We bring you selected judgments recently issued not only by the Supreme Administrative Court (hereinafter “SAC”) but also by regional courts or the municipal court (hereinafter “RC”). For RC judgments that have been appealed in cassation, we will have to wait for the final decisions from the SAC, but even so, they represent interesting cases worth attention.
Evidence of Scope of the Supply
The SAC recently issued a judgment that represents a classic example of proving the supply provided in the form of material, advertising services, and assembly work as essential requirements for tax deductibility of expenditure according to Section 24 (1) of the Income Tax Act (ITA). In this context, it should be noted that a contract and an invoice alone are not sufficient to prove the factual occurrence of supply, and the requirements for proof, especially regarding advertising services, are constantly increasing. This particular SAC decision is interesting because it highlights another important aspect of proving supply, especially when the delivery is contracted as a single supply for a lump sum.
In this case, a contract that included a package of comprehensive marketing services for a single lump sum price was concluded. However, because the taxpayer could not fully and completely prove the entire scope of the contracted supplies, the tax authority excluded all related expenses as non-tax-deductible. The reasoning was based on the impossibility of determining the value of individual parts of the supply, and therefore not even a partial recognition of such expenses was possible.
In response to the company’s request to recognise at least a part of the costs it managed to prove, the SAC confirmed the tax authority’s conclusions, stating that the contractual supply was agreed as a whole, corresponding to the total agreed price, and it was therefore impossible to quantify the value of individual parts of the supply (whether proven or unproven). The court generally stated that to recognise the full expense (the agreed price), the realisation of all agreed services for this price, i.e., the entire supply, must be proven. Since the company did not manage this, all costs (i.e., the full price of the supply) must be excluded as non-tax-deductible expenses.
The judgment thus results in the recommendation that, To simplify the position in the potential proof of tax-deductibility of expenditures, it is more appropriate for contracts involving the delivery of a package of services to agree on the content and price for each component separately, to limit the risk of losing the entire expense in case of evidence shortages for individual items.
Establishment of Holding Structure as an Abuse of Rights
Another judgment is from the RC, so we have to wait for the final ruling on the prohibition of abuse of rights. Nevertheless, let us briefly describe what the situation involved. Given that cases of abuse of rights tend to be very complex, we will simplify the matter for this article, which briefly appeared as follows:
Subsequently, the profitable company A paid dividends to the holding company B, which immediately paid them to company C, with these payments being tax-exempt according to Section 19 (1) (ze) point 1 of the Income Tax Act (ITA). The whole transaction was concluded by company C using the funds thus obtained to return a contribution outside the basic capital to our individual, who did not pay any tax on this payment since they applied the “increased” acquisition cost against the income.
The main question in this dispute is whether the described sequence of transactions breaches the prohibition of abuse of rights. The tax authority, arguing abuse of rights, re-imposed personal income tax on company C, collected by withholding at a special rate, on the funds paid to the individual as the return of a contribution outside the issued share capital against the intended meaning and purpose of the ITA. The tax authority concluded that the profit accumulated in company A was ultimately paid to the individual as a tax-free payment as a result of the holding structure. Had the restructuring operations not occurred, the individual would have received financial resources directly from company A as a distribution of profit shares subjected to withholding tax, which regularly occurred in previous periods.
The RC sided with the tax authority and confirmed that the subjective and objective criteria of abuse of rights were met in this case. The company’s claims about the rationality of the operations did not convince the RC; nevertheless, the company filed a cassation appeal, and we will see how the SAC will rule on this matter.
Potential Impact of Seconded Managers on Functional and Risk Profile
The final judgment concerns another RC case, dealing with the correct application of transfer pricing according to Section 23 (7) of the ITA. This judgment addresses many aspects of determining the appropriate market price, with a notable issue being the determination of the functional and risk profile of the company in the context of the influence of managers seconded by the parent company.
In this case, the Czech company is part of a multinational Japanese group and manufactures components for the automotive industry, supplying its products to related entities and external customers. However, the company reported a loss from its manufacturing activities for the audited fiscal period.
During the tax audit, the tax authority classified the company as a low-risk manufacturer. One of its key reasons was that its production process was subject to strategic decision-making and management (including customer negotiations and pricing) carried out by the parent company through its seconded Japanese managers (particularly the vice-president and president of the company, who was also a statutory representative). The tax authority thus assessed the company as a low-risk manufacturer. It inferred a “hypothetical (fictitious) transaction” in the form of comprehensive manufacturing activities conducted for its parent company, thus also implying the parent company’s obligation to compensate the Czech entity for the incurred loss.
The RC agreed with the tax authority’s assessment of the functional and risk profile. According to RC, the tax authority demonstrated that the parent company influenced key decisions of the claimant through personnel linkage (seconded employees of the parent company in supervisory positions) and strategic decision-making, including production planning, customer negotiations, and pricing. The court upheld that although the Czech company sold products to related parties and independent customers, all production was derived from orders and contracts obtained based on the parent company’s decision-making powers. According to the tax authority and RC, losses incurred by the Czech entity should therefore be compensated by the parent company.
From our perspective, the RC’s view is controversial. It disagrees with the company’s argument regarding the autonomy of its statutory representative and the concept of the due care of a prudent manager, which the company believes implies an independent profile. The RC noted that through this lens, “every entity with a statutory body would be assessed in terms of functions and risks analysed in transfer pricing as a fully-fledged entity.” However, the question is whether this idea could lead to conclusions implying that no Czech company, which is part of a multinational group where the group influences the appointment of its statutory body, could meet the conditions of a fully-fledged entity bearing market risks. We believe such an interpretation contradicts economic reality and fails to respect fundamental transfer pricing concepts and the complexity of corporate governance relationships.
While awaiting the SAC’s decision, it is advisable to reflect on the court’s arguments and potential implications of seconding managers to the Czech Republic by parent companies, as this is a relatively common practice in international management structures.
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