Abuse of law at the Municipal Court in Prague – interest from financing intra-group transformation

At the beginning of 2021, the Municipal Court in Prague addressed the tax-deductibility of interest on an intra-group acquisition loan; eventually, the Court assessed a realised intra-group transformation as an abuse of law and, on these grounds, the related interest as tax non-deductible.

The substance of the dispute lay in the fact that an international group established a new holding company in the Czech Republic, to which it sold its two existing production companies. The holding company financed this acquisition in the form of an intra-group loan. Subsequently, both newly acquired companies merged and the legal form of the successor company changed to a limited partnership, where the holding company acted as a general partner. As a result of the restructuring, the profits generated by the production company acting as a limited partnership, were reduced by the interest on the loan intended for the acquisition at the level of its general partner (the holding company). The Court did not find any economic sense in the establishment of the holding company and considered its function of a general partner to be merely formal.

We would like to add to this conclusion that, in accordance with the legislation, the general partner generally has full decision-making power over the company in which it acts as a partner; in addition, the general partner represents the limited partnership externally and is responsible for its business management. However, the court of first instance accepted the statement of the tax administrator stating that these functions were actually not performed by the general partner.

The tax administrator together with the Court had repeatedly compared the above-described situation to the already-known series of judgements from 2015 concerning the abuse of law relating to intra-group transformation (judgements of the Supreme Administrative Court in the case of file nos. 1 Afs 56/2015, 2 Afs 64/2015, 2 Afs 65/2015, 3 Afs 53/2015, 8 Afs 34/2015, 9 Afs 56/2015, 9 Afs 57/2015, 9 Afs 58/2015). However, the Company argued that in its case the interest was, in contrast to the judgements mentioned, taxed abroad by the creditor. Nevertheless, the Court concluded that the fact that the interest income was taxed abroad is not relevant to the legal assessment of the situation and took no account of it.

Therefore, the Regional Court concluded that the loan received by the holding company did not represent any possibility or opportunity for the group in the Czech Republic to achieve new taxable income or secure or maintain existing income; its sole purpose was to obtain a tax advantage in the form of eliminating taxation of profits generated by the limited partnership. For this reason, the Court rejected the tax-deductibility of interest on the general partner’s loan.

Subsequently, a cassation appeal was filed with the Supreme Administrative Court of the Czech Republic, and we have yet to see the conclusion of this relatively complex dispute.

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