Tax and Legal News – September 2024

(Ab)use of the law

For some time now, we’ve been used to the idea that the wording of the law and its creative application are not enough. Above all, there are the general principles of the abuse of law, with respect to which there is quite extensive Supreme Administrative Court (SAC) case law – we know the basic theoretical principles: the objective test and the subjective test.

Some standard planning techniques of the 1990s and early 2000s are dead and gone. Some, on the other hand, are still (only) hanging on by a thread and specific case law still doesn’t suffice for clear conclusions. The SAC recently adjudicated two specific issues quite extensively: the so-called debt push down and the payment of dividends through a holding. It is astonishing that both have been used essentially since the beginning of the new tax system in 1993 and that the first sensible case law is only now emerging. Unlike, for example, crown bonds, where most of the market ended up in court in a historically short time.

In simple terms, debt push down means a situation in which Company A wants to buy Company B. Company A borrows from the bank, buys shares in Company B, and then Company B merges into itself. As a result, Company A holds the entire business of Company B, the profits of which, among other things, can be used to repay the acquisition debt. The tax effect is such that the interest on the acquisition debt is tax deductible (subject to certain conditions), thus reducing the tax base and tax of Company A, including the tax on business of the original Company B.

In some countries, it is completely forbidden – I cannot pay off a debt from a property I borrowed to buy. Some countries allow it, but the tax deductibility of interest is explicitly denied. The legislators simply do not want to reduce the tax base in these situations. We’re allowed to and do not have an explicit prohibition on tax deductibility. From the perspective of general tax principles, it probably makes quite a bit of sense. I had to borrow to acquire a business that generates taxable profits.

However, such an environment calls for tax planning. What if I have the money, I don't need to borrow from the bank, and I just create the debt and interest expense artificially with an intra-group loan? And what if I don't even want to buy anything and I can only create an acquisition situation by artificially rselling within the group? Here, intuitively, the interest should probably not be deductible from the point of view of higher justice, though not clearly according to the letter of the law. The tax administrator and, consequently, the courts have already reacted and in 2015 the Supreme Administrative Court issued a landmark decision in the well-known CTP case: a group loan, sale between related entities, interest not deductible because the right was abused. This decision defines what constitutes crossing the line. We then awaited another avalanche of decisions in less black and white cases to better understand exactly where that line is. But nothing much happened. Only now, after almost nine years, do we have two more decisions: Teleplan and Jihomoravská armaturka.

Teleplan also involved internal sale. Not surprisingly, the tax authorities were tempted to assess this after CTP. But the transaction was preceded by the sale of the entire group to a third party and external financing at the group level. The debt push down into the Czech company was based on the request of the bank that provided the group financing. And the court says the objective test of abuse of rights is met. But the subjective test is not met, because the motivation was not to reduce the tax, but to meet the requirement of a bank that would not otherwise have lent to it. So the law was not abused, the interest is deductible. A small step for the taxpayer, a big step for interpretive practice.

Armaturka made the same argument. Group level acquisition, external financing, etc. It just couldn't find a push down requirement in the bank documentation that would match the implemented structure. The general provisions on restructuring were not sufficient, the right was abused, the interest is not deductible. In terms of optics, it looks like everything is based on some dubious provision in the bank documentation. But that's what the two instances of case law we now have suggest. By the time we have ten, it might come apart somewhere else.

The dividend payment through the holding company is even more obvious. A shareholder, usually an individual, owns a profitable company, and would like to cash out the profits. Normally, he would pay 15% withholding tax. So he'd rather set up an empty holding company. He sells the profitable company to the holding company (which he 100% owns). He's held the profitable company for three years, so the sale is tax-free. The holding company has no funds, so it owes the shareholders. The profitable company pays its profits to the holding company – tax-free, exempt under EU rules. The holding company will use the payment received to repay the debt to the shareholder. Again, no tax, repayment of the liability is not taxable. Net result – the shareholder makes a profit, no tax paid.

Here, the tax administrator was a bit more active and occasionally levied an assessment. Some cases ended up in court, and the tax administrator was mostly supported. However, this July's Supreme Administrative Court decision in the FPPV case turned out the other way around. The SAC overturned the additional assessments. The objective conditions for abuse of law were met – an unforeseen tax advantage was achieved. However, the subjective condition was not met. The taxpayer allegedly did not take steps to evade the tax, but had a number of other good reasons for doing what he did. He wanted to set up a holding to be used for further investment, one of the current partners was getting out and had to be paid out, a new partner came in and the investment through the holding made sense etc. All right. I can't tell from the text of the decision whether it's more of a rebuke to the tax administrator for not dealing with the subjective condition sufficiently and not looking into it enough, or whether it's being made clear that it's really bulletproof in these circumstances.

Either way, the decision has attracted plenty of attention and raised perhaps a little bit of expectation that the tax world will be a little rosier again. You can even find a nice article in the newspaper HN, which gives hope that the Supreme Administrative Court has stood up for entrepreneurs in a matter that tax administrators used to assess by default. The decision is undoubtedly an important one; it shows us where the SAC will not let tax administrators off the hook. We'll have to wait for some light to shine into the remaining gray area of not-so-nice situations. Maybe when we have ten decisions like this, it will be clearer.