share in the profits. The Supreme Administrative Court once again took a favorable position for taxpayers regarding the distribution of historical profits after transformation into a limited liability company – this time in a case concerning profits of a transformed civil partnership (judgment of the NSA of March 14, 2024, file no. II FSK 808/21).
What are undistributed profits of a civil partnership?
The dispute with the tax authority in the case resolved by the NSA concerned previously undistributed profits of a civil partnership that was transformed into a limited liability company. Its share capital was partially financed by undistributed profits accumulated by the partners of the civil partnership.
It should be clarified that a civil partnership itself is not subject to income tax – it is tax-transparent, meaning its partners are individually liable to pay advance income tax payments throughout the year. This implies that the partners of this civil partnership have already been taxed on the income earned from the partnership activities in the past, proportionate to their share in the partnership.
After transformation into a limited liability company, the partners of this company intended to distribute the previously undistributed profits accumulated by the civil partnership, which were reflected in the balance sheet of the limited liability company. This distribution does not entail a reduction in the number or value of shares and does not affect the right to share in the profits of the limited liability company.
Are distributions from the partnership after transformation subject to taxation?
The Director of the National Tax Information has maintained a position for several years that distributions of previously undistributed profits from a civil partnership will be subject to taxation, as it constitutes income from participation in the profits of legal entities (Article 17(1)(4) of the PIT Act). The tax authority also disregarded whether the entirety of the assets of the former civil partnership was transferred to the share capital or partially to the reserve capital, or whether it is reflected in the balance sheet of the limited liability company as profit from previous years.
The Supreme Administrative Court did not agree with this view – according to the Court, no income category subject to taxation will arise from the distribution of profits accumulated up to the date of transformation into a limited liability company. This is because it is not appropriate to equate profits already earned by a partner of a civil partnership with income of a legal entity (limited liability company). If the partners transferred profits from the civil partnership to the capital of the limited liability company, identified it in the balance sheet, and already paid income tax on it in the past, then the distribution after transformation cannot be treated as income from participation in the profits of a legal entity and taxed again.
It is worth noting that this decision aligns with the developing case law concerning the distribution of historical profits of tax-transparent entities or profits generated during sole proprietorship, which were subsequently transferred to the capital of a limited liability company. Similarly, the NSA ruled in judgments on:
- June 29, 2023 (file no. II FSK 51/21)
- August 30, 2023 (file no. II FSK 252/21)
- October 12, 2023 (file no. II FSK 327/21)
supporting the taxpayers’ position.
