In its recent judgment ref. no. 6 AFS 376/2018-46 of 14 November 2019, the Supreme Administrative Court (hereinafter the “SAC”) dealt with the concept of abuse of law. Let us remind you that the concept of abuse of law is generally interpreted as a situation in which legislation being applied in its literal wording leads to a solution which is contrary to its own sense and purpose. What was the case about? What did the SAC decide?
Description of the case
As a result of the transformation by spin-off, a company, to which an allocated part of assets and liabilities was transferred in the form of cash funds of CZK 210 million, was formed. This newly formed company was owned by shareholders – individuals. One month after the company was formed, all of its shares of CZK 207 million were transferred to a buyer, who did not have funds for this purchase (the buyer was a company with a turnover of hundreds of thousands of CZK). On the same day that the shares were purchased, the buyer as the sole shareholder decided to pay out dividends from the newly acquired company and paid the purchase price of the shares to individuals using these paid funds. Therefore, the result of the transaction was that individuals sold their shares in the company in which there were only cash funds and exempted the income from this sale from tax in accordance with the Income Taxes Act (Act No. 586/1992 Coll., on Income Taxes, as amended). Due to the relationship between the parent company and the subsidiary, the subsequent payment of dividends to the new owner was also exempt from tax. The funds were effectively paid to individuals without related taxation, which cannot be avoided in case such funds are paid to individuals directly from the company being demerged.
Assessment by a tax authority
From the overall assessment of the transaction, the tax authority concluded that the transaction had purely tax and not economic reason. According to the tax administrator, the original shareholders de facto achieved distribution of dividends whose conditions for exemption from income tax were artificially fulfilled. According to the tax authority, neither the purpose of the transformation of the company which then paid out dividends, nor the fact that more bidders participated in the bid regarding the shares, considering that the buyer submitted the most advantageous offer, were proved. The tax authority also considered it illogical that shareholders accepted the sale of shares at a price lower than the value of the funds placed in the company, i.e. that the shareholders were “underselling”. On the contrary, this difference of approximately CZK 3 million was considered as a form of “remuneration” for participating in the transaction of the buyer who was generally an unrelated person.
Assessment by a Regional Court
In the situation under consideration, the Regional Court identified two transactions, namely the transfer of shares and the distribution of dividends. The transfer of shares was manifestly purposive because the buyer purchased the company without wanting to use its assets for his economic activity. According to the Court, it is apparent that the intention regarding the transaction was to immediately take funds out of the company. Obtaining and distributing tax savings was identified by the Court as the only economically rational motive for the entire action. Therefore, the Court concluded that the purposive transaction should not be considered and the payment of dividends should be subject to withholding tax.
Conclusions of the SAC
In line with the judgments of the Court of Justice of the European Union, the SAC recalls that an abuse of law involves both an objective and a subjective element. The objective element means that the application of a legal standard has not fulfilled its purpose, while the subjective element entails the intention to gain an advantage by artificially creating conditions for its achievement. In other words, it is a transaction which has the principal and clearly predominant objective of obtaining a tax advantage. The SAC thus confirmed the opinion of the Regional Court that this case represents an abuse of law as the sole purpose of this transaction was to pay dividends to individuals without appropriate taxation. According to the Court, the situation should be assessed as a whole, also in view of the sequence of individual actions. The purposefulness of those actions appears from all the circumstances of the case. Therefore, the courts found no economically reasonable reason other than tax savings in the transaction in question.