We bring you an overview of interesting case law in the field of corporate income tax, which has recently been dealt with by the Supreme Administrative Court (hereinafter referred to as the "SAC").
The first of the case law concerns the classic issue of proving advertising expenditure as tax deductible under Section 24 (1) of the Income Tax Act. 1 of Act No. 586/1992 Coll., as amended (hereinafter referred to as the “Income Tax Act”), specifically the question of the extent to which the scope of advertising performance agreed in contracts must be proven. At the outset, it should be noted that advertising costs have long been in the crosshairs of tax audits and the standard of proof for this type of costs is very high.
In this particular case, according to the tax administrator, the company did not prove that the advertising was carried out under the contracts on promotion and advertising in the entire agreed scope, i.e., for example, the placement of the logo on LED panels, on TV screens and banners in sports halls and on player jerseys during all agreed matches, broadcasting of the logo in the agreed number of television broadcasts and its permanent placement on the club’s website and in the club’s printed materials. According to the tax administrator, it was not possible to verify the frequency or duration of the advertising from the evidence submitted by the company, as it only captured individual cases of promotion, not its systematic performance according to the concluded contract. The tax administrator argued that the contracts specified the exact and binding scope of the supply, and if the taxpayer did not submit evidence for each individual agreed case of the contractedperformance, it did not meet the burden of proof and all expenses were excluded from the tax base.
The SAC, despite the somewhat strict previous case law, did not agree with the tax administrator and stated that the taxpayer does not have to prove in detail each individual case of advertising, but it is sufficient if it proves the existence and implementation of advertising in the so-called essential parameters of the agreed scope. According to the SAC, the evidence submitted by the company (photographs, video recordings and overviews of advertising performance, which proved the promotion of the logo on LED panels, jerseys, banners, website, Facebook and in television broadcasts) form a representative sample from which it can be concluded that the advertisement was actually carried out, in the essential parameters of the agreed scope. The SAC rejected the tax administrator’s approach, which focused on a detailed breakdown of each individual partial performance and required its documentation in full, as formalized and disproportionate. The SAC emphasized that the purpose of business is to make a profit, and not to collect documents and contacts of potential witnesses for the purposes of possible tax proceedings in the future.
However, we recommend reading this case law to the end, as it states that “The Supreme Administrative Court emphasizes that the above conclusions cannot be generalized in such a way that at least partial actual implementation of the agreed performance or performance contrary to the contractual agreement is always sufficient to claim expenses as tax deductible. The court here reached its conclusions taking into account the specific factual circumstances of the present case, in which there is no doubt that the advertising was actually carried out, to the (least substantial) extent under the advertising contracts.”
The second case law of the Supreme Administrative Court, which we want to deal with, focuses on the interpretation of the provisions of Section 24(2)(zc)of the Income Tax Act, in the version effective until December 31, 2014, which made it possible to consider as tax deductible also costs otherwise not tax deductible, up to the amount of income directly related to them. Although this is a provision that is already regulated differently in the Income Tax Act, the conclusions of the SAC may be applicable when applying the current wording of Section 23(4)€of the Income Tax Act, where we do not include revenues that are directly related to non-tax-deductible expenses in the tax base.
The subject of the dispute was the question whether costs incurred by a company that are otherwise non-tax deductible under Section 25 of the Income Tax Act (e.g. costs of meals for employees over the limit, representation, promotional items over the limit, gifts, penalties, fees, shortages and damages) can be considered tax deductible under Section 24 (2)(zc)of the Income Tax Act, if they were included in the calculation of remuneration for marketing services provided to its parent company.
The SAC emphasized that the direct connection between the cost and the revenue must be factual, specific and documented, not merely accounting or contractual. Mere inclusion of costs in the Cost+ calculation (i.e. the recharging of all costs to the related party with a 5% margin) does not establish a direct connection, but rather a direct proportion. This mechanism only defines the pricing method but does not itself prove that the given costs actually led to achieving revenues. The SAC confirmed that the plaintiff did not discharge the burden of proof, as it submitted only general references to accounting and the contract, did not demonstrate the specific connection between individual costs and specific revenues, and also did not prove the factual (economic) necessity of these expenses to achieve revenues.
Another case law of the SAC dealt with the assessment of whether the reduction of the tax base under Section 23(6)(b) point 6 of the Income Tax Act was actually carried out as a result of a change in the accounting method of valuing inventories of own production.
