Czech Republic vs. EWE s.r.o., June 2013, Supreme Administrative Court , Case No 7 Afs 48/2013 – 31

« | »

EWE s.r.o first criticised the Regional Court for the lack of logical reasoning in the grounds of the judgment, based on evidence that it had established a legal relationship with another person mainly for the purpose of reducing the tax base. Although the facts adduced by the administrative court show that ‘some third parties’ created a relationship between them for that purpose, it does not indicate which evidence shows that it was she who created such a relationship for the purpose of reducing the tax base, as is intended by section 23(7)(b)(5) of the Income Tax Act. This defect in the court’s decision is all the more serious since she herself argued that no evidence was adduced in the administrative proceedings (in the tax inspection report) to show that she was knowingly involved in a chain of otherwise connected persons. It is thus merely the unproven assumptions of the tax authorities. No such evidence was presented by the Police of the Czech Republic in its complaint to the tax administrator. In so far as the Regional Court subsequently found such findings to be correct, its judgment is based on insufficient or incorrect findings of fact. If the administrative court accepted the conclusions of the administrative authorities that the conditions for the application of Section 23(7) of the Income Tax Act were met, it was obliged to state on what evidence it agreed with the conclusion of the Tax Directorate. However, the Regional Court failed to do so and its judgment is therefore unreviewable. This is also because no such evidence exists and was not adduced by the tax administrator, the Tax Directorate or the Regional Court. As far as it is aware, in other cases – for example, in the case of the appeal of STECOMTRA s.r.o., Tax Registration No:26847469 (another end customer of the chain in question), the Tax Directorate in Ostrava stated in its decision on the appeal that the tax administrator had failed to collect such evidence to show that the appellant knew or could have known that it was part of the chain (while it had the same documents from the police as the administrative authorities in its case). Since in her case it was not established that she was a person otherwise connected within the meaning of section 23(7) of the Income Tax Act, there was no legal reason for the tax authorities to ask her to prove the difference between her purchase price and the normal price. She was, therefore, not required to satisfactorily prove the alleged price difference. The tax authorities were therefore not legally entitled to adjust the tax base by the difference found. Any determination of the normal price was therefore irrelevant. The taxpayer’s normal price was the price at which it purchased the services from its supplier (Property). That company also offered its services to others at the prices paid to it. The price invoiced in her case was also the price for similar advertising in other media. The Regional Court therefore not only misinterpreted Section 23(7) of the Income Tax Act, but also incorrectly considered her burden of proof. If there were no material doubts on the part of the tax authority, there was no obligation on the tax authority to prove the differences between the prices. It cannot therefore be concluded that, as a taxable person, it did not satisfactorily document and prove the difference in prices between the services it purchased and similar services contracted between unrelated parties. The Regional Court thus erred in its consideration of the issue of the taxpayer’s burden of proof (Article 92(5)(d) of the Tax Code). Since the Regional Court, without giving any further reasons, merely followed the legal opinion of the Tax Directorate, thereby approving, inter alia, the unlawful procedure of the administrative authorities, its judgment is also unreviewable. By that defective procedure, the administrative court also infringed the applicant’s right to seek protection of her rights before an independent and impartial tribunal.

In its written observations on the appeal, the Directorate of Appeal considers that the extraordinary appeal is unfounded. The judgment of the Regional Court is factually correct and not unreviewable. The objection that the Regional Court, like the administrative authorities, does not indicate which evidence shows that the appellant established a legal relationship with another person mainly for the purpose of reducing the tax base is entirely unfounded. Both the Regional Court and the administrative authorities have dealt with the question of otherwise connected persons and have duly established that fact. The complainant was at the end of the chain when it purchased advertising at 22 times the price charged by the first link in the chain, which provided the service at the normal price. Both the existence of this chain and the amounts invoiced in this chain were proven. The administrative authorities have thus met their burden of proof under Article 23(7) of the Income Tax Act and have established the objective situation, namely that the complainant was part of a chain of otherwise connected persons. The applicant therefore requests the Supreme Administrative Court to dismiss the appeal.

Judgement of the Court

The Court dismissed the appeal of EWE s.r.o.

