Czech Republic vs HPI – CZ spol. s r.o., November 2022, Supreme Administrative Court, Case No 9 Afs 37/2022 – 37

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HPI – CZ spol. s r.o. is a subsidiary in the Monier group which is active in the production, sales and services of roofing and insulation products. In June 2012 the Monier group replaced an existing cash pool arrangement with a new cash pool arrangement.

The documents submitted show that on 1 April 2009 HPI concluded a cash pool agreement with Monier Group Services GmbH , which consisted in HPI sending the balance of its bank account once a week to the group’s cash pooling account – thus making those funds available to the other members of the group, who could use them to ‘cover’ the negative balances in their accounts. The companies that deposited funds into the cash pooling account received interest on these deposits at 1M PRIBOR + 3%; loans from the shared account bore interest at 1M PRIBOR + 3.75%.

With effect from 1 June 2012, HPI concluded a new cash pooling agreement with a newly established company in Luxembourg, Monier Finance S.á.r.l. Under the new agreement, deposits were now remunerated at 1M PRIBOR + 0,17 % and loans at 1M PRIBOR + 4,5 %. HPI was in the position of a depositor, sending the funds at its disposal to the cash pooling account (but also having the possibility to draw funds from that account).

Following an audit of HPI the tax authorities issued an assessment of additional income resulting from HPI’s participation in the new cash pool. According to the tax authorities the interest rates applied to HPI’s deposits in the new cash pool had not been at arm’s length. The tax authorities determined the arm’s length interest rates to be the same rates that had been applied by the parties in the previously cash pool arrangement from 1 January 2012 to 31 May 2012.

HPI filed an appeal and in February 2022 the Regional court set aside the assessment issued by the tax authorities. The Regional Court held that the tax authority’s view, which determined the arm’s length interest rate by taking it to be the rate agreed in the old cash pool arrangement from 1 January 2012 to 31 May 2012, was contrary to the meaning of section 23(7) of the Income Tax Act. According to the Court it was for the tax authority to prove that the prices agreed between related parties differed from those agreed in normal commercial relations. In the absence of comparable market transactions between independent persons, the tax authority may determine the price as a hypothetical estimate based on logical and rational reasoning and economic experience. However, according to the Court the tax authorities did not even examine the normal price for the period from 1 January 2012 to 31 December 2012 but merely applied the interest rate from the cash pooling agreement in force until 31 May 2012.

An appeal was then filed by the tax authorities with the Supreme Administrative Court.

Judgement of the Supreme Administrative Court

The Court decided in favour of HPI and upheld the decision from the Regional Court.

“….The applicant described the operation of the cash pool until 31 May 2012. Monier Group Services GmbH was the managing member and the applicant sent the balance of the account to the cash pool after assessing its cash flow. As from 1 June 2012, Monier Finance S.a.r.l. became the managing member and the balance was automatically sent to the cash pool account on a daily basis. The balance in the applicant’s bank account was thus zero every day. In the event of a negative balance, the applicant would balance the cash pool account. As regards the sharp drop in the interest rates in the cash pool, she stated that they were set according to the interest rates provided for deposits by local banks. In order to encourage members to join the cash pool, the managing member of the group offered them a rate equivalent to 1M EURIBOR or IBOR + 0,17 % (or 0,174 % in 2016). Thanks to the automatic sending of funds to the cash pool, the applicant saved approximately CZK 100-150 thousand per year in bank charges. In the end, the members set the rate as 1M PRIBOR + 0.17%. The 0,17 % corresponds to the margin of the banks, which, however, deducted it from the reference rate of 1M PRIBOR. The members of the cash pool thus obtained a rate 0.34% higher than the conventional banks. Thanks to the interest rate on a daily basis, the appreciation was higher, and this is what made the new contract from 1 June 2012 different from the original contract. Monier Finance acted as an “in-house bank” for the members of the Group and charged a premium in the form of higher interest for the risks associated with lending money to the members of the cash pool and administrative costs.

[19] The tax authorities have not demonstrated a difference between the interest rate agreed between the applicant and the managing member of the cash pool on the one hand and the benchmark rate on the other. Nor did the tax authority prove the reference price (rate) and, on the contrary, required the applicant to explain the difference itself. In short, the applicant’s profit from the interest on the cash pool deposits had decreased, the tax authorities saw no reason for such a decrease and therefore considered the rate which was higher (the rate agreed until 31 May 2012) to be in line with the arm’s length principle. However, it completely refrained from establishing the price that would have been agreed between independent parties and instead asked the applicant to explain the decrease in the agreed interest rate.

—The tax administrator required the applicant to explain the difference between the rates, without having even ascertained the comparative rate itself. Indeed, the tax authorities merely assumed that the original cash pooling agreement provided for a deposit rate of 1M PRIBOR + 3 %. The fact that the new rate was significantly lower could be a significant indication that the taxpayer had decided to shorten the tax. That does not alter the fact that the burden of proof as to the difference between the agreed rate and the benchmark rate (determined in accordance with the procedure set out in paragraph [16] of this judgment) rests with the tax authorities.
[23] There is insufficient evidentiary support for the administrative authorities’ assertion that other entities receive a much higher interest rate for participation in cash pooling. The applicant has stated on several occasions that the higher margin in the cash pooling system since 1 June 2012 is a consequence of the terms of the revolving credit facility granted to Monier Finance (the managing member of the cash pool since 1 June 2012). The tax administration and the complainant have thus not sufficiently reflected the specificities of this cooperation and have completely disregarded the advantages of the cash pooling set up since 1 June 2012. Instead, without further consideration, they considered the market rate to be the one used until 31 May 2012. Nor was it sufficient to state that the applicant had the right under the original cash pooling agreement to request an adjustment of the interest rates in line with market conditions, but that no such adjustment was made (instead, a new cash pooling agreement was concluded). It is up to each tax entity to choose the specific method of negotiating the interest rate on the deposits provided, and the use of various forms of cooperation between individual entities (members of the group) is a legitimate and, from an economic point of view, a perfectly rational way of doing business (cf. the judgment of the Supreme Administrative Court (SAC) No 7 Afs 95/2012-47).

[24]It can thus be concluded that the Regional Court’s conclusion was correct and that the administrative authorities did not really bear the burden of proof. They failed to establish the comparative interest and to compare it with the interest agreed between the applicant and the managing member of the group. On the contrary, they merely assumed that the interest rate was 1M PRIBOR + 3 % until 31 May 2012, 1M PRIBOR + 0,17 % from 1 June 2012 and 1M PRIBOR + 0,174 % from 1 January 2016. The applicant itself stated in its appeal that it was not aware of the usual interest rates for cash pooling. He thereby admitted that he had completely resigned himself to finding out about them. The interest rate agreed until 31 May 2012 cannot in itself serve as a benchmark. That would only be the case if the tax authority could show that it was a reference rate, i.e. if, after economic reflection, it actually concluded that the interest rate met the arm’s length condition.

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