Due to positive feedback on our previous article, we decided to point out several other areas where people often make mistakes during the preparation of the corporate income tax return. This area will also be discussed during our online webcast on 5 June 2018.
Inventory taking should serve as a means of correct assessment of tax deductibility of the individual situations that can occur with respect to inventory. Aside from the well-known reasons for disposals of inventory (such as sale), which are usually a tax deductible expense (hereinafter “TDE”), there are many situations which require deeper knowledge of this area.
Donation of inventory
If you decide to donate some inventory, the expense arising in such a way is as a rule a non-tax deductible expense (hereinafter “NTDE”). The only exception is promotion objects meeting the legal conditions, i.e. it must be an advertising object with the input price lower than CZK 500 net of VAT per piece.
Deficits and damages
With some exceptions, they are NTDEs. However, we would like to point out the definition of “damage”, which means something different according to the Income Taxes Act than what we would normally imagine, and it is essential for assessing the relevant case. Damage represents e.g. impairment that led to disposal of the asset, i.e. it does not apply to small damage to goods that is subsequently repaired.
If your company records inventory where disposals occur naturally (e.g. drying up, evaporation), we recommend starting to consider setting up an internal “natural disposal standard”. If you are able to defend the standard to the tax administrator, the respective disposal may be a TDE up to the given amount.
If someone steals your inventory, you can also treat the expense as a TDE in some cases. E.g. if you have a police report stating that it was committed by a person unknown, or if you report related income (whether from the perpetrator or the insurance company).
Did you liquidate assets during the year? In order to prove the tax deductibility of this expense, you need to have the liquidation report, containing strictly set elements as per the Income Taxes Act.
Sometimes damage can be caused by nature. If it is a so-called natural disaster, the related expense is a TDE. But be careful, not all nature manifestations may be characterised as natural disasters. Has wind blown away part of your inventory? It is a natural disaster only if the speed of the wind exceeded 75 km/h.
Another possibility is accidental exchange. If a warehouse worker mistook one (easily mistakable) type of inventory for another type of inventory and during inventory taking you subsequently identify surplus in one type and deficit in the other, in justified cases you can use the institute of accidental exchange and offset the surplus against the disposal.
Last but not least, we would like to point out that unlike the “old” version of the VAT Act, where the amount of deficit deduction was adjusted in the current taxation period, according to the current wording of the Act, for destroyed, lost or stolen inventory the amount of deduction that was claimed in a previous VAT return must be adjusted.
With the amendment to the Income Taxes Act (hereinafter the “ITA”) from 1 July 2017, the inconspicuous words “at least” have been added to the number of months given by the ITA as the period of amortisation of intangible assets (e.g. software is now newly amortised over at least 36 months). The potential extension of the amortisation period is applicable only to companies whose financial year began after the amendment to the ITA, i.e. companies using the calendar year (from January to December) will use it only for the tax return for 2018.
Most companies are now able to distinguish between operating and finance leases and they are aware of the related tax consequences of both treatments. Starting from 1 July 2017, a new restriction has been incorporated, which means that intangible assets and tangible assets excluded from depreciation may no longer be the subject of finance leases.
Another problematic area seems to be the technical improvement performed by the lessee on the leased asset. You should always consider the tax consequences and not limit yourself only to the legal assessment of the respective contracts. If, for example, you as the lessee terminate the lease agreement, do not eliminate the technical improvement and receive no reimbursement from the lessor for the expenses incurred, the carrying amount will irretrievably become a non-tax deductible expense. It is therefore necessary to always think about the tax impacts, which may occur several years after the conclusion of the contract, already at the time of concluding the contract.
Here, we would like to point out the careful differentiation between gifts and sponsorship – they have the opposite regime of tax assessment.
If you decide to give out anything, it is your obligation to be able to bear the burden of proof in the event of a tax audit. If, for example, you give out your company’s samples or promotion objects at children’s day, photo documentation of the event will certainly come in handy when you need to prove that the recipients of the objects were not e.g. your employees (the tax treatment would be different).
If you decide that to boost your sales with marketing support, e.g. television advertisements, with a cost exceeding CZK 60 thousand and useful life greater than one year, it would be a mistake to recognise this expense only once; from the ITA perspective this is a fixed asset whose acquisition cost will appear in expenses via depreciation for tax purposes.
If your company operates in the investment incentive regime, you should pay increased attention to transfer pricing within the group to make sure the prices are in line with the arm’s length principle.
Since this is an additional benefit in the form of public support, it entails a wide variety of obligations. Among other things, it is necessary to maximise all deductions from the tax base (i.e. the utilisation of loss, deduction for research and development and deduction for the support of professional education), maximise depreciation and tax provisions against receivables.
The number of tax audits focused on research and development deductions has grown substantially in recent years. Never forget that project documentation is a prospective document that looks to the future, but failure to comply with (even just formal) requirements on its content or the failure to sign it before the initiation of development activities leads, according to the current practice of tax offices, to the exclusion of the whole deduction from the tax return and to the application of all sanctions allowed by the Tax Code
Aside from this, you also need clear and demonstrable separate expense records (posting on synthetic accounts is not sufficient). Last but not least, when defending activities you have assessed as research or development, you may benefit from an expert opinion of an independent expert institute. It is not a legal requirement but given the current tax audit practice we strongly recommend it.
At present, you can still record receivables against which provisions are recognised based on the “old” regime, and those whose recognition follows the current rules set by the Reserves Act. With the new Civil Code, the limitation period of receivables has been shortened. If your receivable happens to be past the limitation period, you cannot create a provision against it (not even a partial one). Your legal department should therefore keep a close eye on the limitation period of receivables, among other things.
Have you received dividends from a subsidiary that you record in your tax return as income exempt from tax? Then you should not forget about a review on the side of expenses, since all direct expenses (e.g. interest on loans) and indirect expenses (e.g. part of staff costs) are NTDEs. In addition, if you are unable to prove that the amount of indirect expenses is lower than 5% of the value of received dividends, this amount will become a NTDE. It is a partial paradox that the ITA will force you to make this adjustment even if your subsidiary is in liquidation and you cannot exempt your dividend income from tax (you will therefore have taxable income and the related NTDE).
The article is part of dReport – June 2018, Tax news; Grants and investment Incentives
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