7 Afs
358/2021 - 36
continued
[IMAGE]
CZECH
REPUBLIC
ORDER
ON BEHALF
OF THE REPUBLIC
The Supreme
Administrative Court (SACC), composed of David Hipšr, President of the Chamber,
and Tomáš Foltas and Lenka Krupičková, Judges, has given a decision in the
proceedings before the Chamber, in which the applicant: Stora Enso Wood
Products Ždírec s.r.o., with registered office at Nádražní 66, Ždírec nad
Doubravou, represented by Mgr. František Korbel, Ph.D., lawyer, with registered
office at Na Florenci 2116/15, Prague, against the defendant: Odvolací
finanční ředitelství, with registered office at Masarykova 427/31,
Brno, in proceedings against the judgment of the Regional Court in Hradec
Králové of 27 October 2021, No 31 Af 11/2020 103,
as follows:
Annuls the
judgment of the Regional Court in Hradec Králové of 27 October 2021, Case No 31
Af 11/2020 103, and returns the case to that court for further proceedings.
Reasons:
I.
[1] By
decision of 1 October 2019, No 38330/19/5200 11431 706481, the defendant
amended the amount of the corporate income tax assessed against the applicant
for the 2012 tax year to a final amount of CZK 6 470 210 and, at the same time,
amended the amount of the penalty assessed to a final amount of CZK 1 294 042.
II.
[2] The
applicant brought an action against the defendant's decision before the
Regional Court in Hradec Králové, which, by judgment of 27 October 2021, No 31
Af 11/2020 103, annulled the contested decision and returned the case to the
defendant for further proceedings.
[3] The
Regional Court found merit in the plea alleging that the defendant unlawfully applied
Section 23(7) of Act No 586/1992 Coll., on Income Taxes, as amended ('the
Income Tax Act'), also to the plaintiff's transactions with unrelated persons.
The Regional Court stated that the concept of related persons is explicitly
expressed in Section 23(7) of the Income Tax Act. Despite the precise
definition of that institution, the defendant extended the limits of that
definition to cases of a controlled transaction where the taxpayer is obliged
to follow the orders of the parent company. However, the defendant has no legal
support for such a conclusion. The Regional Court thus upheld the applicant's
plea that only transactions between related parties could be subject to a
comparative analysis. That approach can also be deduced from the binding case-law
of the Supreme Administrative Court, which, in its judgment of 23 January 2013,
No 1 Afs 101/2012 31, stated that, in applying the provision in question, it
must first of all be shown that the persons concerned are connected within the
meaning of the cited provision, that is to say, that they are connected
economically, personally or in another way functionally equivalent to an
economic or personal connection. Similarly, it can be seen from the judgment of
the Supreme Administrative Court of 18 August 2021, No 1 Afs 109/2021 67, that
a prerequisite for the adjustment of the tax base under Section 23(7) of the
Income Tax Act is the establishment that there is a relationship between
related persons. Only if the tax administration bears the burden of proof in
relation to this condition may it proceed to assess whether the prices agreed
between related parties differ from those agreed between unrelated parties in
ordinary business relations under the same or similar conditions. In so far as
the defendant applied Article 23(7) of the Income Tax Act to the business cases
in question, it should have distinguished whether those transactions were made
with related parties or with unrelated third parties, since the applicant's
sales to unrelated parties amounted to 60 % in terms of production volume and
revenue volume. As regards the other pleas in law, the Regional Court held
that, in view of the above-mentioned defect in the contested decision, it would
be premature to assess their merits. The review of the defendant's decision in
the light of the pleas in law relating, first, to the question of the
assessment of the applicant as a full-fledged producer, second, to the question
of the incorrect comparative analysis carried out and, second, to the question
of a satisfactory explanation of the price difference found within the meaning
of Article 23(7) of the Income Tax Act can only be undertaken once it has been
established by the defendant and justified in a lawful manner in relation to
which entities the application of Article 23(7) of the Income Tax Act is
possible in the case of the applicant's tax liability.
III.
[4] The
defendant ('the complainant') lodged a cassation complaint against the judgment
of the Regional Court within the statutory time-limit on the grounds set out in
Article 103(1)(a) and (d) of the Code of Civil Procedure.
