Background Addressed by the Supreme Administrative Court

A foreign investor decided to take over a group of companies, including a Czech operating entity. The investor took a loan from an independent consortium of banks to acquire the multinational group. In the Czech Republic, the takeover was executed by setting up a holding company, which then took out a loan to acquire the Czech operating entity. Subsequently, a merger took place between the holding company and the operating entity, resulting in the transfer or pushing down of the loan to the operating entity itself.

The entire dispute focused on the deductibility of the interest on the loan for the acquisition of the operating entity, which was, at the end of the day, borne by the entity itself from the merger date.

Was this an Abuse of Law?

The tax administrator challenged an abuse of law in the described transactions, concluding that the primary aim of the transaction in the Czech Republic was to obtain a tax advantage through the deductibility of loan interest resulting in the reduction of the operating entity’s taxable profit. However, under the decisions of the administrative courts, abuse of law involves two elements: objective and subjective.

The objective element focuses on whether, despite meeting formal conditions, the true purpose of the relevant legislation was not fulfilled. The subjective element is evaluated based on whether the entity intended to gain an advantage by artificially creating the conditions to achieve it. Both elements must be concurrently satisfied to establish an abuse of law.

The Courts Said No!

The Regional Court in Prague (Case No. 55 Af 4/2020-137, dated 27 September 2022) initially ruled on the case, acknowledging the objective element of abuse of law but finding no evidence of the subjective element in the transactions under review. This decision has now been confirmed by the Supreme Administrative Court. The decisive factor for determining economic rationality (and thereby excluding abuse of law) was primarily the requirement imposed by an independent bank that financed the entire project. The court reasoned that it was economically justified for the bank to insist on pushing a portion of the loan down to the level of the operating entity. This arrangement enhanced the bank’s security for loan repayment: the operating entity would use its revenues and assets to repay the debt, and in case of insolvency, the bank could directly recover its claims from the financed assets, thus strengthening its position as a secured creditor.

According to the court, it was rational for both the bank and the investment group to agree to these conditions. Without bank financing under such terms, the acquisition might not have been feasible or would have been done under less favourable conditions. Therefore, the Supreme Administrative Court concluded that the subjective element of abuse of law was not present and affirmed the deductibility of interest on such financing.

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