Even a legally sound transaction may be viewed as legal abuse by tax authorities. Decision of the Supreme Administrative Court Ref. No. 6 Afs 376/2018

21. 12. 2020

The Supreme Administrative Court ruled in favour of tax authorities that applied - on the basis of tax inspection results - a tax adjustment for corporate income tax in the form of a withholding tax at a special tax rate of 15% of the value of profit distributions due to the failure to withhold and subsequently pay such tax.

Company A was established on the basis of its transformation by spin-off, with funds amounting to CZK 210 million allocated to the company as part of the transformation process. This newly established company was owned by its shareholders – individuals – who transferred their shares to Company B at a price of CZK 207 million shortly after the incorporation of Company A. Company B thus became the sole owner of Company A. However, Company B had no funds to pay the purchase price as of the transfer date; therefore, it decided to pay dividends from Company A on the basis of a resolution concerning the distribution of profits for the purpose of the purchase price settlement - on the same day it became the sole owner of Company A on the basis of a share transfer agreement. Since a conditional relationship of a parent company vs. subsidiary existed as of the dividend payment date in terms of the Income Tax Act, a scheme for an exemption from income tax accorded to dividend payments pursuant to Section 19(1)(ze)(1) of the Income Tax Act was used. Once additional conditions for the said tax exemption were met – i.e. adherence to a shareholding period of 12 months – Company A was wound up.

According to the competent tax authorities, such conduct was clearly calculated, carried out with a view to pay out company’s funds to its original shareholders while ensuring that such income is not subject to tax as opposed to other forms of payment of such funds to the original shareholders (e.g. a distribution of dividends subject to tax or payment of liquidation proceeds).

Company B unsuccessfully argued during the court proceedings that the purpose of the separation of the financial funds and their allocation to a newly established company was a development project implementation; moreover, it failed to prove that several potential buyers expressed their interest in purchasing the shares. The facts that the shareholders agreed to the sale of their shares at a price lower compared to the value of the financial funds in Company A (i.e. they “were selling financial funds at a loss”), that all transactions took place on one day without any time gap, and that the shares had been purchased even though Company B was aware that it did not have the funds to effect such purchase, were also held against the company. Furthermore, the purchase price of the shares was subject to review as well, since the revenue of Company B has amounted to hundreds of thousands of Czech crowns in recent years and it did not make any economic sense for Company B to purchase the shares of a company, the only assets of which were in the form of financial funds that were subsequently transferred in order to pay the purchase price.

The Supreme Administrative Court focused on the economic rationality of executed transactions, concluding that where a transfer of shares in a company associated with subsequent profit distributions has no or negligible economic justification and is clearly aimed at obtaining a tax advantage, it contradicts the purpose, for which tax exemptions were introduced by law, also stating that it is an unambiguous legal abuse in the given case.

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