The Supreme Administrative Court decides compensation upon recruitment is also admissible in the business sector
The current low unemployment rate and the problem of Czech employers to find and keep high-quality employees is the reason for the increased efforts of employers to make their job offers more attractive and to offer a variety of benefits and compensation for their employees. In addition to traditional benefits, one of the ways to attract new employees, even those living at a greater distance from the employer's workplace in the Czech Republic or abroad, is to provide reimbursement of travel expenses related to establishment of employment.
However, the provision of such compensation has long been the subject of debate and uncertain conclusions by legal and tax experts. In particular, it has been disputed whether, and if so under what tax regime, such compensation can be granted to employees of employers from the so-called business sector and whether it is a decisive factor that the residence of the employee to whom it is granted is located abroad. The answers to these questions are provided by the Supreme Administrative Court in its Ruling No. 2 Afs 413/2018-34 of 26 January 2021 (“the Judgement“).
Compensation upon recruitment in an employment relationship (“Compensation upon Recruitment“) is regulated by Section 177 of the Labour Code, which refers to Section 165 of the Labour Code as to the scope and amount of such compensation. Thus, reimbursement of travel expenses, accommodation expenses, or necessary incidental expenses, for example, shall be granted as Compensation upon Recruitment.
Given that the legislation on the Compensation upon Recruitment is systematically classified under travel reimbursements provided to employees of employers from the so-called non-business sector (according to Section 109(3) of the Labour Code, this includes e.g. the state, a local self-government unit, a state fund, etc.), it has been controversial in practice whether, and if so, under what conditions, such compensation can be provided by an employer in the business sector. In this context, it has often been assumed that Compensation upon Recruitment is exempt from personal income tax only if it is provided by a non-business employer, and if it is provided by other than such employers, it must be taxed.
Supreme Administrative Court: Compensation upon Recruitment Can Be Provided Even in the Business Sector
In the Judgement, the Supreme Administrative Court first commented on the question of the possibility of granting Compensation upon Recruitment to an employer from the business sector, even though this issue was not disputed between the parties. It stated that, although Section 177 of the Labour Code is systematically included in the part of the Labour Code regulating the provision of travel reimbursements to an employee of an employer in the non-business sector, an employer in the business sector may also provide Compensation upon Recruitment in accordance with the general principle “everything which is not forbidden is allowed”, applicable to that sector. The Court justified this by the provision of Section 156(3) of the Labour Code, which considers travel reimbursements to be reimbursements granted for expenses calculated in Section 152 of the Labour Code, which include Compensation upon Recruitment.
The Crux of the Dispute − Which Tax Regime?
An issue, in this case, was the tax treatment of the Compensation upon Recruitment so provided and whether it was relevant that the residence of the employee to whom they were provided was abroad.
As regards the facts of the case dealt with in the Judgement, it was a situation in which the applicant, as an employer, granted her employees, based on an internal regulation, Compensation upon Recruitment, namely reimbursement of travel expenses for travel from their place of residence (located abroad) to the place of work and back. The applicant did not pay income tax on employment income in advance on such reimbursements. The applicant was under the impression that he was not obliged to do so because travel reimbursements are not regarded as personal income from employment within the meaning of Section 6(7)(a) of the Income Taxes Act.
However, the Tax Office, as tax administrator, additionally assessed the applicant for payment of personal income tax from employment plus a penalty. The Appellate Financial Directorate upheld that decision, concluding that Compensation upon Recruitment is exempt from personal income tax only if provided to a non-business employer. The Appellate Financial Directorate also held that to be a tax deductible expense for the employer, the Compensation upon Recruitment must be a domestic travel expense. It reasoned that travel reimbursements for foreign business trips are dealt with in the Labour Code in Section 166, which does not list the provision of Compensation upon Recruitment.
The Appellate Financial Directorate did not consider the provision of travel reimbursements to employees for travel from their residence abroad to their place of work or regular workplace in the Czech Republic to be consistent with the Labour Code and therefore did not consider them to be travel reimbursements. As regards the tax treatment of these benefits, it did not consider them to be a tax deductible expense of the employer within the meaning of Section 24(2)(zh) of the Income Taxes Act, but a tax deductible expense classifiable under Section 24(2)(j)(5) of the Income Taxes Act, i.e. an expense incurred for employees’ rights arising from an internal regulation of the employer. Such expenditure is taxable income of the employee under Section 6(1) and (3) of the Income Taxes Act.
Supreme Administrative Court Disagrees with Tax Office
The Supreme Administrative Court disagreed with the above. It held that the reimbursement of expenses granted by the applicant (the employer) to his employees in connection with their employment must be regarded as travel reimbursements within the meaning of Section 152(1)(f) of the Labour Code. This is provided that the employer complies with the conditions and limitations (as regards the amount and duration of the reimbursement) laid down by the Labour Code. Such travel reimbursements are a tax deductible expense of the employer pursuant to Section 24(2)(zh) of the Income Taxes Act and, at the same time, they are not taxable income of the employee up to the amount defined in Section 6(7)(a) of the Income Taxes Act (i.e. up to the amount determined or allowed by a special legal regulation for employees of the employer in the non-business sector).
This landmark Judgement has thus made it clear that the institute of Compensation upon Recruitment is also applicable to employers from the business sector, while even in their case, under the statutory conditions, it will not be taxable income of the employee to whom such costs are provided. The Supreme Administrative Court has also confirmed that the use of this institute is not limited to expenses for trips made only within the Czech Republic but can also be used for trips made by employees from abroad.