The Supreme Administrative Court’s View of Beneficial Ownership in Sublicense

At the end of last year, the Supreme Administrative Court (SAC) handed down a judgment on the application of withholding tax to income paid between two Czech tax residents on the basis of the terms of the concluded sub-licensing agreement. In its ruling (10 Afs 140/2018 – 32), the SAC found that the Czech company receiving royalties had been in fact a 'pass-through’ element only and the beneficial owner of the royalties was a Russian company (tax non-resident). This non-resident company licensed a Czech company, which further ensured production under a sub-licensing agreement in another Czech company (applicant/complainant).

The Regional Court in České Budějovice and subsequently the SAC concluded that the Czech entity had only been the recipient of the royalties, but not their beneficial owner, since it had been obliged to pay fees to the Russian company as a licensor (with which it had a licence agreement concluded) in the same amount as the applicant itself paid to it under a sub-licensing agreement. According to the court, section 19(6) of the Income Tax Act is not fulfilled which defines the beneficial owner as the person receiving payments for his own benefit and not as an intermediary, representative or agent for another person. This should have been obvious to the applicant from the context and it should have therefore withheld and levied the tax at a 10% WHT rate from those fees (pursuant to Article 12(2) of the Double Taxation Treaty between the Czech Republic and the Russian Federation).

The SAC sees no reason to distinguish between the taxation of regular recurring payments, the amount of which is based on the value of production, and the taxation of the so-called one-off (first) payment for granting a licence. The subject of the tax under the Czech Income Tax Act is compensations for the provision of the right to use other economically usable knowledge (know-how) whereby the one-off payment to the licensor (sub-licence) referred to by the complainant as a fee for the conclusion of a licence agreement falls in this category.

Liability is on the tax payer’s side

The SAC’s decision is relatively short, it does not give the details of the contracts and mutual relationships or what role any reorganisation of the beneficiary of (sub) royalties has played in the case. Basically, the cassation complaint merely copies the original action, which has previously been dismissed by the Regional Court, without the applicant coping in any way with its arguments. The SAC thus concluded that according to Czech legislation, the Czech company as a payer of income was responsible for the withholding and payment of the tax in the proper amount and since the applicant was aware that the beneficial owner of the royalties was ultimately a non-resident company from Russia and not the Czech company, it was to withhold and pay the withholding tax in accordance with the relevant Double Taxation Treaty.

In practice, the majority of payers verify this when paying income abroad, but in the context of the relevant judgement, domestic payments need to be viewed from this perspective – in particular where there are indications or doubts as to whether the beneficiary of the income is their beneficial owner.

We remind you that in the spring of the last year, the European Court of Justice issued interesting rulings concerning the requirement of beneficial ownership in relation to the application of the withholding tax exemption on the basis of European directives. (More in the article Interpretation of beneficial ownership by the EU Court of Justice) However, it did not decide regarding the concept of beneficial ownership as such, but rather abuse of law. This subject is quite topical even in the surrounding countries. We therefore recommend that you examine the tax aspects of the income paid and set up pertinent measures so that your company is not exposed as a payer to the risk of additional tax assessment.

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