We bring you selected 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").
In this judgment, the SAC addressed the question of whether commissions paid on the basis of a brokerage contract constitute tax-effective expenses under Section 24 (1) of the Act. 1 of Act No. 586/1992 Coll., as amended (hereinafter referred to as the “Income Tax Act”). The essence of the dispute was whether there was a sufficiently direct and immediate link between the commission paid in a given year and the income generated in the same year.
In the present case, the company concluded a brokerage contract on the basis of which it paid commissions to the intermediary on the income arising from cooperation with the automotive company. According to the company, it was the contribution of the intermediary that was key to winning the contract in 2015. The intermediary was supposed to provide the company with references, know-how, business experience and access to a business opportunity, and he did not apply for the tender himself.
The tax administrator did not dispute that the cooperation with the intermediary could have been significant in 2015. Nor did it deny the existence of a contractual relationship or the actual payment of commissions. However, according to him, the decisive factor was that the tax deductibility of the expense had to be assessed in relation to a specific tax period and to specific taxable income.
In 2018, another tender took place. In it, the company no longer acted as an entity that would be dependent on the references or business history of the intermediary, but as a supplier with its own several years of direct cooperation with the automotive company. Therefore, according to the tax administrator, the income generated in 2019 was not a direct consequence of the original intermediation from 2015, but the result of the company’s independent success in the new tender.
The SAC assessed this situation by confirming the conclusions of the Financial Administration. He reminded that for the recognition of an expense under Section 24 para. 1 of the Income Tax Act, it is not sufficient to prove only that it has actually been expensed. At the same time, the taxpayer must prove that the expense was used to achieve, secure or maintain specific taxable income. This relationship must be sufficiently direct and immediate. It is not enough that the expenditure is only historically, indirectly or economically distantly related to income.
The SAC also emphasized that the intermediary no longer participated in the tender in 2018 in the manner envisaged by the mediation contract. At that time, the company had its own supplier history and its own business position vis-à-vis the automobile company. According to the SAC, the revenues generated in 2019 were thus derived from the company’s subsequent independent success in the tender in 2018 and were therefore no longer the result of mediation.
In the case under consideration, the SAC thus confirmed that the tax effectiveness of an expense under Section 24 (1) of the Tax Act. 1 of the ITA requires more than just an economic or historical context. A commission paid to an intermediary can only be tax deductible if the taxpayer proves its direct and immediate relationship to specific taxable income.
The decision can be seen as a warning that long-term commission mechanisms linked to future income need to be evaluated on an ongoing basis and that sufficient documentation must be available to prove a direct and immediate link between the brokerage commission and the company’s specific income.
In this case, the subject of the dispute was the question whether expense interest on CZK bonds can be excluded from tax-deductible costs under the thin capitalization rule under Section 25 (1) of the Tax Act. 1 lit. w) of the Income Tax Act. The key point of contention was not the very existence of the so-called crown bonds or the related interest payments, but whether there was a relationship of related parties between the issuer of the bonds and their holders within the meaning of Section 23 (1) of the Act. 7 of the Income Tax Act.
In this case, the business group was restructured, which resulted in a situation where natural persons who originally held an ownership interest in the group continued to retain influence over its functioning, but at the same time became its creditors as holders of crown bonds.
The tax administrator concluded that interest costs on bonds are subject to the thin capitalization rule. At the same time, the company reported negative equity, and since the creditors from the bonds were, according to the tax administrator, persons otherwise connected with the company, the tax administrator excluded all this interest as a non-tax deductible expense. It was the fulfilment of the definition of “otherwise related persons” and the related application of the thin capitalisation test that became the core of this litigation.
The judgment summarizes that when applying the thin capitalization test, i.e. Section 25 para. 1 lit. w) of the Income Tax Act, it is necessary to examine the cumulative fulfilment of several conditions. There must be a credit financial instrument, interest must be paid, the debtor must be low-capitalized and the creditor must be a related party to the debtor pursuant to Section 23(1) of the Income Tax Act. 7 of the Income Tax Act. In the case under consideration, it was therefore disputed whether the bondholders were related parties to the company.
Although the individual partners did not own a 25% share in the capital, the tax administrator assumed that the shareholders acted in concert. Through their voting rights at general meetings, they have decisively influenced the transformation of the group, the bond issue and the subsequent setting of debt financing. According to the tax administrator, this created a relationship of otherwise related persons pursuant to Section 23 (1) of the Tax Code. 7 lit. b) point 1 of the Income Tax Act, as the shareholders participated in the control of the company. It was not just a matter of formal ownership of shares or an abstract possibility of exercising shareholder rights. The decisive factor was that those rights were actually used to approve actions that resulted in imposing a significant interest expense on the company, while at the same time retaining control of the group.
The SAC confirmed that a shareholder with a share of less than 25% may also be a person otherwise related if he or she actually participates in the control of another person. According to the SAC, the term “participation in an inspection” cannot be reduced only to membership in a supervisory body or to the performance of audit activities in the narrow corporate sense. The court interpreted it more broadly as a form of factual influence on the tax-relevant conduct of another person. According to the SAC, participation in an audit is thus a separate category, different from participation in management, but pursuing a similar tax purpose. Both categories capture various forms of influencing the taxpayer that may be relevant for the assessment of the relationship of related parties.
The SAC also agreed with the conclusion that the original shareholders acted in concert in order to enable the issuance of crown bonds and maintain control over the companies in the group. It was not decisive whether the shareholders agreed on all individual personnel or corporate issues. What was important was that their concerted action was aimed at a common result: the issuance of bonds, the setting of debt financing, the execution of subsequent mergers and the preservation of influence over the group. According to the SAC, it was this joint procedure that established a sufficient basis for concluding on the existence of a de facto control. The court thus rejected the narrow interpretation according to which the relationship of related parties could be inferred only from formal shares or from the direct performance of functions in the company’s bodies. The broader economic and corporate context of the transaction may also be decisive for tax purposes.
However, it is important for practice that the SAC corrected the Regional Court on the issue of the time for assessing the condition of the existence of related parties. It described as incorrect the conclusion of the Regional Court that for the application of the thin capitalization rule, it is sufficient to prove the connection of persons only at the time of the establishment of the debt relationship, and this connection will subsequently be automatically applied in all subsequent tax periods. According to the SAC, the conditions of thin capitalization, including the existence of a related party relationship, must always be assessed in relation to a specific tax period.
The judgment is thus further confirmation of the trend in which administrative courts, when assessing restructuring and debt financing, examine not only the legal form, but also the actual economic effect of the transaction and the real distribution of influence among the parties involved.
Please note that this article was translated into English by AI. If you have any questions or require any clarification, please do not hesitate to contact us at infocz@deloittece.com.
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