Is withholding tax a tax expense?

What kind of expenditure can be considered a tax-deductible expense?

A tax-deductible expense is any economically justified and reasonable expenditure related to the business activity, the primary purpose of which is to generate, secure or maintain a source of income. Assessing such an expenditure requires verification of its purposefulness, i.e. its genuine focus on generating income. For an expense to be recognised as a tax-deductible cost, there must be a causal link whereby the incurrence of the expense contributes to the generation or increase of revenue.

This means that all expenses incurred that meet the above conditions, excluding those specifically listed in the CIT/PIT Act, may constitute tax-deductible costs.

Income tax as a tax-deductible expense

As a general rule, ‘own’ income tax cannot be classified as a tax-deductible expense. It should be borne in mind, however, that withholding tax paid by a payer is not their own tax, but someone else’s tax, merely collected and remitted on behalf of a non-resident by the payer.

Method of determining the amount of withholding tax

The rules governing the collection of withholding tax stipulate that withholding tax should be deducted from the amount of remuneration due to a foreign contractor. In business practice, however, there are situations where this is not feasible, in which case the full burden of the tax falls on the payer.

In practice, there are two methods of settling withholding tax:

1. Determination of gross remuneration – the parties to the contract specify the remuneration as a gross amount. The Polish payer deducts the tax due from this amount and transfers the remainder to the foreign contractor.
2. Determination of net remuneration – the agreed amount constitutes the net remuneration, and the contract stipulates that no tax deductions are to be made from this amount. The payer is then obliged to calculate and pay the withholding tax from their own funds, which requires the benefit to be grossed up beforehand in order to correctly determine the tax base.

Gross-up clause – essence and function

A gross-up clause is a contractual provision imposing an obligation on the payer to gross up a monetary payment in a situation where withholding tax must be deducted from the remuneration amount. The purpose of the clause is to ensure that the contractor receives a net payment of the agreed amount, regardless of the tax obligations incumbent on the payer.

Grossing up remuneration – a practical example

To calculate the gross amount, the net amount due under the contract must be divided by the difference between 1 and the withholding tax rate.

For example: to gross up a net amount subject to withholding tax at a rate of 20%, the net amount must be divided by 0.8 (1 – 0.2 = 0.8).

A Polish company is obliged to pay a licence fee of PLN 30,000 net to a German company. The withholding tax rate for this type of income is 20%. The gross amount will therefore be PLN 37,500. Withholding tax is the difference between the above amounts, i.e. PLN 7,500.

Recognition of withholding tax as a tax-deductible expense

The amount of withholding tax calculated on the gross amount of the receivable and paid by the taxpayer as the withholding agent may therefore be treated as a tax-deductible expense. Such an expense is recognised as a tax-deductible expense at the time it is incurred. This approach is confirmed by the interpretative practice of the Director of the National Tax Information Service, e.g. the interpretation of 7 October 2022, ref. no.: 0111-KDIB2-1.4010.526.2022.1.BJ.

It should be noted, however, that in order to recognise withholding tax as a cost, it must be demonstrated that the expenditure was incurred for the purpose of generating revenue or maintaining or securing a source of revenue.