Recently, the Extended Chamber of the Supreme Administrative Court (SAC) expressed its opinion on whether the tax administrator is obliged to take account of so-called essential expenditures (costs) in a situation when goods or services were in fact acquired, but the taxable entity does not prove the tax deductibility of expenditures spent on these goods or services and the remaining uncontested expenditures are not sufficient to achieve a specific taxable income. That is in a case when the substantial part of accounts (tax records) was not challenged.
Circumstances of the case
Costs incurred by the taxpayer for auxiliary construction work invoiced by three contractors were not recognised as tax deductible. The taxpayer did not prove that they had received the work from the declared contractors, nor did they prove its scope or price. In the tax proceedings, neither the real performance of work nor the taxpayer’s statement that they were unable to perform the auxiliary construction work using their employees was put into question. The tax was determined based on proving evidence, not on aids.
The Regional Court stood up for the taxpayer, saying it cannot be tolerated that the expenditures to reach taxable income applied by the taxpayer might be ignored in full, even though their real amount was not proven reliably. If the real amount of the expenditures declared, which, on the other hand, are objectively necessary to reach taxable income, was not proven, the tax administrator should have determined the tax using aids and discovered the so-called essential expenditures.
After the Appellate Financial Directorate lodged an appeal in cassation, the case was submitted to the Extended Senate of the SAC, as the issue of whether the questioning of even a marginal part of the accounting books or rather a specific expenditure or kind of expenditure, may lead to switching to aids, was interpreted differently in the SAC’s case law to date.
Switching to aids and the tax administrator’s obligation to take the so-called essential expenditures into account
The tax is determined primarily based on the statement of the taxpayer and the correct amount is determined by proving evidence. The taxpayer bears the burden of proof regarding the amount of tax deductible expenses. Only when the tax cannot be determined based on evidence because obligations were not met when proving evidence, a surrogate tax determination method may be considered, i.e. tax determination using aids when the tax administrator is to consider the so-called essential expenditures as well. To determine the tax obligation based on aids, the following three conditions must be met:
According to the Extended Senate of the SAC, the rate of discrepancies or errors found, which arose because legal obligations were not met, and the possibility to be able to determine tax by proving evidence based on these misconducts or not, is always to be assessed in relation to the tax obligation for a specific taxable period. That is, not in relation to one of the business cases within the taxable period or only in relation to the accounting deficiencies expressed in percent.
It has to be examined whether, even in a situation when the taxpayer did not prove spending a specific expense or prove its amount, it is still possible to determine the tax for the taxable period based on proving evidence or not. The Extended Senate of the SAC declined the opinion that if the taxpayer has failed to bear the burden of proof regarding an expense (including its amount) exercised for real goods or services, the tax administrator is, without further questioning, obliged to switch to determine tax using aids and take the so-called essential expenditures into account.
On the other hand, according to the Extended Senate of the SAC, it is not true that you can switch to determining tax using aids solely provided that the tax administrator questions a significant part of the accounting (i.e. business activities are clouded). A high rate of discrepancies or errors found, which do not allow for determining tax by proving evidence, may not always be caused merely by questioning a significant part of the accounting. Another reason for switching to using aids may also be a significant blackout based on the overall number of discrepancies in the accounting records or on the overall volume of questioned transactions.
Objectively minimum necessary expenses (essential expenditures) when proving evidence
So far, essential expenditures have been applied merely when determining tax using aids. The Extended Senate of the SAC has newly dealt with applying essential expenditures when determining tax by proving evidence and concluded that this possibility exists. Since it is necessary to allow the taxpayer to prove real or, more precisely, objectively minimum necessary expenses spent by him, even in a situation when the factual supplier of the existing goods or services was a different entity than the entity named in the accounting documents.
According to the Extended Senate of the SAC, in case the taxpayer is unable to bear the burden of proof related to a specific expense, or rather its amount, as tax deductible, they may correct their former statements and offer new statements on having to spend a specific minimum amount of funds on purchasing goods or services in question. However, the taxpayer is obliged to prove these new statements duly. The means of evidence will probably come from another field than accounting and will de facto replace or supplement the implausible, incomplete, inconclusive, or incorrect original documents. However, it should be noted that this is an extreme situation, where the taxable entity did not abide by the standard manner of claiming expenditures as expected by law. If the taxable entity wants to eliminate the consequences of its error, it is obliged to prove that the essential expenditure was spent.
The court’s conclusion
Tax deductibility of expenditures (expenses) pursuant to Section 24 (1) of the Income Taxes Act is to be proven by the taxpayer. When the taxpayer proves that the expenditure (expense) in fact occurred (had to in fact be spent), even though under other circumstances (including another amount), as declared on the documents, the expenditure may be recognised as tax deductible, when other legal conditions are met.
When the taxpayer does not prove circumstances in favour of tax deductibility of a specific expense (group of expenses) pursuant to Section 24 (1) of the Income Taxes Act, the tax administrator is not obliged to switch from determining tax by proving evidence to determining tax using aids and to determine a relevant part of expenditures that are objectively minimally necessary for purchasing existing goods or services (so-called essential expenditures).
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