Conditions to utilise the deduction of R&D expenses through the lens of judicial decisions
The Regional Court in Brno has considered several key issues relating to the utilisation of research and development (R&D) deductions and has come to substantial conclusions.
1. Formal conditions
In the first part of its judgement, the Court provided its statement on whether the taxpayer’s definition of the method of review and assessment of the solution process in the R&D project and the results achieved was sufficiently specific when it stated in respect to this statutory requirement in the R&D project the following: “Review of meeting the objectives: The project solution will be reviewed and assessed by Mr. M.T. once a year. He will prepare a report on the review.” The state administration referred to this method as insufficient, stating that formal requirements were not met. We know from the established practice of the courts that any failure to meet formal requirements may lead to the rejection of the entire deduction.
According to the Court, the law does not indicate any level of specificity with which the method of review and assessment of the project solution process and the results achieved should be defined. Under these circumstances, it should be agreed with the taxpayer that all R&D projects approved by the taxpayer included the method of review and assessment of the project solution process; although the taxpayer’s brief definition of the review and assessment method may be considered on the verge of permissibility.
The Court considers it to be sufficient if the taxpayer selects such a method to review and assess the project solution process and the results achieved that will clearly show who will perform the review and assessment, with what time schedule, what is considered to be a success or failure of the project with respect to the defined project goals, and in what manner the assessment will be recorded.
2. Keeping separate records of R&D expenses
In the state administration’s opinion, the taxpayer’s expense records met the formal requirements for connection with bookkeeping; however, given the lack of records on the course of solution of individual projects, the connection between the expenses recognised and specific projects could not be verified.
According to the Court, the Defendant explicitly stated that the Plaintiff’s records of operating expenses of individual R&D projects formally met the requirement for separation from other operating expenses of the Plaintiff. The issue of providing evidence of the connection between the Plaintiff’s individual expenses and specific R&D projects does not relate to the very existence of separate records, i.e. the meeting of the formal requirement to be able to deduct the expenses from the tax base; it is rather a matter of bearing the burden of proof with respect to the effectiveness of individual expenses utilised. The Plaintiff’s method of recording operating expenses of individual R&D projects thus may not be the reason for the blanket rejection of the option to deduct R&D expenses from the tax base.
In the challenged decision, the state administration criticised the taxpayer for changing employees working on individual projects compared to those specified in the R&D projects.
By law, an R&D project should contain the “names and surnames of people who will provide a professional solution of the project including their qualifications and forms of employment relations”. According to the Court, the quoted provision does not indicate the need to specify all employees who will participate in the R&D project but only those who will provide a professional solution of the project.
In addition to the above, the Court states that it does not agree with the Defendant’s conclusions that in order to bear the burden of proof in this respect it should be proven what exactly the specific employees did in the R&D projects on individual days. If the taxpayer proves the work of its employees on the R&D project through, for example, an amendment to an employment contract specifying the authorisation to work on the project and containing work records that clearly show how much time an employee spent working on the project on a specific day, or in any other appropriate way, it is up to the tax administrator to challenge the evidence in a reliable manner.
3. Defined R&D features
The Court also disagreed with the conclusion of the state administration relating to the factual review of research activities of taxable entities that in proving the existence of an appreciable element of novelty and technological uncertainty in the reviewed R&D projects, the tax administrator’s obligation to assign an expert deduced from judgements made in accordance with the Tax Code only arises if the taxpayer provides all means of evidence to prove the existence of the element of novelty and technological uncertainty. If the tax administrator lacks sufficient technical knowledge to assess the existence of the appreciable element of novelty and technical uncertainty in the R&D projects reviewed (which was repeatedly confirmed by the judicial decisions of the Supreme Administrative Court) it will usually also lack sufficient technical knowledge to assess the relevance and sufficiency of the evidence submitted by the Plaintiff to prove the existence of the elements. It will thus be the expert’s task to assess whether the means of evidence submitted by the Plaintiff are sufficient to assess the appreciable element of novelty and technological uncertainty and, subsequently, the existence of the elements as such.
We believe that this is another beneficial judgement that will increase the attractiveness of deduction among taxpayers. With respect to the deduction, we always recommend that our clients assess the status by an independent expert institute and make the deduction using our R&D Calculation Tool to make sure that selected formal requirements for deduction are met.