What should you not underestimate in preparing the corporate income tax return?
For a whole series of entities, this year’s deadline for filing a due corporate income tax return is 1 July. The article below summarises the areas where, in our experience, entities frequently make mistakes, highlights the existing judicature and also provides a brief summary of the selected areas that you should not neglect in relation to the most recent amendment to the Income Taxes Act (the “ITA”).
1. Areas where mistakes are frequently made
Provisions against receivables and write-off of receivables
One of the frequently debated issues is whether it is possible to release a statutory provision against a receivable as of the balance sheet date and write off the receivable through tax-deductible expenses if the receivable became time-barred during the year. The existing wording of the ITA does not make this possible and, in the event of a tax audit, the tax-deductibility of this expense could be contested by the tax administrator.
For the correct utilisation in compliance with the ITA, it is necessary to have an internal system in place that will enable you to write off the receivable and release the tax provision before the receivable itself becomes time-barred.
Rental versus leases including the issue of technical improvements
The tax consequences of the termination of a lease contract may significantly increase the cost of a tax situation that is not overly complicated (eg, a move into new premises, termination of a lease contract, expiry of the period for which the lease contract was concluded etc). Even as early as in concluding a lease contract where technical improvements will be made on the leased premises and you, as a lessee, will be entitled to depreciate them, the situation also necessitates a tax analysis in addition to proper legal treatment.
If, for example, you, as a lessee, terminate the lease contract, do not remove the technical improvements and do not receive any compensation for the costs incurred from the lessor, the undepreciated portion of technical improvements will irrevocably become a tax non-deductible expense. Therefore, it is necessary, as early as in concluding the contract, to bear in mind the tax implications that may materialise years later. Adverse impacts may also apply to the lessor itself, for which the undepreciated portion of technical improvements may represent taxable income.
Holding an equity investment in a subsidiary
The appropriate treatment of exempt income in the form of a profit share paid by a subsidiary usually does not cause much trouble for entities. Where they sometimes make mistakes is the issue of relating expenses. In line with the ITA, it is necessary to treat all direct expenses relating to the holding of an equity investment in a subsidiary as tax non-deductible and, in respect of indirect expenses, you must be able to prove that they are lower than 5% of the dividend paid, or treat the value of 5% of the dividend paid as a tax non-deductible expense. In line with the ruling of the Regional Court (29 Af 53/2016 – 88), it is necessary to consider the circumstances of indirect expenses in a broader context and exercise caution if you expect them to be zero. This is for the reason that you may easily lack sufficient evidence and face an additional assessment of indirect expenses in line with the above-stated fiction of 5% of dividend paid, including relating sanctions.
Combination of Deductions, Gifts, Discounts and Tax Offsetting
If the tax return of your company is more complex, including, for example, tax-deductible items (research and development deduction, deduction of support for specialised education, tax loss), provided gratuitous supplies (gifts), discounts (eg, arising from an investment incentive or the employment of people with disabilities) or, for example, crediting of tax paid abroad, it is highly important to pay attention to the rules of their utilisation and the mutual interconnection of the relevant provisions. As, for example, gifts cannot be transferred to subsequent years, giving preference to them in decreasing the tax base over a transferred tax loss (transferrable for up to five taxation periods) automatically comes into consideration; however, such treatment would be a major mistake.
2. From the existing judicature – intercompany services
Ruling file ref. 8 Afs 216/2017 – 75 debated the situation where support services are provided by the parent company to the subsidiary (eg, management, service, technology and other services). Even though the payer (subsidiary) had a whole series of supporting documents demonstrating the provision of services (contract, invoice, presentation, telephone conferences etc), the tax administrator contested the entitlement to the tax deductibility of the services. In fact, according to the court, the tax payer failed to demonstrate for what portion of the total invoiced amount the specific services accounted. According to the court, the condition for the tax deductibility of these cases is, on the one hand, the clear specification of costs incurred and, on the other hand, their relation to the clearly specified provision of the service.
3. ITA amendment
In relation to the most recent ITA amendment, we consider it to be appropriate to point out, well ahead of time, the first two below-listed areas which will be relevant for a majority of companies from the next year onwards, and the new reporting duty, which has already come into effect.
Excessive Borrowing Costs
Besides the standard limits for the tax deductibility of loan interest within the group (the “thin capitalisation test”), the limits to the deductibility of interest are extended for taxation periods beginning on or after 1 April 2019 to include the newly introduced institutes of excessive borrowing costs. If what are referred to as excessive borrowing costs exceed the higher of the limits stipulated by law (30% of EBITDA or CZK 80 million), the positive difference will become a tax non-deductible expense. Excessive borrowing costs represent tax-deductible expenses (ie, borrowing costs that passed the thin capitalisation test as tax-deductible) following the deduction of borrowing income.
With effect from 1 January 2020, the ITA will introduce the obligation to treat the relocation of assets as part of a single tax payer from the Czech Republic abroad as constituting taxable income. The cost of the transaction must increase the tax base and will be carried at the amount that it would have in the event of a transfer between unrelated entities subject to a charge. In essence, the provision may apply to situations where assets are relocated by a Czech resident to its permanent establishment abroad, when assets are relocated by a non-resident from a permanent establishment in the Czech Republic abroad or when residence is relocated from the Czech Republic abroad.
Reporting Income Paid Off Abroad
The newly introduced reporting institute stipulates the obligation to also report payments that are not subject to taxation or exempt from withholding tax (eg, dividends, interest, royalties) on a monthly basis if they exceed CZK 100,000. Given the transitional provisions, please note that if such income is paid in April 2019, it will need to be reported as early as in May 2019. The Ministry of Finance has already released the relevant report on the financial administration’s website. It is also possible to apply with the tax authority for an exemption from the reporting duty for up to five years.
The article is part of dReport – May 2019, Tax news; Grants and investment Incentives.