Mandatory information in project documentation for deduction of research and development: extreme formalism or legitimate expectations?

Requirements for the content of the document entitled “Research and Development Project” (currently “Project Documentation”) became a subject matter of numerous disputes between taxpayers and the tax administrator. The Supreme Administrative Court repeatedly confirmed that only the Research and Development Projects containing all exhaustively listed requirements give rise to the entitlement to use the deduction of research and development. The amendment to the Income Taxes Act has changed the concept of using the deduction since 1 April 2019 in order to remove the then perceived shortcomings in the law and make the deduction simpler, more attractive and more available to a greater number of taxpayers. The government even stated that the deduction of research and development would be the most significantly subsidised form of public financing for corporate investments.

The deduction of research and development is undoubtedly an interesting instrument that can be used by companies engaged in development activities to decrease their tax base. However, there are cases that make us approach this “double cost deduction” with caution. By way of illustration, let us consider a case where a taxpayer undoubtedly incurs research and development costs, however he gets into a dispute with the tax administrator as a result of, almost negligible, formal deficiencies. These may include for example a failure to list the qualifications and labour relations of development employees in the Research and Development Project. This exact situation happened to a taxpayer from Moravia. As a result of such deficiency, a deduction exceeding CZK 40 million was not accepted.

In fact, the term “qualifications” may mean for example “university degree”; labour relationship may be the term “employee”. Both these facts are easy to be found, or documented in another manner. However, as they are required as one of the mandatory information in the Research and Development Project, the Regional Court in Brno was, in its ruling, uncompromising – as the taxpayer did not provide a formally flawless copy of the Research and Development Project, and therefore did not meet the basic requirement of the lawmaker for the granting of the income tax deduction, the court refused to address its further objections (e.g. preparation of expert opinions confirming its activities as development activities) and did not accept the deduction.

It is certainly appropriate to recommend to companies engaging in research and development to use the deduction, however, at the same time, they should not underestimate formal requirements of deductions. A careful, ideally multi-stage check of all mandatory required information of the project documentation should be an integral part of the preparation of research and development deduction. In addition, preparation of all means of evidence before the start of a potential tax audit may be a crucial step towards a successful application of the deduction.

If you are interested, we will be happy to guide you through a “mock” tax audit.

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