NSS k dohode o narovnani

NSS on the Settlement Agreement

If disputes arise between subjects regarding the existence of mutual rights, it is possible to settle these disputes by means of a so-called settlement agreement. Under such an agreement, the disputed rights and obligations are extinguished and at the same time new rights and obligations are created, for example, a new obligation or claim under the settlement agreement replaces the original disputed obligations or claims.

The Income Tax Act does not expressly include a tax treatment of costs arising from a settlement agreement. Only Instruction D-59 states  that the expense belongs to the period in which the settlement agreement takes effect. In the context of the Coordination Committee (see statement of Tax advisory chamber dated  26.1.2005, 05/26.01.05, Tax aspects of the Settlement Agreement), which focused on the tax aspects of settlement agreements, the tax deductibility of the related costs was justified by the following arguments:

• The agreement is concluded between separate legal entities in the course of business.
• The conclusion of the agreement avoids future litigation and eliminates the associated future costs.
• A cost related to a disputed liability that is extinguished in a settlement would be considered tax deductible.
• The costs associated with a payment under a settlement agreement are not specifically listed as tax-deductible in the Income Tax Act.

In a recent judgment, the Supreme Administrative Court (see Case No. 5 Afs 236/2022 - 36) considered a situation in which a company entered into a settlement agreement. The reason for concluding this agreement was not to change the nature of the original (disputed) liabilities, but to eliminate future costs related to possible litigation. According to the taxpayer, the expense claimed was in the nature of a kind of compensation payment minimising future costs and thus logically resulting in higher taxable profits in subsequent periods.

The SAC did not agree  with the taxpayer's argumentation . In this case, the compensation payment could not be considered as a tax deductible expense due to the lack of a link between the expense and future income. Furthermore, according to the SAC, in general, in the context of tax law, costs incurred as a result of a settlement agreement cannot be completely separated from the original disputed costs, which are changed by the conclusion of the agreement. The tax deductibility of a payment from a settlement agreement must be determined by whether the cost relating to the disputed (agreement-adjusted) liability would already be tax-effective. According to the Court, a contrary conclusion would lead to the conclusion that the negotiation of a settlement agreement could also replace liabilities relating to non-recoverable costs.

What to take away from this? When using the Settlement Agreement, there should be a genuine dispute or doubt as to the validity of the contractual relationship between the parties involved. The application of the agreement to other cases, such as compensation payments or correction of accounting errors, may be problematic in practice and may not be consistent with the purpose and intent of the settlement. If you will be dealing with the setting up of such an agreement in practice, it is advisable to check all the implications (including tax ones) in advance.

If you have any questions, please contact the authors of the article or the advisory team you are working with.

Authors:

Ivan Zhurkin

Martin Rabušic