Czech Republic vs. O. V., March 2009, Supreme Administrative Court , Case No 8 Afs 80/2007 – 105

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The appellant O.V. disagreed with the tax authority’s conclusion that the rent he paid to his father was not at the normal rate. In support of this claim, he submitted evidence. In connection with the conclusion of the donation contract, the O.V. became both the person liable and the beneficiary of a large easement over the property on plot No 31/1 and the co-owner of the land under the leased building, which was evidenced by documentary evidence, but which the tax administrator ignored and failed to assess. However, these are decisive facts which, in normal commercial relations, have a significant influence on the amount of rent. O.V. also rejected the method of calculating the normal price, which the tax authority determined on the basis of the arithmetic average of the lease contracts selected by it. It considers that this procedure is unlawful because the taxpayer has no possibility of obtaining input information. The normal price can be determined as the price given by a certain price range within which the rent in a given location varies and which is determined by the boundary between the highest and lowest rent. Furthermore, the complainant disagrees that the tax liability was established by means of evidence, since the tax base was adjusted on the basis of special legislation under section 23(7) of the Income Tax Act. The tax authority acted contrary to Article 31(2) of the Tax Code, since it limited the evidence to that which supported its view and, on the contrary, did not deal with the evidence submitted by O.V. It also acted contrary to Article 31(4) and Article 2(3) of the Tax Code, as it infringed the principle of a fair trial and the principle of free evaluation of evidence.

The second ground of appeal concerned the deed of gift by which O.V.’s father gave O.V. an ideal half of the dwelling house on building plot No 32, including that plot. However, the object of the gift could not be the annexe, since at the time of the tax audit it was not registered in the Land Registry and the parties to the gift agreement had never discussed its donation. Moreover, the annexe forms part of the marital property of O.V’s parents and it is therefore not possible for it to be disposed of exclusively by his father. The tax authorities are not entitled to decide on the content of the contracts and the will of the parties to the contracts if the parties to the contracts interpret their content in the same way. In the event that the content of the contract appeared unintelligible to the tax authorities, they were obliged, in accordance with Article 35(3) of the Civil Code, to take into account the interpretation of the content of the will of the parties to the contract. Moreover, O.V’s father did not hold the subject-matter of the donation as business property and therefore O.V. does not agree that the donation is subject to income tax. Only the annexe was added to the business property, not the original property donated. That fact also shows that the father continues to regard the annexe as his property.

The tax authorities maintained that its decision was correct and lawful. The tax administrator acted in accordance with the provisions of Article 2 of the Tax Code, evaluating both the documentary evidence submitted by O.V, the statements of witnesses D. and K., and that which he himself had obtained. The evidence also shows that the subject of the donation contract was the entire property, including the annexe, and that, in accordance with Article 3(4)(a) of the Income Tax Act, the donation was subject to tax.

The Regional Court decided in favour of the tax authorities, and O.V. filed an appeal with the Supreme Administrative Court.

Judgement of the Supreme Administrative Court

The Supreme Administrative Court set aside the judgment of the Regional Court and referred the case back to that court for further proceedings.

“Commercial transactions between close persons may be influenced by the personal relationship of the parties and are therefore not always motivated by the mere desire to obtain a pecuniary or other benefit, as is the case in normal commercial relations under conditions of functioning competition. Although, in view of the principle of contractual freedom, such conduct is possible in civil or commercial relations, from the point of view of tax law it is in effect sanctioned by an adjustment of the tax base by the difference found. The essence of the provisions of Section 23(7) of the Income Tax Act is to prevent tax evasion in such contractual relationships in which one party to the contract deliberately takes actions that are financially or otherwise disadvantageous to it, so that the other party, on the contrary, obtains a tax advantage consisting in a reduction of the tax base. The taxpayer must prove that the deviation from the normal price has a purpose other than tax evasion. The Income Tax Act therefore requires close traders to exercise greater care and caution in determining the contract price than independent persons.

Section 23(7) of the Income Tax Act does not expressly refer to either the normal price or the usual price, but only to prices negotiated in normal commercial relations. Both terms are very similar in content and do not contradict the meaning and purpose of the Act, and therefore it is possible to use both terms with reference to the provision in question in the Income Tax Act. In practice, however, the term “normal price” is rather used, in particular because the quoted provision itself refers to Act No. 151/1997 Coll., on the valuation of property, which already legally defines the term “normal price” for the purposes of this Act.

The Income Tax Act does not specify the exact way in which the tax authority is to determine the normal price in a competitive environment, but merely defines it in a less precise manner. It is only in cases where this price cannot be determined under section 23(7) that the price determined under the Valuation of Property Act is used. This does not mean, however, that the determination of its amount depends on the discretion of the tax administrator. The legislator has given the taxpayer a considerable margin of appreciation, which allows it to proceed in the light of the specifics of each individual case. It is at his discretion which entities he includes in the sample for the determination of the normal price, but on the other hand, the entities chosen must correspond to the situation of the tax subject (persons close or otherwise connected) and he must justify his choice. It is required to ensure that any increase in tax liability is lawful and fair and that its decision is reviewable.

In the view of the Court of Justice, the most appropriate method for determining the normal price is the comparative method of selecting a suitable sample of entities carrying on business under the same or at least similar conditions. In applying Section 23(7) of the Income Tax Act, the tax administration must, having regard to the principles of tax procedure, such as the principle of reasonableness, and the obligation to ascertain the facts as fully as possible, choose the means which will help to determine an amount which is as close as possible to the situation of the taxable entity (the connected persons); in other words, they will be as close as possible to it. Ideally, therefore, the calculation should be made by entities carrying on the same or at least similar business activities, at the same time and for the same length of time, in premises of a similar structural and technical condition and location in the municipality, and the size of the leased premises. It must also take into account whether the rent includes only the premises or also equipment and services, and must not disregard the rent determined by the same landlord in other cases where the other party to the contract is not a close or otherwise connected person. In doing so, it must select a sufficient number of subjects to enable it to draw a sufficiently objective and fair conclusion on the basis of their data.”

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