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Dear Readers,

We want to inform you about Judgment of the Supreme Administrative Court (the “SAC”) Ref. No. 10 Afs 16/2023 - 78 dated 23 July 2024. In that judgment, the SAC dealt with economic rationality of establishing a holding in connection with abuse of rights.

What Was the Judgment About?

FPPV s.r.o. (the plaintiff) established a holding as one of the methods of financing the purchase of one of the partners’ investment. Subsequently, the plaintiff paid a share in profit of the parent company, from which it paid the purchase price for the transfer of investments to the plaintiff’s partners (natural persons). The transaction was financed from both finance acquired from shares in profit and finance obtained from an investment loan.

In both transactions (income from shares in profit and income from the investment’s transfer), tax exemption was applied in compliance with:

• Section 19 (1) (ze) of the Income Tax Act (the “ITA”) subject to compliance with Section 17 (3) of the ITA – for the income from the share in profit paid by the subsidiary; and
• Section 4 (1) (q) of the ITA – for the income from the transfer (against consideration) of the investment in the corporation.

The major issue was to consider whether artificial conditions of the holding were established and if the law’s purpose was contradicted in the case under discussion.

Decision of the Tax Administrator and the Regional Court (the “RC”)

The tax administrator found the concerned transaction questionable and assessed additional withholding tax from the payment of the shares in profit and the investment’s transfer.

In the tax administrator’s and the RC’s view, the holding’s establishment had no objective reason because the holding did not perform any relevant economic activity. In fact, all activities were performed by subsidiaries from the beginning. Moreover, the holding did not perform any management activity or the subsidiaries’ governance.

The RC also states that the plaintiff did comply with formal conditions of the law but the acting was in contrast to the purpose thereof and, as a result, the plaintiff misused the law’s text in order to avoid taxation. The plaintiff’s acting attained both the objective (formal compliance with the law’s conditions) and subjective (the major purpose of the executed transactions was to obtain tax benefits) elements of the rights’ abuse. In the RC’s opinion, the purpose of this artificially established situation was to induce a causal connection between the transactions, which were primarily intended to reduce tax liability.

The SAC’s Statement

The SAC opens its statement by saying that distribution of the burden of proof applies in the concerned case. The taxpayer proves facts in a tax claim and additional submissions, and the tax administrator proves the meaning and purpose of a law, the application of which ultimately resulted in the abuse of rights in connection with a consideration of specific circumstances.

The SAC also states (referring to SAC’s Judgment Ref. No. 1 Afs 35/2007‑108) that a taxpayer has the exclusive right to structure their operation so that they can minimise their tax liability. What renders this procedure legitimate is the choice of the most advantageous tax option, which is economically rational given the business’ purpose. However, if the taxpayer’s conduct has no objective explanation other than achieving a tax advantage, such conduct contradicts the law’s meaning and purpose. Referring to Judgment Ref. No. 10 Afs 289/2021‑42, the SAC adds that all relevant circumstances have to be taken into account in assessing compliance with the subjective and objective element of rights’ abuse. Based thereon, the tax administrator should rule out the rational justification of the taxpayer’s conduct and find the artificial structure aimed at obtaining tax benefits.

The SAC found in the concerned case that the objective element had been complied with. By combining the transaction of the shares in profit’s payment and the purchase price’s payment for the investments, tax exemption was achieved in both cases. As a result, the exemption’s purpose pursuant to Section 19 (1) (ze) of the ITA, which is taxation of income only in the final recipient, was not met. In the SAC’s view, tax authorities failed to prove that the only purpose was to obtain tax benefits (the subjective element). In the SAC’s opinion, tax authorities took only certain facts of the case into consideration in the assessment and focused exclusively on the tax purpose without considering other factors. In the SAC’s view, the plaintiff sufficiently explained the holding’s establishment.

The SAC did not agree with the RC’s assertion that the subsidiaries did not cooperate with one another or were not managed and the holding therefore had no economic purpose. In the SAC’s view, those assertions do not have any weight with respect to the economic justification and, moreover, a holding does not have to manage its subsidiaries. The SAC also confirmed settlement of investments as one of the legitimate reasons for establishing a holding structure, the more so that the plaintiff clearly explained their opting for this solution.

In the SAC’s opinion, the case under discussion did not involve any abuse of rights because the subjective element of the abuse of rights’ test was not met. The SAC set the RC’s judgment aside because tax authorities failed to bear the burden of proof, and referred the case back to the Tax Appeal Board for further proceedings.

If you want more information about the judgment, please feel free to contact us. We will be happy to help you.

Stela Bartošová
bartosova@clarksonhyde.cz