Custom development and its utilisation as part of a tax-deductible item for research and development

In August 2020, the much-expected Instruction No. MF-17 was issued in the Financial Bulletin, reacting to the amendment to the Income Taxes Act in relation to the tax-deductible item for research and development and commenting on, inter alia, the much-debated issue of custom development. Apart from that, the Financial, Tax and Accounting Bulletin featured an article by a General Financial Directorate representative that focused on the same issue as well. How is custom development treated in practice?

The above article by a General Financial Directorate representative reacts to a sentence that was added to Instruction No. MF-17: “The stated criteria for distinguishing research and development from other (related) activities can also be met by other activities performed on the basis of a contractual relationship (e.g. on the basis of a confirmed order or a contract).” No legal provision prohibits utilising custom development as part of a tax-deductible item for research and development. The criteria for fulfilling material conditions for utilising tax deductions remain the same for custom and “non-custom” development, i.e. the activities must include an appreciable element of novelty or clarification of a scientific or technological uncertainty.

By definition and based on our experience, utilising custom development as part of a tax-deductible item is not uncommon in practice. However, the obligation remains with the taxpayer to defend the existence of the stated material conditions and to prove that the activities were not just “ordinary ones”. In this context, taxpayers sometimes have to handle the fact that “novelty” and “uncertainty” are not legally defined terms. Many taxpayers, therefore, have to deal with the situation by commissioning a technical assessment as part of an expert opinion.

It might seem that taxpayers who have an appropriate expert opinion at their disposal already solved the issue of defending the existence of the material conditions for tax deduction and what remains is “only” proving that the formal requirements have been met. However, as the abovementioned article of the General Financial Directorate mentions, and as our practical experience also confirms, many expert opinions often comment on legal matters as well. The expert often answers the question of whether the tax deduction was utilised correctly and whether the expenses included in the tax deduction were research and development ones. It is important to point out that assessing legal matters is in the remit of the tax administrator, not the expert. Judgments have demonstrated that the tax administrator is not obliged to accept suchconclusions of expert opinions, as is for example the case of the judgment of the Regional Court in Ostrava: “The defendant (here: the tax administrator) raised objections to the expert opinion and the expert commenting on the issue of whether this particular case constitutes development or innovation; the Regional Court agrees with the defendant that the issue is a legal one, and it is not for the expert to comment on it.” Therefore, a taxpayer can easily find itself in a situation where it commissioned an often costly expert opinion (or, worse yet, a specialist statement or confirmation), which may not be of use in practice at all.

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