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Dear Readers,

This article is to inform you about Judgment No. 7 Afs 121/2023–44 of the Supreme Administrative Court (the “SAC”) dated 17 May 2024. In that judgment, the SAC dealt with a question what nature in a transaction between apparently independent entities will meet conditions pursuant to Section 23 (7) (b) (5) of Act No. 586/1992 Coll., on Income Taxes (the “AIT”), i.e. will be, in terms of the supply’s nature, seen as a transaction between related parties with duties in relation to the arm’s length price. The above-provided provision defines related parties as parties that also include those whose relationship was established primarily for the purpose of reducing the tax base or increasing a tax loss.

What was the Judgment about?

A company (complainant) contracted a commercial supply in the form of advertising and promotion services, and applied costs of that supply in full as tax deductible. Based on a tax inspection, the tax administrator removed the costs from the tax base and imposed an additional corporate income tax on the company. According to the tax administrator, the transaction was purposeful and irrational and the agreed price was unusual in the tax administrator’s opinion. In the tax administrator’s view, the agreement was primarily supposed to lead to a reduction in the tax base and, as a consequence, that transaction meets the nature pursuant to Section 23 (7) (b) (5) of the AIT. The Regional Court agreed with the tax administrator’s conclusions.

The price of the advertisement was substantially higher than prices that would have been agreed under standard market conditions. The transaction’s irrationality was documented by illogical and unreasonable conduct, which a reasonable business person would not be likely to perform because the advertising’s efficiency ultimately resulted in an increase in turnover due to increased invoicing to existing customers.

The complainant disagreed with those conclusions because, in its opinion, tax authorities did not bear the burden of proof and compliance with the condition in the above-mentioned provision of the AIT was not sufficiently proven.

The SAC’s Opinion

The Supreme Administrative Court agreed with the complainant that the burden of proof was to be borne by the tax administrator. According to the SAC, two conditions have to be concurrently met for the transaction to meet the definition pursuant to Section 23 (7) (b) (5) of the AIT – the existence of a legal relationship and the purpose thereof, which is mostly to reduce the tax base.

In the SAC’s opinion, the first condition was substantially met by the provision of a supply and by entering into a written agreement. In relation to the second condition, the SAC highlighted a difference between the intention and the purpose. According to the SAC, it is the ultimate purpose of the transaction, which is to result primarily in a reduction of the tax base, to be of key importance rather than the intention of a legal relationship’s establishment. The tax administrator is obliged to prove the taxpayer’s acting for the purpose of optimising taxes against the tax base’s level. Hence, the above-mentioned provision applies to situations where a taxpayer seeks to artificially optimise their tax base with the use of items with no economic value for the taxpayer.

The SAC say that it is not sufficient to only prove one condition, i.e. to prove the existence of the supply’s price difference from the arm’s length price, to meet the definition of otherwise related parties pursuant to the above-mentioned provision. The relationship’s consummation has to also be linked to circumstances of the final outcome of the relationship’s establishment. This means that the circumstances and the outcome resulted in a supply, the purpose of which was to reduce the tax base, with a subsequent implication for the tax’s level. The SAC therefore stated that the above-mentioned provision reflected the taxpayer’s freedom in agreeing commercial prices but the tax administrator does not have to accept the agreed amount, if the objective purposes of satisfying economic needs (i.e. spending of costs in compliance with Section 24 (1) of the AIT) fail to be sufficiently met.

In the SAC’s view, administrative bodies bore the burden of proof and agreed with the tax administrator’s and the Regional Court’s conclusions. Hence, in the SAC’s opinion, the business transaction in the present case was illogical and unusual and did not show any added value for the taxpayer; as a consequence, this transaction met the definition of a transaction between related parties pursuant to Section 23 (7) (b) (5) of the AIT.

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