What were the facts of the case from the perspective of the claimant?

The claimant was established in 2011 as a holding company to provide the group of private equity investors with more operational manner of managing the individual project companies, which were to be gradually integrated into the newly established holding structure. The holding structure was primarily intended to enable the entry of new investors who would bring additional funds to the holding company by purchasing its shares. Such funds would increase its registered capital and would be used for new acquisitions together with funds obtained from the sale of completed projects.

However, this plan proved to be unrealistic shortly after the establishment of the holding company (apart from other aspects, considering the recodification, which affected the legal framework of private equity holding companies that could newly operate only in the form of investment companies or funds supervised by the Czech National Bank).

The investors (i.e. the shareholders of the claimant), who initially contributed one profitable project company to the holding company (the value of contribution was valued at CZK 870 million), subsequently needed to recover the funds to be invested in their other investment opportunities. In the relevant situation, they considered three options with the following tax implications:

• The liquidation of the holding company and the payment of a liquidation balance – for the investor – an individual, the income would be reduced by the acquisition price of the contribution; therefore, no factual taxation would take place.
• The buy-out of own shares by the holding company – for the investor – an individual, the income would be exempt considering the time test fulfilled; and
• The reduction in the registered capital, and the payment of the difference in share price to the individual shareholders (this option was chosen, and its related tax implications are described in detail below).

The General Meeting of the holding company then decided on the reduction in the registered capital by CZK 400 million and on the payment of a difference in the share price over the period of 5 years. The investors, as the shareholders of the holding company, then paid themselves money from the reduction in the registered capital using the exempt dividends paid by the contributed project company. The income received by shareholders in connection with the reduction in the registered capital was not subject to 15% withholding tax, as it was the income that was reduced by the acquisition price of the contribution (shares) to zero. This procedure was supported by the argument that the source of the reduction in the registered capital was not the profit of the holding company, but the repayment of funds contributed.

What was the position of the tax administrator and the Regional Court on the case?

The tax administrator argued that (i) the establishment of the holding company and the contribution of the profitable project company, (ii) the subsequent reduction in the registered capital, and (iii) the payment of the difference in the share price to the individual shareholders from exempt dividends constituted the purposive sequence of steps with the sole purpose to obtain a tax advantage and achieve untaxed profit for the shareholders. According to the tax administrator, the establishment of the holding company did not in fact bring any benefit; therefore, it was an unnecessary act from the economic perspective.

However, the Regional Court did not fully support the tax administrator in this conclusion. In its judgment, case no. 30 Af 24/2020-112, the Regional Court confirmed the presence of the objective element of the abuse of law, i.e. that the tax advantage, obtained by the taxpayer as a result of the transaction carried out, was contrary to the purpose and meaning of tax regulations. Nevertheless, according to the court, the tax administrator failed to demonstrate the existence of the second element of abuse of law, i.e. the subjective element, that the obtaining of the tax advantage is the sole or at least the main purpose of the act performed by the taxpayer.

In comparison to the previous judicial decisions we have presented on this topic, this time, the tax administrator failed to satisfy its burden of proof. The tax administrator had no evidence for its allegations on the subjective element of the abuse of law, and according to the court, the tax administrator committed several distortions in its assessment of evidence presented by the claimant. Although the Regional Court admitted that doubts of the tax administrator could have legitimately arisen from the personal interconnection of persons, the relatively short interval between the establishment of the claimant and the reduction in its registered capital, or the vague subject of activities and business of the holding company. Nevertheless, based on these facts alone, without further acts carried out, it cannot be concluded that the establishment of the holding company and other related transactions did not pursue any meaningful economic objective; therefore, were purposive.

The Regional Court also did not ignore the fact that, within the tax proceeding, the tax administrator did not expressly deal with the fact that all the above-stated options of transferring funds from the holding company to its owners would not result in taxation anyway.

Therefore, the Regional Court cancelled the decision of the tax administrator and returned the case to its reconsideration. If the tax administrator wishes to maintain its conclusion of the abuse of law, it will have to present further evidence and arguments. An appeal in cassation has not been filed in this case, so it is questionable how the case will continue in the further proceeding of the tax administrator. We will keep you informed of any further developments.