The Supreme Court on Concurrence of Function Again

Last year in the autumn, we informed you of the Supreme Court ruling which contradicts the current judicial practice stating it is not acceptable for a company statutory body member to assume their duties as an employee of the respective company as the corresponding employment agreement would be deemed invalid.

The Constitutional Court did not see a reason why a statutory member should not be able to perform (a part of) their duties based on an agreement reflecting the Labour Code regime. Furthermore, the Constitutional Court ruled that no law specifically disallows functions to be accumulated and the ban has been introduced by general courts although a substantiated explanation as to why the stance should be maintained was required.

This claim was addressed by the Supreme Court in their ruling issued in January, 2017.

The Supreme Court maintained their stance claiming that the accumulation of functions, in this specific case they were the posts of a general manager and the board chairman (overlapping in the function descriptions corresponding to the activities of the statutory body), is legally inadmissible while substantiating the opinion in detail.

The main arguments articulated by the Supreme Court were as follows:

1. Not even upon the contracting parties’ agreement may a legal relationship be subject to the Labour Code unless the relationship is defined as a dependent activity, and
2. in the opinion of the Supreme Court it is not the case if the statutory body assumes both managing and executive functions without the existence of a subject directing the statutory body’s actions, and thus fitting the definition of employment – an employee performing dependent activities for the employer and following their orders on their responsibility for remuneration. Also, the employment relationship is obstructed by
3. the difference of interests, where in ordinary circumstances the employees aim to enter into as lucrative a contract (agreement) as possible; hence, the same physical person which is a party to a contract (agreement) as an employee may not protect their interests of an employee and those of the company as the employer accordingly at the same time.

The above, naturally, does not necessarily mean that the contracting parties may not, while negotiating the respective agreement on the performance of the function (or a similar contract between the company and the statutory body in accordance with the Civil Code), agree on such terms which would assign the statutory body similar responsibilities (advantages) an employee assumes while performing their functions for the employer unless prohibited by law. The Supreme Court specifically lists holiday/vacation, remunerations for obstacles to work and similar benefits even without the employment contract concluded in agreement with the Labour Code. It should be noted, however, that it is absolutely impossible (the same as in the case of employment) to negotiate limitations of the statutory body’s responsibilities.

Also, nothing prevents other activities for the company to be performed by the statutory body on the basis of an employment. The activities, nevertheless, must differ from those of the statutory body’s.

Technical Improvement to be Depreciated by Sub-lessee

The technical improvement – a term relating to Czech tax law. What is it?

Technical improvement is defined as expenses incurred in connection with finished superstructures, extensions and construction changes, reconstructions and modernisations of tangible assets exceeding CZK 40,000 with individual property per a taxable period. Reconstruction, then, is such an alteration of the property which results in a change of its purpose or technical parameters, while modernisation leads to improvements in the equipment or usability of the property. Technical improvement may concern any type of asset – machinery, vehicles, buildings and so on.

The following text focuses on technical improvements of leased tangible assets, i.e. expenses incurred by a future or a current lessee of somebody else’s assets. Most commonly, these are construction changes made by the lessee so that the property would fit their requirements – new spatial dividers in offices, business or production facilities altered in accordance with their specific needs or modernisation of old and unsuitable premises adjusted to their activities. Some of these may, according to the character of the works, be subject to building permits, other need to be reported or, in the case of modernisation or a mere change of several components, no supervision of the Building Authority is needed. All these actions, however, are financed by the lessee of the asset, they are performed on somebody else’s property and the owner does not reimburse the expenses in any way, for example in a form of a subtraction from the rent.

The Czech Income Tax Act provides for such cases by allowing the lessee/user of the asset to depreciate the expenses if the following conditions are met:

1. the expenses related to the technical improvement need to be incurred by the lessee
2. the lessor of the property (usually the owner) needs to express explicit consent and a contract on depreciations of the technical improvement needs to be signed, and
3. the input price of the asset may not be increased by the amount equal to the expenses regarding the technical improvement by the lessor/owner.

If the above conditions are met, the lessee is allowed to include the asset into their books to the same accounting class as the lessor does and depreciate it over the course of the lease in accordance with the Czech Income Tax Act.

After the lease has ended, the residual price of the technical improvement needs to be decided upon. As the technical improvement (usually construction changes) is an inseparable part of the lessor’s property, it is mostly impossible to distinguish, let alone separate, these two. It means that two situations may undfold:

1. the lessee “sells” the technical improvement to the lessor; in other words, the lessor reimburses the corresponding expenses incurred by the lessee, increases the value of the asset and will depreciate the increased price. The lessee excludes the technical improvement from their assets – it means they include the purchase price in their expenses and the selling price in their revenues. The operation is neutral in terms of income tax.
2. The lessor does not reimburse the technical improvement, which remains installed in the assets, and the lessee does not receive any consideration. In such a case, the lessor gains a non-monetary income the value of which equals the residual price of the technical improvement and needs to be determined in accordance with the Income Tax, while the lessee is left with a non-taxable expense on the day of the asset retirement, i.e. the day of the termination of the lease contract.

A combination of the two above is often made use of in practice; it may, then, be generally concluded that the lessee is only allowed to claim the residual price as taxable up to the amount of the expenses relating to the technical improvement, i.e. the amount reimbursed by the lessor.

Up until recently, the Income Tax Act has solely permitted the lessors and lessees to adopt the above procedure and it has not been possible for persons/entities in a sub-lease relationship, i.e. in cases when the lessee sub-leased the property or its part to a sub-lessee, to do so. Should the sub-lessee perform technical improvement of any kind (a construction change etc.) in order to conduct their business activities in accord with their intentions, they were not able to depreciate the expenses and these were non-taxable ones.

The situation is to be changed by an amendment to the Income Tax Act, which ought to become effective on 1 July, 2017. The expenses relating to the technical improvement will be possible for a sub-lessee to depreciate, and the Act will have similar impact on the lessee (being, in fact, a lessor). The lessee will depreciate the expenses in question in the same fashion as they do with their other assets after the sub-lease contract has expired/been terminated. The new rules will apply to technical improvements completed and brought into effect after the Income Tax Act amendment becomes effective.

To conclude, we should like to stress that we welcome the amendment as it guarantees fair and just procedures in the so comparable cases of leases and sub-leases.      

The article on „ The Rights Protection in Cases of Business Partner’s Insolvency “ published in October can be found here.