Press cuttings - Polish Court Opinion Threatens Financial Sustainability of Foundations by the editors of SEAL
06.03.2001
On November 20, 2000 the Supreme Adminsitrative Court (NSA) of Poland issued a landmark ruling that threatens to adversely affect foundations and the wider Third Sector in Poland. Although not yet a binding decision, the case goes to the heart of the survival and self-sustainability of foundations, in particular the building of endowments, by taxing investments in securities. It also promises to test how well Polish foundations can respond, organise, and act together to advocate for legal reform.
The Case
The case concerns the taxation of investments made in the 1990s by the Foundation for Polish Science, a member of the European Foundation Centre (EFC). Under current law, the income of taxpayers whose statutory goals are of a publicly beneficial nature (e.g. scientific, educational, cultural, environmental, charitable, healthcare) is exempt from taxation, specifically that part of their income which is destined for these goals. Unfortunately, for twelve years the provisions of this law (and similar provisions in previous versions of this law) have allowed for a contradictory interpretation.
The Foundation for Polish Science (FNP) used a large part of its income to invest in short-term financial securities (mainly state and treasury bonds, and quoted stocks) in order to secure the best return on its capital and therefore income to be earmarked for its statutory goals. The Foundation believed that these investments, being income destined for future expenditure on publicly beneficial statutory goals, were consistent with the law and accordingly exempt from taxation.
The tax authorities, however, took a different view. In 1998 the office for tax inspection carried out an audit of the FNP focusing on the years 1995-1997. As a result of this audit, it presented the FNP with a tax bill amounting to 80 million zloty (some 20 million euros) in back taxes and penalty interest for the years mentioned. (The interest rates charged are much higher than market rates.) The tax inspectors applied a different, narrower interpretation of the law, whereby expenditures on short-term securities cannot be deemed to be expenditures on statutory activities, and are therefore subject to tax. According to them, the only tax-exempt form of investments available to a foundation are fixed-term bank deposits. The decision of the tax inspectors was upheld by the Tax Revenue Chamber, a tribunal of first instance.
The FNP challenged the decision of the Chamber, filing a complaint with the Supreme Administrative Court (NSA). The Foundation argued that its expenditures were indeed for the ultimate purpose of achieving its statutory goals, and that the law specifically indicates that there is no time limit within which expenditures on statutory goals must take place. Moreover, the law does not distinguish between fixed-term bank deposits and short-term securities. The Foundation's position was supported by the government's own Legislative Centre as well as a number of leading experts.
FNP: Financial Background
It is instructive to look at the 80 million zloty tax bill against the financial background of the FNP. The foundation was set up in 1991 for the purpose of supporting Polish science with start-up capital of 95 million zloty taken from part of the liquidated state Fund for the Development of Science and Technology. Since that time, it has received no support whatsoever from the state. Through its wise management of investments, the FNP was able to build up assets totalling 300 million zloty. Between 1991 and 2000, it gave grants totalling 170 million zloty, primarily to help Polish scientists at all stages, with stipends, travel grants, research grants, and prizes for notable scientific work. It also financed the purchase of equipment and the development of libraries. The FNP's annual grantmaking is in the vicinity of 24 million zloty (about 6 million euros). The tax bill is clearly substantial when compared to the FNP's assets and budget.
The Ruling
The NSA's ruling, which came more than a year after the FNP went to court, in fact, dealt with two questions:
- First, does statutory activity, eligible for tax exemptions, have to be conducted directly by a foundation, or does it also encompass financial support for institutions conducting such activities? In other words, does the Foundation for Polish Science have to conduct research itself or can it support others who do this?
- Second, should income invested in securities, and destined ultimately for the support of statutory goals, be tax-exempt?
Officially the court ruling was an advisory judgement, which will be followed in 2001 by a binding decision. However, for all practical purposes this judgement is final since it is very unlikely that the binding decision will differ from it. The judgement applies not only to the FNP but all organisations mentioned in the current law who as part of their work engage in public benefit activity.
