The tax authorities of the Czech Republic issued an assessment of additional income taxes and penalties for FY 2010 and 2011, because AZETKO s.r.o. according to the tax authorities did not receive an arm’s length remuneration for administration and operation of a website and e-shop on behalf on a related party, Quantus Consulting s.r.o.
AZETKO disagreed with the assessment and brought the case to court.
The regional court ruled in favor of AZETKO, but the tax administration appealed the decision to the Supreme Administrative Court.
Judgement of the Supreme Court
The Supreme Court found the tax administrations change in pricing method under the appeal of the case unsubstantiated. The tax administration had originally applied the CUP method, but in the appeal proceedings instead used the net margin transaction method (TNMM). On that basis, the appeal was dismissed by the Court.
The conditions for application of the transfer pricing provisions in Section 23(7) of the Czech Income Tax Act was summarised by the Court as follows
If it is proved that the parties are related persons within the meaning of Section 23(7) of the Income Tax Act, it is for the tax administrator to prove that the prices agreed between these persons differ from the prices that would have been agreed between independent persons in normal business relations under the same or similar conditions. Therefore, the principle that in tax proceedings it is the tax subject who bears the burden of allegations in relation to its tax liability and the burden of proof in relation to these allegations does not apply (cf. The tax administrator must therefore carry out a comparison in which it must establish both the price agreed between the related parties and the normal price (compared with the average price, the so-called reference price) at which independent persons trade in a comparable commodity. A necessary (but not sufficient) condition for the adjustment of the tax base under Section 23(7) of the Income Tax Act is the existence of a price difference.
In order to establish the ‘normal’ nature of the price, the administrator must be able to bear the burden of proof in relation to all relevant aspects. The tax authorities can, and usually will, determine the normal price by comparing the prices actually obtained for the same or similar commodity between genuine independent operators. However, it may determine it, in particular because of the absence or unavailability of data on such prices, only as a hypothetical estimate based on logical and rational reasoning and economic experience.
On the issue of business strategy the court provided the following insights
“According to the above-mentioned guidelines, a business strategy is understood as an attempt to penetrate a new market, where prices can be significantly distorted by higher costs of introducing a product to the market while applying a lower final selling price of this product, but it can also be different circumstances. In assessing this factor, the SAC agrees with the regional court that the administrative authorities assessed the business strategy only for the applicant, namely that it is an established company with an established business program. However, for the companies being compared, they did not assess this factor, and the influence of this question on the assessment of the present case cannot be ruled out without further ado.”