[5] The
complainant argued that the relationship between the applicant and its parent
company, Stora Enso Wood Products GmbH ('the parent company SEWP'), was
assessed in the tax proceedings, where the applicant followed the instructions
of the parent company, and not the relationship between the applicant and its
customers, as the Regional Court wrongly concluded. The subject-matter of the
tax proceedings was the relationship between the parent company SEWP and the
applicant, which provided a service to its mother consisting in the realisation
of loss-making production without appropriate compensation. Only that
relationship was the subject of the tax authorities' examination. A dependent
transaction is therefore any commercial relationship between related
undertakings, whereby a 'parent company order', meaning the influence of a
related undertaking on an independent transaction, can also be regarded as a
commercial relationship. In view of the fact that there was no dispute in the
tax proceedings that the applicant and its parent company SEWP were related
parties, the tax authorities did not err in applying Section 23(7) of the
Income Tax Act to the relationship in question.
[6] The applicant
further argued that the contested judgment of the Regional Court is
unreviewable for lack of clarity and for lack of reasons. The conclusions drawn
from the judgment under appeal are not applicable in the further proceedings.
The subject-matter of the tax proceedings was the relationship between the
applicant and its parent company, SEWP. The complainant, having annulled its
decision, cannot assess a completely different relationship, that is to say,
the relationship between the applicant and its customers, which was not the
subject-matter of the review in the previous proceedings. The judgment under
appeal also lacks any reasoning as to why the Regional Court subjected to
review a relationship which was not the subject of review in the proceedings
before the tax authorities. Furthermore, the Regional Court completely
disregarded the applicant's arguments in its statement of defence, which
related to a plea raised for the first time in the application.
[7] For the
reasons set out above, the complainant requests the Supreme Administrative
Court to set aside the judgment under appeal and to refer the case back to the
Regional Court for further proceedings.
IV.
[8] In its
statement of appeal, the applicant submitted that the complainant had clearly
acted contrary to Article 23(7) of the Income Tax Act in so far as it
characterised all the transactions made by the applicant in 2012 as controlled
transactions because of the alleged nature of the applicant as a manufacturing
company with limited functions and risks and did not distinguish whether those
transactions were made with related parties or with third, unrelated entities.
The sales to unrelated parties amounted to approximately 60 % in terms of production
volume and revenue volume. The Regional Court was therefore correct in
concluding that the complainant had incorrectly applied Section 23(7) of the
Income Tax Act also to transactions with unrelated parties. The complainant's
interpretation is not based on the law or other non-legally binding documents
and is also contrary to the constant case-law of the Supreme Administrative
Court. The applicant further submits that it is clear from the judgment under
appeal how the complainant is to proceed in the subsequent proceedings. The
applicant's plea that the contested judgment is unreviewable is, therefore,
false and misconceived. The applicant also adds, for the sake of completeness,
that it is completely irrelevant whether it raised the objection in question
(concerning the incorrect application of Article 23(7) of the Income Tax Act
also to transactions with unrelated parties) for the first time in the
administrative action. It was the duty of the tax administrator, or rather the
complainant, to act within the limits of the law and to apply the provision in
question in the correct manner. The complainant's assertion that that fact is
relevant in the present case is therefore completely absurd. In the light of
the above, the applicant submitted that the Supreme Administrative Court should
dismiss the appeal as unfounded.
V.
[9] The
Supreme Administrative Court examined the appeal within the limits of its scope
and the grounds put forward and, in doing so, examined whether the contested
decision was vitiated by any defects which it was required to take into account
of its own motion (Article 109(3) and (4) of the Civil Procedure Code).
[10] The
appeal is well-founded.
[11] The
administrative file shows the following facts: The applicant is part of the
global Stora Enso group, which is a worldwide supplier of innovative
environmental solutions in the fields of packaging, biomaterials, wood products
and paper. The Stora Enso group was organised into four divisions according to
the focus of its product range and the applicant operated a wood production
plant in the 2012 tax year. The applicant is a subsidiary of the Austrian
company Stora Enso Wood Products GmbH, which owns 100 % of the applicant's
share capital.
