Error-prone areas in preparing corporate income tax returns

With the deadlines for filing corporate income tax returns approaching, we are providing you with a summary of a few areas that may bring about complications in practice. After all, we have observed a lot of confusion regarding deadlines for filing tax returns, particularly last year, due to statutory changes and support measures issued by the Ministry of Finance in relation to the pandemic.

Provisions against receivables and write-offs of receivables are frequently discussed matters. Is it possible to release a statutory provision against a receivable as of the balance sheet date and write off the receivable through tax-deductible expenses if the receivable has become statute-barred during the year? The current wording of the Income Tax Act (ITA) does not allow this option and the tax deductibility of this expense could be questioned by the tax administrator in the event of a tax audit.

For proper treatment in accordance with the ITA, it is necessary to have an internally set up system in place that allows you to write off the receivable and release the tax provision before the receivable becomes statute-barred.

The issue of renting vs. leasing, including technical improvements, is not addressed by companies only in the case of changing office/production space. The tax consequences of termination of a lease agreement might make an often not very complicated situation in terms of taxes significantly more expensive (e.g. moving to new premises, termination of the lease agreement, expiration of the agreed lease term, etc.). Already at the conclusion of the lease agreement, when the leased premises will be subject to technical improvements and you as a lessee will have the right to depreciate them, the situation requires not only legal treatment but also the necessary tax analysis of the issue.

If, for example, you terminate the lease agreement as a lessee, you do not remove the technical improvements and do not receive any compensation from the lessor for the investment, the part of the technical improvement which was not depreciated will irretrievably become a tax non-deductible expense. It is, therefore, necessary to consider the tax consequences already at the time when the agreement is concluded, as they may arise many years thereafter. The agreement might be flawless in legal terms, but if the tax consequences have been neglected, this may negatively affect both the lessee and the lessor, for whom the non-depreciated part of the technical improvements may become, for example, taxable income.

Holding an equity investment in a subsidiary has tax consequences when the subsidiary pays a profit share. An error-prone area often includes the situation of related costs. Pursuant to the ITA, all direct costs related to the holding of an equity investment in a subsidiary must be treated as tax non-deductible and, in the case of indirect costs, it must be possible to prove that they do not exceed 5% of the dividend paid or the value of 5% of the dividend paid must be treated as a tax non-deductible expense. According to case law, it is necessary to view the circumstances of indirect costs in a broader context and to be prudent if you presume that they are zero, as you can easily experience failure of evidence and face an additional indirect cost assessment under the above-mentioned fiction of 5% of the dividend paid, including the related penalties.

The combination of items that reduce your tax base and tax liability can make your company’s return significantly more complex and complicated. In the case of a combination of, for example, items deductible from the tax base (deduction for research and development, deduction for professional training support, tax loss), provided gratuitous performance (donations), tax relief (e.g. due to investment incentives or employment of disabled people) or, for example, tax credit for tax paid abroad, it is very important to pay attention to the rules for their utilisation and the interdependence of the relevant provisions. Since, for example, donations cannot be brought forward and thus automatically indicate a preference in the reduction of the tax base over, for example, a deductible item (which can be brought forward if the conditions are met), such an approach would be an error.

Transfer pricing (pricing between related parties) creates issues, for example, for situations where a parent company provides support services to a subsidiary. As the case law shows, even though the taxpayer (the subsidiary) had a number of underlying documents proving the provision of services (presentations, telephone conferences, etc.), the tax administrator questioned the tax deductibility of these services. According to the court, the taxpayer did not prove to what extent the respective service had contributed to the total amount of the invoice. According to the court, the condition for the tax deductibility of these situations is an unambiguous specification of the expense incurred on the one hand and its relation to the precise provision of the service on the other hand.

Related to this topic are the essential conditions for proving the so-called “substance” and “benefit” tests, i.e. that the service was actually provided and that the recipient company benefited from the service. Companies thus often have transfer pricing documentation in place. Nonetheless, today’s inspections go far beyond that and require far more rules to prove transfer pricing is correct.

For years, the Schedule of Related Party Transactions was considered by some taxpayers to be a mandatory appendix to the tax return, which the tax administrator did not even check. The opposite, however, turns out to be true. The interconnection that can be concluded from the appendix as opposed to the information in the tax return or statements can easily lead to the initiation of a tax audit or, at the very least, to a procedure intended to remove doubts. In particular, the sections of the appendix that could make an impression of understatement of income in the tax return require your close attention.

Disclosure of financial statements through filing with the income tax administrator represents another step by the public administration towards the digitalisation of taxes and the reduction of duplication at the submission of the same forms to multiple public authorities. The taxpayer will thus fulfil the obligation to disclose the financial statements at the moment the tax return is filed with the tax administrator. This change is also linked to a change in the tax return form. The obligation to disclose financial statements has been stipulated in legislation for many years. Nonetheless, a large number of taxpayers do not comply with this obligation despite the risk of heavy penalties.

Donations and sponsorship are subject to a different tax assessment regime, yet their distinction might be complicated in practice. If you decide to donate anything, it is your obligation to meet the burden of proof in the event of a tax audit. For example, if you gave away samples or promotional items from your company at a children’s day event, you will need to have photo documentation from the event to prove that, for example, your employees did not take the items (the tax regime would be different in that case).

If you decide to drive your sales by, for example, advertising on television as part of your marketing efforts and the acquisition meets the conditions to include the investment in intangible fixed assets, it would be an error to account for the expense on a one-off basis. The acquisition cost will only be included in expenses through tax write-off.

Audit adjustments subsequent to the closing of accounts are something that many companies encounter when they subsequently prepare their tax returns. Taking them into account in the tax return and reviewing them from year to year can cause accounting and tax inconvenience, as well as significant additional tax assessments.

The issues of what is subject to withholding tax or what constitutes a reporting or notification obligation are not paid sufficient attention in the context of tax returns. It is then easy to neglect withholding obligations and filing relevant foreign income tax notices/payer withholding tax reports, including neglecting the not always clear deadlines for individual filings.

A specially developed Tax Navigator app helps Deloitte clients prepare their corporate income tax returns. Read more information about this app, and if you have any questions, please do not hesitate to contact us.

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