According to the tax administrator, the plaintiff did not prove that there was actually a change in the accounting method, and not just a mere revaluation of inventories or correction of an accounting error. According to the tax administrator, in order to prove a change in the inventory valuation method, it is necessary to document the specific composition of the original calculation formula and its difference from the new one. The tax administrator concluded that the plaintiff had not proved this, as the mere difference in inventory valuation (two different numbers) alone doesn’t not prove a change in the accounting method, because it does not explain the content of the formula used or which items were omitted or added. A mere change in the prices of inventories or the auditor’s approval of their new valuation does not prove a change in the accounting method within the meaning of Section 23(3)(b)point 6 of the Income Tax Act.
In this case, the SAC agreed with the tax administrator’s procedure and confirmed that the taxpayer did not prove the content of the original calculation formula or a specific change in its items, and that mere differences in amounts did not prove a change in the accounting method. The SAC explicitly stated that the correctness of the new inventory valuation alone is not sufficient to conclude that it is the result of a change in the accounting method; the same applies to the auditor’s opinion, which only addressed the correctness of the new valuation. The SAC explained that a change in the accounting method within the meaning of Section 23(3)(b)point 6 of the Income Tax Act presupposes the existence of an admissible original and new method (i.e. in accordance with accounting regulations). It follows that any transition from a method contrary to the legislation to a compliant method is a correction of an error (not a change in the method capable of reducing the tax base). In other words, in order to prove a change in the accounting method, you must be able to prove not only the new method, but also the original method, both of which must be correct and legitimate.
In the context of the dispute, the SAC also addressed the question of the legal binding nature of interpretative statements of the National Accounting Council (hereinafter referred to as the “NAO”), specifically on the taxpayer’s objection that the Regional Court interpreted legislative terms in contradiction with these interpretative statements. In this regard, the SAC stated that the interpretative statements of the National Audit Office are not legally binding and that even a possible contradiction of the judicial interpretation with these statements cannot constitute the illegality of the judgment justifying its annulment. In addition, however, the SAC added that the interpretative statements of the National Accounting Authority interpret accounting regulations and in their preambles emphasize the obligation of accounting entities to keep accounts in accordance with the Accounting Act.
The last court decision that we will mention in this article is a case assessed as an abuse of law In the given case, it concerned the application of a contractual penalty paid as a result of delay in the payment of interest on the loan provided as a tax-deductible expense.
At the outset, we would like to remind you that the cost in the form of a paid contractual penalty is a tax-deductible expense according to Section 24(2)(zi) the Income Tax Act, but only if its application does not contradict the meaning and purpose of the Income Tax Act. However, according to the tax administrator, the taxpayer abused the right by purposefully creating a prerequisite for the occurrence of a contractual sanction when it entered into a novation agreement with a new creditor who acquired the receivable under the loan by assignment. The tax administrator saw the problem in the fact that the company had agreed to non-standard contractual arrangements, such as a disproportionately high contractual penalty applicable even in the event of a delay in the payment of interest on the loan, even by onecrown Furthermore, the tax office did not like the fact that although the taxpayer had sufficient funds, it systematically preferred the payment of outstanding debts to its own shareholders over the payment of contractual interest on loan agreements.
This case was interesting mainly due to the way in which the SAC dealt with the company’s objection that it did not gain any tax advantage, which is a condition for concluding abuse of law.The company had negotiated follow-up contractual penalties with its subsidiaries, which were the final beneficiaries of the funds from the loan received. Thus, the company argued by stating that the paid contractual penalty (cost) was fully reimbursed by its subsidiaries, which sent it the corresponding amount of contractual penalties (revenue), whereby the revenue and the cost cancelled each other out, so that the tax base was not reduced and the company could not benefit from the tax advantage. The company further stated that if there was an abuse of law at all, it would not be on the part of the company, but on the part of its subsidiaries, which only realised the cost (the contractual penalty paid to the parent company) without generating a corresponding return.
However, the SAC rejected the company’s claim that it did not receive a tax advantage. According to the SAC, the tax advantage arose from the fact that the plaintiff reduced the tax base by the contractual penalty paid. The fact that it subsequently increased its revenues (by fines from subsidiaries) does not mean that it did not receive a tax advantage. According to the SAC, the company transferred the tax advantage to its subsidiaries, but the entity that obtained it was primarily the company itself. The SAC emphasized that tax law does not examine how the taxpayer dealt with the tax advantage, but whether it was obtained obtained. The SAC also rejected the argument that the tax should have been assessed to the subsidiary companies, as what was challenged was the transaction between the plaintiff and the creditor from the loan agreements (resulting from the novation), not between the plaintiff and its subsidiary companies. According to the SAC, the subsidiaries companies did not participate in the abuse of law – in particular, the subjective criterion (purpose of the conduct) was not met in their case.
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