Income from abroad. How to properly account for them?
The development of remote work and the increasing mobility of workers, phenomena that accelerated during and after the pandemic period, have resulted in an increasing number of taxpayers facing obligations related to the settlement of income earned abroad (as well as the settlement of income earned in Poland by persons from abroad). Key in this context is, first of all, the correct determination of the so-called tax residency and the choice of the method of avoiding double taxation.
Over the past few years, we have seen increased mobility of employees. More and more people (mainly those employed by multinational companies) are delegated to perform their duties in foreign branches of a given company or a related entity. In addition, the pandemic has helped to revolutionize the way work is done, meaning that there are more and more cases where an employee is employed by a company based in country “A” while performing his duties – completely remotely – from country “B.”
The new cases have not yet been extensively analyzed by tax authorities or administrative courts, so if you want to apply them, it is worth looking into the potential PIT and social security implications – especially since they can sometimes be more complicated than they might seem at first glance. It is also worth analyzing the situation of those employees who are employed by the company and earn foreign income (or perform work abroad) – in the context of potential additional obligations. The deadline for their 2022 return was May 2, 2023.
First, determination of tax residency
First, when wishing to analyze the tax implications of labor mobility, it is necessary to establish the so-called tax residence, i.e. where a person lives for tax purposes. This is important because in the country of tax residency the taxpayer is obliged to tax all the income he earns (regardless of where it is earned). This does not mean that in the case of earning income abroad (which will be taxed there), there will be a need to tax it – once again – in Poland, because the provisions of the double taxation treaty with the country in question will apply (more on this in the next section).
The PIT Law (in Article 3(1a)) distinguishes two conditions upon fulfillment of which a person should be considered a Polish tax resident:
- having a center of personal or economic interest (center of vital interests) in Poland,
- physical residence in Poland for more than 183 days a year.
Importantly, in order to be recognized as a Polish tax resident, it is sufficient to meet one of the conditions indicated above.
The concept of having a center of personal or economic interest in Poland (center of vital interests) is not explicitly defined in the law. However, it has repeatedly been analyzed by tax authorities for the purpose of issuing interpretations. The factor most often taken into account in practice is the presence in Poland of a spouse, partner or minor children. Accordingly, going to another country with the entire family in most cases will result in the transfer of the center of personal interests to that country. In contrast, going to work abroad while the spouse and children remain in Poland will most often result in maintaining the center of personal interests in Poland. Sometimes, however, these basic premises are not sufficient to determine the situation of a given taxpayer – for example, in a situation where he moves to Poland with only part of his family. In the most complex situations, it is necessary to analyze all aspects of the taxpayer’s professional and personal activities.
It is worth noting that it is possible for a person to be recognized as a tax resident by both countries in which he earns income. In this case, the question of residency should be resolved on the basis of the conflict rules contained in the relevant double tax treaty.
Double taxation treaties
Once an employee’s tax residency, i.e. the country in which he is liable for tax on all his income, has been established, it is important to focus on the provisions of the double tax treaty [DTT] with the country in which the taxpayer earned income.
It is not uncommon for those in charge of accounts to think that withholding tax abroad closes the case and relieves the taxpayer of the obligations arising from earning income abroad in the country of residence. Nothing could be further from the truth. As indicated earlier, such a person is obliged to show the income earned from abroad in the annual return filed in the country of residence.
In general, most DTT assume that wages and similar remuneration are taxable only in the country of residence (tax residence), assuming, however, the exception that if the work is performed in a second country, the income may be taxed in that second country.
In practice, this means that if an employee has been seconded, for example, from a Polish company to a related German company and performs work in Germany, in a situation where part of the salary is paid by the German company, there is a basis for taxing part of the income in Germany. Their taxation in Germany will not involve the necessity of re-taxation in Poland, since DTT are intended to avoid double taxation. Nevertheless, the taxpayer will be required to show in his annual Polish tax return (country of tax residence) the income earned in Germany and indicate that it was exempted from taxation on the basis of one of the methods of avoiding double taxation (the method that should be applied in a given case follows directly from the provisions of the DTT).
The DTT provides for two methods of avoiding double taxation:
- the method of exclusion with progression – which involves determining the tax rate applicable to income earned in the country of residence by taking into account income earned abroad. Income earned abroad is not taxed in the country of residence, but affects the tax liability in the country of residence (because it affects the tax rate that is applied to income earned in the country of residence),
- the method of proportional deduction (tax credit) – thanks to the MLI Convention, currently the most widely used method – involves calculating tax in the country of residence on all income earned by the taxpayer (in the country of residence and from abroad), and then reducing the tax thus calculated by the tax paid abroad (this method is less favorable compared to the method of exclusion with progression).
It is common to combine both methods in a single DTT. This is because it is not uncommon to use the exclusion method for employment income, and the tax credit method for dividend income. Taxpayers using the tax credit method are additionally entitled to take advantage of the abatement allowance (however, taxpayers earning income from so-called tax havens cannot use it). It consists in deducting the amount constituting the difference between the tax calculated using the tax credit method and the tax calculated using the exemption method. Unfortunately, as of January 1, 2021, the abolition relief is limited to PLN 1360.
It is also worth noting the so-called “return relief” introduced under the Polish Deal, which can be used not only by Polish citizens returning to Poland, but also by foreigners who transfer their tax residence to Poland. One of the main conditions for taking advantage of it, however, is not having a tax residence in Poland for at least three years. The relief assumes exemption from taxation of income of up to PLN 85,528 per year, and is available for 4 consecutive years.
It is also worth mentioning that the PIT calculation on income does not always complete the annual settlement process. Top earners may be required to pay a solidarity levy – if their income exceeds PLN 1 million.
Individual analysis always needed
Each case of performing work abroad may involve different tax consequences due to the need to examine a number of factors, such as the personal situation of the taxpayer and the relevant provisions of the DTT, among others. Consequently, each individual case should be evaluated on a case-by-case basis.
Regardless, it is also worth noting a common mistake. This is because it happens more than once that those in charge of the accounts consider that the collection of tax abroad closes the case and relieves the taxpayer of the obligations arising from the receipt of income abroad in the country of residence. Nothing could be further from the truth. As indicated earlier, such a person is obliged to show income earned from abroad in the annual return filed in the country of residence (using the appropriate double taxation avoidance method). It is worth keeping this in mind when preparing annual tax returns for 2022.