[12] On 9
November 2015, the Specialised Tax Office ('the tax authority') initiated a
corporate income tax audit of the applicant for the tax year 2012, which
focused in particular on the examination of the method of determining transfer
prices between related parties within the meaning of Article 23(7) of the
Income Tax Act. On the basis of a functional and risk analysis (in which it
examined the extent to which the applicant depended on the decision-making
mechanisms of another entity in the group), the tax administration concluded
that the applicant did not act as a fully-fledged independent entity in its
production and related activities, but as a producer with a limited functional
and risk profile, since its production activities were influenced by
transactions and relationships with related parties, with the applicant's main
direct controlling element being its parent company, SEWP, which provided
direct direction, coordination and management, both in terms of personnel and
in terms of the competences and decision-making powers which it, as a superior
entity to the applicant, possessed. The business model set up by the parent
company SEWP did not therefore allow the applicant to negotiate contractual
terms with its customers, nor was the applicant directly responsible for the
purchase and delivery of goods. In the proceedings, the tax authorities did not
dispute that the production and sale of lumber by the applicant was made both
to related parties and to unrelated third parties (hereinafter referred to as
'independent customers'). However, what was relevant in the present case was
the finding that the sales to independent customers were also influenced by the
'orders' of SEWP's parent company. The tax authorities then examined the
relationship between the applicant and its parent company SEWP and concluded
that the price for the service provided by the applicant to its parent company
SEWP was not set in accordance with the arm's length principle under Article
23(1) of the Law on the sale of goods. 7 of the Income Tax Act, or pursuant to
Article 9(1) of the Double Taxation Treaty between the Czech Republic and the
Republic of Austria No 31/2007 Coll. of 8 June 2006 ('the Double Taxation
Treaty'). The service provided by the applicant was characterised by the tax
administrator as the provision of production activities by the applicant,
which, however, did not have full managerial control over its orders and
transactions (this decision-making belonged to the parent company SEWP), as a
result of which it sold its products to its customers below its operating costs
and thus lost profits. The applicant was not compensated for this service by
the parent company SEWP. The tax authorities therefore adjusted the applicant's
profitability according to comparable independent entities by an amount of CZK
44 626 284, which represented the compensation that the applicant should have
received from SEWP's parent company and which would have ensured that the
applicant would have achieved a profitability at the lower end of the range
found to be normal, using the net margin method for determining transfer
prices. The tax audit report No 133452/18/4200 30762 604171 was discussed with
the claimant on 16 August 2018.
[13] On the
basis of the tax inspection report, the tax administrator issued an additional
payment order dated 17 August 2018, no. 136958/18/4227 24791 607756 ("the
additional payment order"), by which the claimant was assessed corporate
income tax in the amount of CZK 10,145,050 and notified of the obligation to
pay a penalty on the assessed tax in the amount of CZK 2,029,010. On 18
September 2018, the applicant lodged an appeal with the tax administrator
against the additional payment assessment. In the decision on the appeal, the
complainant agreed with the tax administrator's conclusions, stating that the
price of the service agreed between the claimant and the parent company SEWP
was not set in accordance with the arm's length principle pursuant to Article
23(7) of the Income Tax Act and Article 9(1) of the Double Taxation Treaty,
respectively, given the claimant's position (i.e. a manufacturer with a limited
functional and risk profile). The only change from the tax authority's
conclusions is that the complainant changed the amount of compensation assumed,
as a result of a different method of calculating the applicant's profitability,
to CZK 33 118 241. The decision on the appeal amended the amount of corporation
tax assessed on the applicant to a final amount of CZK 6 470 210 and at the
same time amended the amount of the penalty assessed to a final amount of CZK 1
294 042.
[14] In the
present case, the essence of the dispute is the question of the lawfulness of
the application of Section 23(1)(a) of the Act. 7 of the Income Tax Act,
according to which it is stipulated that if the prices negotiated between
related persons differ from the prices that would have been negotiated between
independent persons in normal business relations under the same or similar
conditions, and if this difference is not satisfactorily documented, the tax
administrator shall adjust the taxpayer's tax base by the determined
difference; if the price that would have been negotiated between independent
persons in normal business relations under the same or similar conditions
cannot be determined, the price determined in accordance with a special legal
regulation shall be applied. It is therefore clear that the purpose of this
provision is to determine and regulate for tax purposes the procedure for
determining the so-called transfer prices for transactions between related
parties in such a way that the so-called arm's length principle is maintained
in the case of such transactions.
