Key ruling of the Supreme Administrative Court

Good news entrepreneurs eligible for investment incentives

With effect from 1 May 2015 an amendment to the Law on Income Tax brought a reduction of sanctions for entrepreneurs who failed to comply with the conditions set out by the investment incentives regulation. Under previous legislation, in such cases the Tax Office was entitled to revoke the whole investment incentive and retrospectively impose tax for the entire time the subject applied the investment incentives in the form of tax deduction.

Such penalty could be viewed as excessively severe. Even in case of failure to comply with the conditions in a single year the entrepreneur was obliged to return the full amount of the investment incentive. The taxable subject was obliged to submit additional tax declarations for each tax period in which it applied a tax deduction.

The Czech Supreme Administrative Court has (based on the petition filed by Schaffer&Partner, represented by Šárka Gregorová) now confirmed that more moderate penalties will apply also for entrepreneurs who failed to comply with the conditions for being eligible for investment incentive before 1 May 2015.

The regulation of investment incentive is especially complicated for companies that are part of a group of affiliated companies. Additional conditions for intercompany prices, for which they may sell their services and products within the group, apply for these companies. So called “transfer prices” can be neither too low nor too high so that fictitious profit spill-over between individual members of the group for the purpose of fiscal evasion may not be achieved.

In case the transfer pricing regulation is not set in accordance with the law and as a consequence the subject increases its tax basis resulting in applying higher tax deduction, the individual member of the group violates the special conditions for investment incentive and may lose its tax deduction altogether.

In the case ruled by the Supreme Administrative Court was the tax subject a member of an international group of companies and applied tax deduction based on investment incentive. The tax authorities carried out a tax inspection upon which they concluded that the transfer prices were set in breach with the law. According to the tax authorities the parent company invoiced to the tax subject (the daughter company) for its services too small amounts, leaving the daughter company too profitable. Based on this the tax office revoked the investment incentive of the tax subject and retrospectively imposed income tax for the whole inspected period.

The tax subject did not agree with the conclusions of the tax office and protested against the retrospectively imposed income tax. Its argumentation was based on two different aspects. In the first place, the taxpayer insisted that the transfer prices were set in the line with the law and the economic analysis of the taxing authorities was performed erroneously. Secondly, the tax subject opposed the fact that the tax authorities used the Income Tax Act in the wording valid till 30 April 2015. According to the tax subject’s opinion the tax authorities should use the Income Tax Act as amended from 1 May 2015, which sets reduced sanctions for breach of special conditions (i.e. for incorrect setting of transfer prices)

The tax subject, represented by the tax and legal team of Schaffer & Partner in the proceedings in front of the tax office and courts, was successful in its line of reasoning. The Supreme Administrative Court (and the Regional Court before it) has adopted a clear position with respect to the application of the Income Tax Act. In the opinion of the Supreme Administrative Court, the new more moderate legislation must be, according to the transitional provisions, applied also in cases when the entrepreneur breached the special conditions for investment incentive before 1 May 2015. The date of the tax inspection and the date of the discovery of the misconduct of the tax subject do not play any role in setting the applicable regulation.

The interpretation of the transitional provisions approved by the Supreme Administrative Court is fundamental especially for groups of affiliated companies and members of concerns eligible for investment incentive. Should a member of a group apply transfer prices contrary to the law, under the new more restrained legislation it loses the right to a tax deduction based on being eligible for investment incentive only for the tax period in which such violation arose. This loss of right corresponds to the amount of the tax attributable to the part of tax basis, which originated in the violation of the transfer prices.

As an example may serve a corporation, that paid too low transfer prices for services of a different member of its concern. Such company has violated the special conditions for applying its right to tax deduction, because its costs for these services were too low by which the company has illegally increased its tax basis. The tax authorities shall, according to the new legislation, set the correct price for such services within the concern. The difference between the agreed price and the price set by the tax office shall be multiplied by 19% with the resulting number setting the maximum amount in which the tax subject may lose the eligibility for investment incentive. 19% is the Corporate Tax Rate for legal entities in the Czech Republic.