Situation of facts

Prior to the establishment of the holding company, there was an operating company who´s shareholders were individuals. In particular, due to planned changes in the composition of the shareholders, when one shareholder wanted to withdraw from the business and a new shareholder was to join, a holding company was established, to which shares in the company and its sister company were sold. The holding company then settled the purchase price of the shares in the subsidiaries from the funds it received as a profit share from the subsidiaries.

The operating company obtained the funds for sharing its profit from a bank loan.

Subject matter

The subject matter of the dispute was the assessment of withholding tax on the profit paid by the taxpayer-the operating company to its parent company  – the holding company. The taxpayer initially claimed an exemption under Section 19(1)(ze) of the Income Taxes Act. The holding company then used the funds from the profit to repay the purchase price of the shares in subsidiaries. As the original shareholders met the time test under Section 4(1)(s) of the Income Taxes Act, this income was exempt from tax.

The tax authority considered the establishment of the holding structure to be artificial, as the holding company did not perform any activity for the first four years of its existence, and therefore applied the abuse of law principle to this situation. The tax authority argued that the transfer of the shares could have been carried out in other manners and that the establishment of the holding structure had no other objective than to obtain a tax advantage.

SAC assessment

The SAC first summarised that the abuse of law consists of two components: an objective component, which assesses compliance with the spirit and purpose of the law, and a subjective component, which assesses whether the predominant intention of the taxpayer was to obtain a tax advantage. In the case under review, the SAC found that the objective condition for the application of the abuse of law was met, since the combination of the exemption of the payment of the profit from the operating company to the holding company together with the subsequent exemption of the income from the sale of the shares in operating company resulted in the taxpayer’s profit not being taxed at all. According to the SAC, this is contrary to the meaning and purpose of the exemption of profit shares from income tax between parent and subsidiary companies provided for in Section 19(1)(ze) of the Income Taxes Act. While the purpose of this provision is to ensure that profits flowing through corporate structures are not taxed multiple times, the purpose is not to ensure that they are not taxed at all. Thus, profits should be taxed when paid to the ultimate owners – the individuals. However, this was not the case here as the holding company used the funds from the profit to repay the purchase price of the shares, which was exempted by the shareholders.

However, the mere fulfilment of an objective condition is not sufficient for the application of the abuse of law principle. The subjective condition, i.e. that the predominant purpose of the transaction was to obtain an unlawful tax advantage, must also be met. The subjective aspect is proved by the tax authority. Unlike the Regional Court, the Supreme Administrative Court found that in this particular case the tax authority had not borne its burden of proof.

This judgement is notable for the fact that the SAC dealt in detail with the concept of a ‘holding structure’. According to the SAC, a holding structure is one of the ways of structuring a business, which has a number of advantages. At the same time, holding is a concept that is not explicitly defined in Czech law (the closest concept being the legal regulation of a controlling person and a concern in the Business Corporations Act). Therefore, a holding company can perform a number of different activities. When establishing a holding company, it is necessary to consider several issues, in particular legal, tax, economic and business aspects.

A holding company may only manage the shares of subsidiaries or it may also provide services. The nature of the holding company and the way it operates may vary (pure holding company or mixed holding company) and may change over time. The fact that a holding company is built up and its activities developed gradually cannot give rise to a conclusion of abuse of law regarding its establishment.

In the present case, the taxpayer declared that the reason for the establishment of the holding company was to settle the shares in the subsidiaries. The taxpayer further argued that the holding company sought to make further acquisitions. In this respect, the tax administrator questioned, for example, that the e-mail addresses of the subsidiaries were used in the acquisition activities and therefore the relationship with the holding company was not proven. However, the SAC found this argument incorrect, as the legislation does not prohibit business activities, including certain acquisition negotiations, from being carried out by the holding company at the level of its subsidiaries. Also, the fact that the acquisitions were not brought to a successful conclusion does not necessarily mean that the conduct was utilitarian.

The tax authority also questioned the financing where the taxpayer took out a bank loan to pay the holding company a profit share. In this respect, it is necessary to appreciate the way in which the SAC approached the assessment of the tax authority’s burden of proof. The SAC stated that it was for the tax authorities to prove that the taxpayer’s actions were purposive and economically unjustified, or to refute the taxpayer’s version. On the contrary, in order to carry their burden of proof and demonstrate the subjective element of the abuse of law, they had to prove that the taxpayer’s conduct was utilitarian, i.e. prove that the result might in fact have been achieved without the establishment of the holding company.

If the tax authorities merely assumed that the subsidiaries could have paid the profits immediately from their own resources, without proving this, that is a presumption which impermissibly interferes with the taxpayer’s entrepreneurial freedom and discretion as regards the economic aspects of its business and is contrary to the principle of restraint on the part of the tax authorities.

In conclusion, it should be stressed that in this case it was decisive that the taxpayer provided several legitimate reasons for the establishment of the holding company. These included the need to straighten out the amounts of shares in the subsidiaries, the subsequent changes in the shareholders, and the acquisition activity that the taxpayers had documented. The tax authorities did not refute the taxpayer’s version and thus did not bear their burden of proof. Thus, according to the Supreme Administrative Court, the stated purposes of the establishment of the holding company outweighed the tax purpose, which, in the words of the court, was a desirable but not the principal reason for the tax entity’s actions.