A recent Czech Supreme Administrative Court decision invoked the doctrine of abuse of law disallowing the tax deductibility of interest on a shareholder loan in an acquisition transaction. Since similar acquisition structures are in common use, the court ruling raises concerns whether or not it is to be considered as a revolutionary change in the legal and tax environment for real estate and other acquisitions in the Czech Republic.
The Supreme Administrative Court of the Czech Republic (the “Court”) recently issued a ruling supporting a regional court’s confirmation of the results of a tax inspection, on the basis of which a declared tax loss of the Claimant was materially decreased and a significant penalty (approx. €600,000) was imposed.
The subject matter of this case was the alleged abuse of law involving corporate restructuring with the intention to achieve tax advantages. The case related to restructuring measures involving shareholder loans, a subsequent intra-group merger and a contribution in-kind, the result being that a once-profitable real estate business became loss- generating and the cash generated by it was funneled up the structure without any material taxation in the Czech Republic.
The Court confirmed that although there was no technical breach of provisions of applicable tax laws, the usage by such company of legal mechanisms with the aim to achieve tax advantages without a proper commercial rationale is to be regarded as an abuse of law.
The Court referred to the doctrine of abuse of law as formulated in certain rulings of the Court of Justice of the EU and also reiterated an already known and used principle of tax law that transactions are supposed to have clear and sound, economically rational and justifiable reasons other than tax reasons. Some business reasoning was presented by the Claimant to the Court but such reasoning was not considered as sufficient to legitimatize the particular manner of restructuring involving a large loan generating sizeable interest payments.
This Court ruling evidences growing sophistication of both tax authorities and tax courts in the Czech Republic. The taxpayers and tax advisors should be aware that tax compliance involves not only technical adherence to particular provisions of tax laws but also observation of more broadly, and sometimes quite vaguely, phrased tax rules and principles such as abuse of law, economic grounds, substance over form, etc. The Court was keen to reiterate that its ruling does not disqualify commonly used acquisition techniques involving acquisition shareholder loans and post- acquisition mergers, but rather emphasizes the importance of sound economic reasons for such techniques, apart from merely tax savings. The Court repeated the idea of some of its preceding rulings according to which “it is necessary to carefully distinguish a situation when a tax subject chooses, from various alternatives coming into consideration that all have their independent reasons, such alternative that is most tax-favorable for him, which is a legitimate, law-approbated approach, from a situation where just the main purpose of the activity or transaction in question is the attainment of a tax advantage.”