Corporate income tax in recent judgments of the Supreme Administrative Court

In August 2023, the Supreme Administrative Court ("SAC") issued a number of judgments against the affected tax entities. In this article, we present an overview of selected judgments in the area of corporate income tax, in which the tax liability, including related penalties, was assessed on the basis of the SAC's decision:

Advertising costs

• The judgment of the SAC 4 Afs 39/2023 confirmed the conclusions of the tax administrator, who assessed corporate income tax on the taxpayer in the course of a tax audit, due to the failure to prove the tax effectiveness of advertising costs in accordance with Section 24(1) of Act No. 586/1992 Coll., on Income Taxes, as amended ("ITA"). The tax administrator had doubts about the actual broadcast of advertisements on LCD screens to the extent and at the time declared by the taxpayer. These doubts were not refuted even by the witness testimonies, which showed elements of unreliability. Although the tax entity submitted a number of documents proving contractual arrangements with the providers of advertising services (formally impeccable accounting documents, bank statements), the SAC concluded that even documents with all the requisites may not be the basis for the recognition of costs under Section 24(1) of the ITA if it is not also proven that the performance actually took place (i.e. not only the formal requisites of the documents are decisive, but also the factual situation).
• In its judgment 6 Afs 69/2023, the SAC upheld the conclusions of the Regional Court, which had challenged the prices agreed between the entities in the context of the provision of advertising services. The taxpayer claimed as tax costs the expenses for advertising services in the form of advertising of its company on panels in the arenas and stadiums of sports clubs, which he purchased through a chain of subcontractors (some of whom were non-contactable and did not fulfil their tax obligations). Within this chain, the price of these services was increased many times over without changing their content and scope. According to the tax administrator, the tax entity established a legal relationship with the primary suppliers of services mainly for the purpose of reducing its tax base, and the parties to the transaction were thus assessed as so-called otherwise connected persons pursuant to Section 23(7)(b)(5) of the ITA. As the differences in these prices were not documented to the satisfaction of the tax administrator, the tax entity adjusted the tax base by this difference and charged income tax.
• The judgment of the SAC 4 Afs 221/2022 confirmed the conclusions of the tax administrator, who assessed that the accommodation and advertising expenses reported by the tax entity could not be recognised as tax-effective under Section 24 of the ITA, as their actual implementation had not been confirmed. The tax entity had not proved the declared expenditure for accommodation of employees (which business trips were involved, who was accommodated, for what purpose, etc.) and the exact scope, the actual supplier of the advertising expenditure and its direct and immediate impact on taxable income. The Supreme Administrative Court stated that if the taxpayer had already thought when arranging the advertising services to also prove that they were supplied to the extent declared (e.g. by checking with its employees), this would be evidence of fundamental importance, assuming that credibility was established.

It follows from these judgments that if the tax entity is to establish the legitimacy of the application of the incurred advertising costs as a tax expenditure in the event of a tax audit, it must be able to provide not only complete and correct supporting documents, but also to prove the actual implementation of the performance in the declared scope, volume and time. At the same time, we urge compliance with the principle of "arm's length pricing" agreed between related parties as defined by the ITA.

Research and development ("R&D")

• In its judgment 10 Afs 12/2021, the SAC upheld the Regional Court's conclusions regarding the failure to meet the conditions for the possibility of deduction for R&D support. In this case, the taxpayer did not fulfil one of the essential conditions, which was the prospectivity of the R&D project, i.e. that the R&D project had to be announced before its implementation. If a business is to act in an economically rational manner and actually invest in real R&D, it is not possible to start an R&D activity and decide at a certain stage (in this case after the contract has been awarded) to set up and approve the project. In addition, during the tax audit, corrections were made to R&D projects and the records of the eligibility of personnel costs showed deficiencies, inconsistencies and ambiguities.
• In its judgment 4 Afs 229/2022, the SAC agreed with the legal opinion that if the expenses incurred for R&D were not recognised as costs under the relevant accounting regulations, they cannot be recognised as deductible items. In this case, the taxpayer accounted for the materials and components used in the implementation of the R&D projects and claimed deductible items as tangible fixed assets in progress (account group 04), not as costs (account group 05). Its plea that it was a mere accounting error did not succeed.

The rules for the possibility of claiming R&D costs as a deductible item from the tax base are strictly defined in the ITA. This is a rather demanding administrative process, which we will be happy to guide you through so that your company can ensure the legitimacy of the deduction for R&D support in the event of an audit of this area by the tax office.

Crown bonds

• In the judgments cited below, the SAC commented on the application of the abuse of rights principle in relation to the issue of so-called crown bonds, concluding that the objective and subjective elements of the abuse test were met in all the cases in question. In those cases, the intentional acquisition of a tax advantage contrary to the purpose of the ITA was proven:
  • 2 Afs 167/2022 (SAMARINDA SE)
  • 4 Afs 231/2022 (KOH-I-NOOR HARDTMUTH a.s.)
  • 5 Afs 110/2022 and 5 Afs 111/2022 (KRKONOŠSKÉ PAPÍRNY a.s.)

Crown bonds are still in the crosshairs of audits by tax authorities, which aim to uncover artificial needs to issue bonds, on the basis of which issuers were taxed on the interest expense while creditors were taxed on the interest income at zero withholding tax (thanks to rounding down the tax base per individual bond to whole CZK). We therefore draw attention to the need to demonstrate the economic sense of the transaction. If you require further information and assistance in the context of a tax audit, we would be pleased to offer you our expert support.