We present three noteworthy judgments from the Supreme Administrative Court from this year and last year, all of which address accounting issues. The first case involves the timing of accounting for expenses and income. The second case addresses the accounting treatment of estimated payables. The third case examines whether expenses incurred for repairs before renovation can be included in the technical improvement of a building.
The Supreme Administrative Court of the Czech Republic (SAC) addressed the case of UNISTAV a.s. (the plaintiff) against the Appellate Financial Directorate (AFD, the defendant), which involved the improper application of certain expenses and the failure to account for collected income. The judgment, 2 Afs 79/2023-62, dated 28 February 2024, provided significant conclusions on the timing of accounting for loan interest and the recognition of work in progress.
Interest income on loans granted
According to the SAC, the applicant should have charged (and included in tax allowable income) interest on the loan until the loan was repaid in full (repayment of principal), regardless of whether or not such interest was paid by the debtor. This means that interest should have been charged even if the loan was overdue and the debtor had not repaid it. The SAC cited Supreme Court case law, which states that a creditor is entitled to commercial interest until the principal is repaid (unless otherwise agreed), in addition to the default interest in case of default. Although the plaintiff made an accounting (non-tax) provision for the outstanding loan amount, the SAC did not consider this as evidence of bad debt. The SAC noted that the plaintiff had not provided any proof that the legal relationship between them and the debtor had been terminated or that they had unilaterally waived the claims from the loan agreement. Consequently, the SAC concluded that the plaintiff had failed to prove the uncollectibility of the receivable and did not address the issue of charging interest on the uncollectible receivable.
The plaintiff also referenced the National Accounting Board interpretation of the standard I-10, Timing of Accounting for a Creditor’s Accrued Receivable, arguing that they were not required to account for interest on an uncollectible receivable. However, the SAC clarified that the plaintiff misunderstood the scope of this interpretation. The interpretation pertains exclusively to interest on default and other penalties (which are reported in Class 64 accounts) and does not apply to commercial (income) interest, which is reported in Class 66 accounts.
Work in progress
Another point of contention was the accounting of expenses and income for one of the construction contracts where the plaintiff, as a contractor, hired subcontractors for certain activities. This contract was invoiced to the customer after the completion of individual milestones. The plaintiff argued that costs related to a milestone invoiced in a subsequent period were reimbursed by the customer as part of the invoicing for an earlier milestone in the current period. However, the SAC held that when the plaintiff received supplies from subcontractors that were clearly related to a milestone not yet invoiced or completed, it could not be argued that the purchaser had reimbursed these costs in an earlier milestone since the related activity had not been properly delivered. The plaintiff should have recorded these costs in the work-in-progress account, which they failed to do.
In a dispute between JET Power stavební s.r.o. (the plaintiff) and the Appellate Financial Directorate (AFD, the defendant), the Supreme Administrative Court addressed the legitimacy of creating an estimated payable for the projected total cost of construction work. Judgment 7 Afs 317/2022-30, dated 29 February 2024, provided a significant ruling on the correct accounting for these items.
Subject of dispute
The dispute concerned whether it was permissible to create an estimated payable for the total projected cost of construction work at the time of concluding the construction contract with a contractor. The contractor had begun the construction work in the relevant accounting period (by applying for a zoning permit) but had not yet delivered any performance under the contract.
Court ruling
In its judgment, the Supreme Administrative Court agreed with the Regional Court that the prerequisite for accounting for an estimated payable is the existence of a liability for a performance that has already been carried out and pertains to a specific accounting period, even if the exact amount cannot be determined by the end of the balance sheet date and the relevant documentation will only be available in the following accounting period.
The SAC concluded that one of the statutory prerequisites for creating an estimated payable in a particular accounting period is the actual incurrence of an expense in that period, not merely the conclusion of a contract or the creation of a potential claim for payment of an undelivered performance under the contract.
In a dispute between Štefan Novák (the plaintiff) and the Appellate Financial Directorate (AFD, the defendant), the Supreme Administrative Court addressed whether the costs of repairs carried out prior to the technical improvement of a building could be considered part of that improvement. The judgment of the Supreme Administrative Court, 6 Afs 273/2022-43, dated 13 December 2023, provides a clear definition of the difference between technical improvement and simple repairs in the context of VAT.
Subject of dispute
The subject of dispute was whether the expenditure incurred on repairs to the heating, carpets, and CCTV system prior to the extensive renovation of a hotel should have been included in the technical improvement of the building. The tax administrator argued that these repairs constituted a single investment unit with the technical improvement and should therefore have been considered part of the technical improvement.
Court ruling
In defining the costs of technical improvement, the Supreme Administrative Court asserts that jointly assessed expenses (costs), or in this case taxable supplies from a VAT perspective, must constitute a coherent entity in terms of their purpose, as well as material, and temporal scope. The inclusion of certain sub-activities (which in isolation might resemble simple repairs), within a unit regarded as a technical improvement can only be justified if these sub-activities either facilitate the execution of the technical improvement or are its inevitable consequence.
In its judgment, the SAC provided a practical example where, in the process of constructing a new partition to divide existing rooms, repairs were made to the plaster in those rooms. Due to the difficulty in distinguishing between the repair of existing plaster and the implementation of new plaster, case law has established that in such cases it is impractical to make such a distinction. Therefore, the entire intervention in the property is considered a technical improvement.
However, in the present case, the defendant successfully demonstrated that the replacement of a carpet, the repair of the heating system, and the replacement of non-functioning components of the CCTV system were not incidental to or related to the renovation carried out, neither in substance nor in time. Hence, those expenses were correctly classified as repairs.
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