The Effects
What will be the effects of this court ruling? Five main effects can be anticipated:
- To begin with, the FNP's income will be greatly reduced, requiring it to sharply cut back on its grantmaking activities. Funds placed in fixed-term bank accounts may be able to cover inflation, but cannot really bring any profit. The FNP's assets have already shrunk for the first time since 1991. According to FNP President Maciej Grabski, the prohibition against investment in securities will force foundations to behave in an uneconomical, wasteful way, spending their income immediately and directly for statutory goals, rather than investing and multiplying it for the future. Grabski believes that as it uses up its accumulated resources, there is a distinct possibility that his foundation may face liquidation in the not so distant future. Simply put, if it ceases to invest in profit-bearing securities, the foundation will soon be without funds for its statutory goals.
- The many scientific institutions that the FNP supports will also be hard hit.
- The ruling affects not only the FNP and its grantees, but also a whole range of other foundations, organisations, and associations that seek to manage their financial resources in an economically rational manner in order to carry out their statutory activities on a long-term basis. The overall effect will be to reduce the resources available for public benefit activities in Poland. Larger organisations may survive even after paying back five years of back taxes but many smaller ones could collapse.
- The court ruling will hinder the establishment of new philanthropic organisations which gather funds for long-term support of publicly beneficial local initiatives in small towns and the countryside.
- Large foreign funders foundations will be discouraged from making grants to Polish NGOs fearing possible unfavourable tax consequences.
What can be done now to deal with this situation? 1) The FNP could appeal to the Supreme Court or even the Constitutional Tribunal, and if they uphold the NSA, the European Court of Justice remains the last resort. 2) Another option is to ask the Ministry of Finance for a one-off waiver of the collection of back taxes on investments in securities. An appeal addressed to the Minister of Finance by leading members of Poland's scientific community makes this request, pointing out that such taxation will lead to a drastic reduction in funds for Polish science.
Beyond these remedies, foundations in Poland believe that clarification of the law is absolutely essential. Steps in this direction are already being taken. A working group consisting of leading Polish foundations, among them EFC members, has been formed to lead this effort (see the article "End of Endowments in Poland" on page 8). It is advocating to persuade a group of members of Parliament to submit an amendment to the law that will make the law more precise by specifying the various types of financial instruments on which expenditures would be tax-exempt.
It is expected that debate in Parliament will focus on two areas: 1) the list of legal bodies that the amended law applies to - at a minimum, this should encompass all foundations, and at a maximum, all organisations listed in the current law that engage in public benefit activities, including church organisations and political parties, and 2) the list of financial instruments that can be considered tax-exempt - it is likely that many MPs will oppose the inclusion of company shares.
Clarification and precision are the keys to any amendments since the current law allows for contradictory interpretations. Until the tax authorities hit the FNP with their huge tax bill, the right to a tax exemption for expenditures on securities was considered implicit. The task facing lawmakers now is to make the right to such an exemption explicit.
The tax situation is part of a bigger problem: the need to make the overall legal and fiscal environment for NGOs in Poland more favourable. There is a lack of understanding of the role of foundations and the Third Sector generally. Positive developments can be reported in the drafting of a law on cooperation between the government and NGOs. The Chancellory of the Prime Minister has recently published its draft of such a law. The draft incorporates ideas from the NGO sector as well as other solutions. The government is now awaiting the response of foundations, associations, and other non-profit organisations affected by the proposed law.
Conclusion
The court decision of November 20, 2000 threatens the continued existence of the Foundation for Polish Science as an independent, non-state sponsor of the Polish science sector and generally represents a serious setback for the building of endowments in Poland. It clearly indicates that changes in Polish fiscal legislation will be necessary in the future.
Today, the legal-fiscal environment for Polish NGOs lags behind that of their counterparts in certain neighbouring countries such as Hungary, Slovakia, and the Czech Republic. One has to only think of the 1% Law in Hungary, recently adopted in Slovakia as well, which allows citizens to earmark 1% of their taxes to an NGO of their choice. Since Poland, along with these three countries, is in the first wave of European Union accession countries, it is important for the country to create a more favourable environment for its Third Sector that is in line with prevailing European standards.
The editors would like to thank Jerzy Radziwill for his assistance with this article.