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17 August 2009

Confidential information –decision of the Director of the Tax Control Office (42/2009)

On 17 August 2009 the proxy of Netia S.A. (the “Company” or “Netia”) received information about the delivery of a decision of the Director of the Tax Control Office in Warsaw (“UKS Director”) according to which Netia’s corporate income tax (“CIT”) due for the year 2003 was set at PLN 58.7 million plus penalty interest. The decision was issued despite the legal arguments presented by the Company, which stated that the conclusions delivered by the Tax Control Office were incorrect and groundless. According to the UKS Director, Netia understated its taxable revenues by PLN 303 million by excluding from its revenues the accrued and not received interest from loans granted by Netia in previous years to its subsidiaries which subsequently merged with Netia on 31 December 2003. In the opinion of the UKS Director, the fact that the Company did not claim the repayment of the loans and accrued interest from its subsidiaries justifies the adjustment of Netia’s revenues pursuant to Article 11 of the CIT Act. According to this regulation, the tax authorities are entitled to make adjustments to taxable revenues if, as a consequence of a capital relationship or a personal relationship, a taxpayer provides services to related parties on terms more favourable than those generally accepted at the time and place where such service is provided, and as a result of these transactions the entity does not report the taxable income or reports lower income than expected had such relationships not existed.

According to Netia, the decision of the UKS Director is in conflict with the relevant tax regulations for the following reasons:

1. according to the CIT act, only interest received constitutes taxable revenue, and Netia did not receive any interest;

2. there is no regulation in the CIT act according to which interest revenue recognition is dependent on conducting execution proceedings with respect to such interest;

3. the UKS Director confirmed in the protocol and the decision that the loans were granted on market terms; the interest on the loans was determined on market terms;

4. Netia was not able to report interest income in 2003, because even if Netia had received interest from its related companies, the amount received would have been spent on the repayment of Netia’s interest liabilities and the repayment of the interest would have been a tax deductible cost; interest received is a taxable revenue and interest paid is a tax deductible expense;

5. the execution of interest by court enforcement proceedings, which according to the UKS Director is the only proper way to proceed when debts remain unpaid, would be inefficient from a business and economic point of view and would have led to the bankruptcy of the subsidiaries. The Company chose the less expensive way, by settling its receivables through merger with its subsidiaries and thereby taking over their operating assets. In parallel to this restructuring, Netia restructured its own liabilities with the external lenders to the group;

6. the UKS Director made an incorrect assumption that the loan granted by Netia to Millennium Communications was a comparable market transaction to the loans granted to the related companies; in fact, Netia was involved in numerous litigations with Millennium Communications due to the unsuccessful acquisition of that company by Netia;

7. if the interest on the loans had been written-off by Netia, it would not have constituted taxable revenue;

8. in the UKS Director’s decision, Netia’s taxable losses were settled incorrectly, resulting in a significant overstatement of tax being claimed; and

9. there is a dispute between the Company and the UKS Director whether the decision of UKS Director has been effectively delivered to the proxy of Netia; in Company’s opinion the decision of UKS Director has not been delivered effectively.

Due to the reasons indicated above, the Company intends to appeal against the decision issued by the UKS Director. The UKS Director’s decision is not final and it is not enforceable as it was issued by the first instance tax authority. The Company has received opinions from several independent tax and legal advisors which conclude that the claims of the Director of the Tax Control Office have no legal grounds. Due to the above, the Company does not intend to create a provision for the amount of the tax arrears reported in the tax decision.

Legal basis: Art. 56 sec. 1.1 of the Act on Public Offerings, the Terms Governing the Introduction of Financial Instruments into Organized Trading, and on Public Companies (Journal of Laws. 2005, No. 184, item 1539).