“The Supreme Administrative Court notes that a person under section 23(7)(b)(5) of the Income Tax Act is any person who benefits from the actions of persons in a chain whose effect and purpose is predominantly to reduce the tax base or increase the tax loss (here, a 22-fold increase in the tax-effective expenditure). This does not change the complainant’s assumption that the Tax Directorate is obliged to prove the subjective aspect of such unfair conduct, i.e. her knowledge of such conduct (intent), i.e. that she entered into the contractual relationship with knowledge of a possible reduction in her tax base. The question of fault is relevant in criminal law, but not in the tax administration proceedings (tax law).

Moreover, the fact that a possible expense originated with persons who are otherwise related does not in itself entitle the tax administrator or the tax directorate to exclude from the taxable costs a portion of the taxpayer’s (the complainant’s) costs (to the extent of the difference between the cost incurred and the cost that would have been incurred had the cost been incurred between persons who are not otherwise related). Such a procedure is provided for by law and only follows when the taxpayer fails to demonstrate to the satisfaction of the administrative authority, on its request, and to prove by relevant evidence, that there were rational reasons for incurring the cost (and charging it) for the service purchased at a price higher than the price between independent persons in normal commercial relations. That was the case here, where the tax authorities did not grant the complainant’s request.

The complainant is therefore wrong in assuming that it was incumbent on the authorities to prove and provide evidence that the complainant was knowingly involved in a chain of otherwise connected persons within the meaning of section 23(7) of the Income Tax Act. In that regard, it is sufficient for the administrative authorities to prove and demonstrate, even if only by circumstantial evidence, that there is a chain of suppliers, that the complainant is involved in it, the flow of funds related to the supply to the complainant and, at the same time, to demonstrate that the agreed price differs from the arm’s length price. These facts were sufficiently clarified in the tax proceedings. The Regional Court therefore did not err in finding the decision of the Tax Directorate to be in accordance with the law and dismissed the action in that respect.

Nor is the applicant’s complaint of infringement of Article 92(5)(d) of the Tax Code well-founded. The tax administration has discharged its burden of proof in that respect. When it called on the complainant by a notice of 15 December 2010, No 99551/10/273930603352, to provide it with satisfactory evidence of the difference between the unit price of an advertising spot broadcast by television stations of CZK 44 300 (which was invoiced to the complainant in 2007 and 2008 by BP Property s.r.o., subsequently renamed Property Praha s.r.o, 1307/2 14 October Square, Prague 5, then Vídeňská 144, Prague 4, then Púchovská 2219/8, Prague 4, Tax ID No: CZ26096951), and the prices established by the tax administrator, which would have been agreed between independent persons in normal business relations under similar conditions, the burden of proof shifted entirely to the complainant, who, however, did not bear it within the meaning of Article 92(3) and (4) of the Tax Code. There is therefore no merit in the complainant’s objection that the tax administrator infringed Article 92(5)(d) of the Tax Code, which, in the complainant’s view, the Tax Directorate failed to take into account and for which (procedural defect) the Regional Court should have annulled its decision on the application.

Lastly, the complainant is mistaken if it assumes, and now in the appeal it also submits, that the normal price for it should have been the price at which it purchased the service from its supplier (Property) – from whom other persons also purchased it – and not the price of the same service from other suppliers according to their quotations (ARBOmedia, AtMedia) in the relevant period, which was used as the normal price by the tax administrator. The normal price is to be understood as the price normal in an ‘undeformed market for services’, i.e. the price offered to other consumers – a price unencumbered by previous increases in the chain of companies or other purposeful conduct by the complainant’s suppliers. This is not altered by the fact that another end customer of the complainant’s supplier (the alleged STECOMTRA s.r.o.) was not charged tax in that context.

For all the reasons set out above, the Supreme Administrative Court did not find that the contested judgment of the Regional Court infringed the complainant’s right guaranteed by Article 36(1) of the Charter of Fundamental Rights and Freedoms, as the complainant alleged in the conclusion of her appeal without further details.

In regards to related parties the Income Tax Act makes a distinction:

(1) Capital related persons, which are further divided into (i) directly capital related (direct interest in the capital or voting rights of the other person) and (ii) indirectly capital related (indirect interest in the capital or voting rights); and

(2) Otherwise connected persons.

The category of otherwise connected persons significantly expands the range of entities to which the rules apply. Among other things, related persons include persons who have created a legal relationship primarily for the purpose of reducing the tax base or increasing a tax loss. On this provision, the Supreme Administrative Court has consistently held that the purpose of the provision is to prevent shifting of profits between taxpayers and to sanction abusive price speculation.

Click here for English Translation

Click here for other translation


Related Guidelines