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The Warsaw Voice » Real Estate » January 13, 2010
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Tax Aspects of Investment Projects
January 13, 2010   
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Tax issues are among the most complicated aspects of the legal environment in investment projects. A good tax policy can unquestionably make a project more successful by reducing fiscal burdens and thus increasing the investor's profit. On the other hand, wrong decisions involving taxes can have a disastrous effect on the progress of even the best managed projects.

A number of tax dangers and opportunities emerge in the course of the investment process, and some of them are typical of construction projects. Among the most important tax-related aspects are those connected with the capitalization of expenses, financing business ventures as well as planning the accounting of losses for tax purposes. Investment operations also offer an opportunity to create more economical tax structures, one example being the "step-up" procedure, which allows the initial value of a project to be increased.

Planning tax losses is an especially important process, particularly in the case of long-term projects that generate losses in their early stages. This process protects the investor from being unable to deduct all the losses incurred during the investment period from the sales that will be generated in future tax years, and it also enables a better balancing of the amounts of income and losses in individual tax years.

Despite the seeming simplicity of the issue, substantial problems can arise in identifying the right moment at which to classify expenses incurred during a construction project as tax-deductible expenses. The choice between whether a given expense should be capitalized in the project's value or listed as a cost indirectly linked to sales can be made easier if one obtains a legally binding tax law interpretation, but even then it is possible that two different companies run by the same investor will receive two contradictory replies. It's worth noting that tax authorities are increasingly ruling that most costs indirectly linked to a project should be treated as income-generating costs and not as costs that increase the project's initial value. This applies, for example, to the costs of insuring a project, administrative fees (permits), real estate tax, perpetual usufruct fees, general administration costs of construction (organizing on-site backup facilities, utility fees and so on). In practice, this means greater tax losses during work on the project. consequently, proper tax planning takes on increased importance.

Exchange rate differences-that occur when the currency exchange rate on the day of receiving funds in a foreign currency is different from the exchange rate on the day of accounting these funds-can cause practical problems, as proved by the numerous and frequently contradictory decisions of tax authorities. The following issues can raise doubts: different rules for determining and recording exchange rate differences for bookkeeping purposes and for tax purposes; the need to apply the correct exchange rate; and the capitalization of exchange rate differences in the project's value.

The choice of a particular means of financing construction projects has a number of tax implications. Doubts arise at the moment of calculating interest on loans as a tax-deductible cost. In the case of projects financed within a given corporation, special attention needs to be paid to restrictions stemming from what is known as insufficient capitalization. According to the law on corporate income tax, such restrictions apply, for example, to the possibility of including among tax-deductible costs interest paid on loans obtained from entities that on their own or collectively hold at least 25 percent of the borrower's equity if the total debt toward the lender is more than three times higher than the value of the borrower's equity. Furthermore, affiliated companies face an increased risk of disputes with tax authorities regarding the correctness of mutual account-settling. This risk can be minimized by preparing the appropriate tax documentation for these transactions and obtaining a decision from the Ministry of Finance confirming that the method of setting prices in transactions between the affiliates is correct.

The step-up procedure in an investment process usually involves making an in-kind contribution to a newly established or existing company in the form of real estate or a project in progress, which can offer the possibility of setting the initial value of this contribution at its market value. This measure allows significantly higher tax-deductible costs to be generated without bearing them in the economic sense-whether through higher depreciation deductions on the increased value of the in-kind contribution, or by increasing the tax-deductible cost of selling the project. This option complies with the letter of the law and has been confirmed by numerous interpretations from tax authorities, though at present the Ministry of Finance's stance on the matter is changing. Step-up creates real savings, thereby increasing future investment capacity and improving the market position of the company using this measure.

Taking advantage of existing opportunities and eliminating tax risks has a tangible impact on the profitability of construction projects, which is a major consideration, especially during the ongoing economic crisis, strong market competition and the increasingly fiscally tough attitude of tax authorities. Professional tax consulting is becoming a key determinant of a successful investment process.

Honorata Green, Partner, Head of M&A Tax, KPMG Tax
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