[15] In
deciding this case, the Supreme Administrative Court based its decision on the
conclusions it expressed in its judgment of 27 April 2022, No. 7 Afs 398/2019
49, in which it dealt with the application of Section 23(7) of the Income Tax
Act and also (among others) the objection that the defendant erred in its legal
assessment of the case if it did not distinguish between transactions carried
out with related parties and with unrelated parties.
[16] There
is no dispute between the parties that the applicant and its parent company,
SEWP, are connected persons within the meaning of Article 23(7) of the Income
Tax Act, since the latter owns 100 % of the applicant's share capital. However,
in the applicant's view, the Regional Court erred in concluding that the tax
authorities applied Article 23(7) of the Income Tax Act to the relationship
between the applicant and its independent customers.
[17] The
complainant and the tax authorities took the legal view that the principle that
a company should not be forced to carry out transactions which are
disadvantageous to it applies in a group. If a controlling person (typically
the parent company) exerts its influence to implement a transaction which
causes the company to suffer a pecuniary loss, the controlling person is
obliged to compensate the company for the relevant loss by the end of the
accounting period at the latest, or, at least within the same period, to
conclude an agreement with the company in which the manner and time limit for
compensating such loss are agreed. In the present case, since the applicant did
not prove how the loss incurred in the determination of the sales prices
applied between the applicant and its business partners (related and unrelated
parties) was compensated by the parent company, nor did it explain why it was
not adequately compensated for its service to the multinational Stora Enso
group in its income, the tax authorities proceeded to determine the normal
price and to increase the income tax base by the difference found.
[18] In the
light of the above, the Court finds that, in so far as the Regional Court held
in the judgment under appeal that the tax authorities had unlawfully applied
Section 23(7) of the Income Tax Act or Article 9 of the double taxation treaty
to the applicant's transactions with its independent customers, who were not
demonstrably connected persons, that argument cannot be upheld. In the present
case, there was no application of Section 23(7) of the Income Tax Act to the
relationship between the applicant and its independent customers. Section 23(7)
of the Income Tax Act, or Article 9 of the double taxation agreement, covered
the transaction which the tax authorities of both instances regarded as the
provision of a service by the applicant to its parent company SEWP, i.e. a
related party, in the form of the production and sale of sawn timber. Since the
applicant, on the instructions of its parent company, was selling its products
below its operating costs and thus losing profit, the applicant should,
according to the tax authorities, have received a payment from its parent
company to compensate for the loss thus incurred (the difference between its
profitability and that of independent comparable operators). Therefore, on the
basis of the relevant evidence, the tax authorities concluded that a service
was provided between the applicant and its parent company SEWP, thereby
creating a relationship between them to which Section 23(7) of the Income Tax
Act could be applied. The complainant then defined the service in question as
'a service consisting in bearing risks which are beyond the control of the
taxable person and which are determined by related parties' (see paragraph 99 of
the contested decision).
[19] With
regard to the Regional Court's assertion that the tax authorities should have
distinguished whether the business transactions were made with related parties
or with unrelated third parties, since the applicant's sales to unrelated
parties amounted to 60 % in terms of both production and revenue, the Supreme
Administrative Court, in agreement with the complainant, states that this issue
may be relevant at the stage of determining the price of the service performed
by the applicant for the parent company. In the present case, however, the
Regional Court did not assess whether the price of the service was correctly
set, but only whether the first condition was met, i.e. whether Section 23(7)
of the Income Tax Act was applied to the relationship of related parties.
[20] It can
thus be concluded that the Regional Court erred in concluding that the tax
authorities applied Section 23(7) of the Income Tax Act to the applicant's
relationship with its independent customers in the present case. On the
contrary, it is clear from the content of the contested decision that the cited
provision was applied to the applicant's relationship with its parent company
SEWP, i.e. to the relationship of related parties.
[21] In the
light of the foregoing, the Supreme Administrative Court annulled the judgment
of the Regional Court under Article 110(1) of the Civil Procedure Code and
referred the case back to it for further proceedings. In the further
proceedings, the Regional Court is bound by the legal opinion expressed by the
Supreme Administrative Court in this judgment (Article 110(4) of the Civil
Procedure Code).
[22] The
Regional Court will decide on the costs of the appeal proceedings in a new
decision (Article 110(3) of the Code of Civil Procedure).
Operative
part of the judgment: no appeal is admissible against this judgment.
Done at
Brno, 25 August 2023.
David Hipšr
President of the Chamber