We bring you an interesting judgment of the Supreme Administrative Court (the "SAC"), which dealt with the issue of abuse of law in the deduction of expenditure on advertising from the corporate income tax base.
In the litigation, the SAC assessed whether the deduction of expenses (costs) for advertising (the promotion of the company as the main partner of a basketball club at matches and related events), which the company procured through another company abroad, constituted an abuse of law within the meaning of Section 8(4) of the Tax Procedure Code.
A key factor in the SAC’s decision in this case was the fact that the tax administrator did not question the actual implementation of the advertisement nor the fact that the advertising could have fulfilled its economic purpose, and that the costs as such formally corresponded to Section 24(1) of the Income Tax Act. However, the tax administrator claimed that the relevant transactions were part of an artificially created scheme in which the foreign company acted only as the holder of advertising rights, while the actual provision of the promotion took place through the basketball club, and that the predominant purpose of the payments was not advertising, but rather obtaining a tax advantage consisting in reducing the tax base of the company (by claiming the advertising costs as tax-deductible expenses) and also the generation of untaxed income for the chairman of the board of directors of the company.
As supporting indicia, the tax administrator emphasized the flow of funds, whereby the company sent payments for the benefit of a foreign company (or other foreign companies within the group) to Cypriot accounts. These companies then sent the amounts to another foreign company owned by the chairman of the board of directors of the company, and that account was used both for cash withdrawals and for transfers to the private accounts of the chairman of the board of directors and his wife. According to the tax administrator, the advertising was only a side effect, and even if the promotion was actually provided, the predominant purpose of the chosen arrangement was to achieve a tax advantage, and therefore such a legal act should not be regarded for tax administration purposes as giving rise to tax-deductible expenses.
The Regional Court agreed with the tax administrator’s conclusion and stated that the tax administrator had discharged the burden of proof and proved an abuse of law in relation to the advertising provided. According to the Regional Court, the company’s conduct met both conditions of the abuse of law test. The aim of the transactions between the key entities that were economically and personally intertwined was not primarily advertising, but the concealed payment of untaxed income to the chairman of the board of directors of a company using advertising. Large volumes of cash withdrawals and transfers through foreign accounts, including accounts in so-called tax havens, served to conceal the real ultimate recipients of the funds. According to the Regional Court, the scheme was typical of tax fraud, as it included personal connections, foreign jurisdictions, nominee persons and cash withdrawals. The Regional Court stated that the intermediary companies were redundant because the company using the advertising and the basketball club were personally linked. At the same time, the basketball club received only a fraction of the amounts that the company paid to foreign advertising intermediaries.
In the action brought before the Supreme Administrative Court, the company objected in particular that the objective condition of the abuse of law test was not met, as the reduction of the tax base by advertising expenses is a natural consequence of the deduction of expenses under Section 24(1) of the Income Tax Act, if the advertising brings an economic benefit. It was not proved in the tax proceedings that the advertising expenditure served only as a mechanism for a substantial part of the funds to end up with related parties. On the basis of the facts stated, the company also tried to challenge the reasoning on which the Regional Court based its finding of the abuse of law, which was based on an artificial structure and personal connection, the alleged overvaluation of the price (which was not examined in the proceedings) and transactions between a foreign company providing advertising and a foreign company owned by the chairman of the board of directors.
The SAC assessed all these arguments and concluded that the objective condition of the abuse of law test was not met in the case under consideration. As mentioned above, the SAC proceeded from the fact that the tax authorities did not claim or prove that the advertising costs were ineffective, artificially created, without economic rationality or that the advertising was factually meaningless. On the contrary, the SAC emphasized that the tax administrator admitted that the advertising had been carried out and could have fulfilled the intended economic purpose. Therefore, it cannot be concluded that the company would obtain a tax advantage by deducting these expenses contrary to the meaning and purpose of Section 24(1) of the Income Tax Act. The SAC identified the tax administrator’s considerations regarding Section 24(1) of the Income Tax Act as contradictory, since on the one hand it admitted that the conditions of Section 24(1) of the Income Tax Act had been fulfilled, while on the other hand it inferred from the subsequent transactions that the expense had ultimately been incurred for another purpose (namely, the diversion of funds to the chairman of the board of directors). The SAC stated that the tax authorities should have resolved this issue unambiguously. If they considered that the purpose of advertising costs was only to obtain a tax advantage, the direction of evidence and legal qualification should have corresponded to this (which did not happen). The SAC explained that the tax administrator had incorrectly treated “the absence of an objective, logical explanation of the activity …” as satisfying the objective condition,because such a consideration is aimed at the subjective condition (the prevailing purpose), rather than at an objective contradiction with the purpose of the legislation.
In that judgment, the SAC also formulated a more general conclusion on the application of the principle of abuse of law to “ordinary” purchases of goods or services. In these cases, according to the SAC, abuse of law will be considered only exceptionally, due to the fact that the provisions of Section 24(1) of the Income Tax Act are formulated in very general terms and the provision itself already sets out the purpose of the expenses (costs) incurred – they must serve to achieve, secure and maintain taxable income. If the expenditure does indeed serve that purpose, it will be very difficult to find an argument as to why such expenditure also constitutes an abuse of law from an objective point of view. That is, specifically, how such expenditure materially defeats the purpose of the legislation, even though it was used for the purposes provided for by law. The SAC also emphasized that tax law has other instruments for many excesses (it explicitly mentioned the possibility of adjusting the tax base in the matter of the arm’s-length price under Section 23(7) of the Income Tax Act) and the prohibition of abuse of law should be applied as a measure of ultima ratio.
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