14 6 Af 36/2020
[FIGURE]
CZECH REPUBLIC
ORDER
ON BEHALF OF THE
REPUBLIC
The Municipal
Court in Prague, sitting as a Chamber composed of the President, JUDr. Ladislav Hejtmánek, and the Judges, JUDr.
Hana Kadaňová and JUDr.
Nadězda Treschlová, in
the case
Applicant: Avon
Cosmetic Limited
established at
Nunn Mills Road, NN1 5PA
Northampton,
United Kingdom of Great Britain and Northern Ireland
represented by
Ernst & Young Ltd.
Na Florenci 2116/15, Prague 1
against
Defendant:
Appellate Financial Directorate
Masarykova 427/31, Brno
against the
defendant's decision of 3 November 2020, No 41537/20/5200-11431-712136
as follows:
I. The action is
dismissed.
II. Neither party
is entitled to the costs of the proceedings.
Reasoning:
1. The applicant
seeks the annulment of the defendant's decision rejecting her appeal and
confirming the decision of the Tax Office for the Capital City of Prague ('the
Tax Office', or, in general, simply 'the tax administrator', which is the
general term used for the defendant, in so far as the distinction between the
various offices does not affect the clarity of the text) of 11 June 2005.
4566469/18/2001-53521-102252 ('the first-instance decision'), by which the
applicant's application for exemption from royalty income pursuant to Section
38nb of Act No 586/1992 Coll. was rejected, on income tax, as amended
(hereinafter also referred to as 'the Income Tax Act') on the ground that all
the statutory conditions for the exemption of royalty income under that provision
were not fulfilled, in particular the condition under Article 19(5)(2) of the
Income Tax Act, i.e. the requirement that the recipient of the royalties be the
beneficial owner thereof.
2. In its
application, the applicant first summarised the facts
and stated in general terms that, pursuant to a licence
assignment agreement concluded on 30 June 2016 with the historical owners of
the AVON intellectual property licence rights, AVON
International Operations Inc. and Avon Products Inc., tax residents of the
United States of America, it became the recipient of royalties from, inter
alia, the Czech company Avon Cosmetics spol. s r.o., and became the exclusive holder of the licence rights for the Europe, Africa and Middle East
region. This was done for economic reasons due to the winding down of AVON's
activities in the US and the gradual transfer of the intellectual property
rights themselves to the UK. Upon taking over the licensing rights, the
applicant was entrusted with certain rights and obligations, such as licensing
the rights to the individual local Avon companies in Europe, Africa and the
Middle East, accepting on its behalf and for its own account the payments of
the individual local Avon companies in the designated areas, registering,
administering and enforcing the payments, and at the same time ensuring
compliance with other contractual terms, administer and monitor the use and
exercise of intellectual property rights by the local companies in each
country, monitor violations of the use of licensed rights by the local
companies in each country, terminate the grant of licensed rights to individual
local companies when circumstances so require and design and implement a
strategy for the exploitation and development of intellectual property rights for
the Europe, Africa and Middle East region. This part of the application is
merely descriptive and does not contain any relevant objections to the
contested decision, and is therefore not dealt with specifically as a plea in
the remainder of the judgment.
3. The applicant
considers that the defendant acted unlawfully in refusing to grant the
applicant exemption from royalty income on the ground that the condition laid
down in Article 19(5)(2) of the Income Tax Act, namely that the applicant is
not the beneficial owner, was not fulfilled. The defendant then interprets the
concept of beneficial owner to mean that the recipient of the royalties is the
beneficial owner of the royalties only if it can use them without restriction
and is not obliged to pass on the payments to another person, the exercise of
functions and the bearing of risks associated with the activities and assets
from which the royalties derive are not relevant to the assessment of
beneficial ownership, beneficial ownership of the royalties is not dependent on
the setting up of functions within the group and the assessment of beneficial
ownership and misappropriation are separate and unrelated issues. Thus,
according to the defendant, the above interpretation of beneficial ownership
can be summarised as meaning that the only criterion
for assessing beneficial ownership is whether the royalty recipient has an
obligation to pass on the payments received to another person. However,
according to the applicant, that interpretation is unlawful because it does not
reflect the meaning and purpose of the concept of beneficial owner introduced
into tax law.
4. The applicant,
referring to the legislation, in particular Section 19(6) of the Income Tax Act
and Section 38nb(4) of the Income Tax Act, submitted that the recipient of
royalties is the beneficial owner if it receives those payments for its own
benefit and not as an agent, representative or principal for another person,
that legislation being the implementation of European Council Directive 2003/49/EC
('the Directive'). With regard to the interpretation of the concept of
beneficial owner within the meaning of the Directive and, consequently, the
Income Tax Act, the applicant refers to the decision of the Court of Justice of
the European Union of 26 June 2003. In that decision, the Court of Justice of
the European Union held that, in interpreting the Directive, account must also
be taken of the OECD Model Tax Treaty ("the Treaty"), including its
amendments and the commentaries thereto, from which it follows that the purpose
of introducing the concept of beneficial owner is to prevent abuse of the
benefits of double taxation treaties and to prevent tax avoidance or evasion.
According to the Commentary to Article 12 of the Treaty, the concept of beneficial
owner is not to be used in a narrowly technical sense but is to be understood
in the context and in the light of the purpose of the treaty. It is clear from
the above that beneficial owner is not the case where there is abuse of tax
advantages or tax avoidance. Furthermore, the Court of Justice has defined in
its judgment the characteristics from which an abuse of tax advantages may be
inferred and the advantages under the directive may not be granted to the
entity, in particular in situations where the economic operators have only
carried out formal or artificial operations which lack any economic and
commercial justification and whose main purpose is to obtain an undue
advantage, or where it is a group of companies which is not set up for purposes
which reflect economic reality, has a purely formal structure and its main
purpose or one of its main objectives is to obtain a tax advantage which is
contrary to the object or purpose of the applicable tax legislation.
5. The applicant
considers that the defendant, in applying the concept of beneficial owner to
the facts of the case, failed to take into account the fact that the applicant
receives royalties from Avon Cosmetics spol. s r.o. in its own name, on its own account, benefits
economically from them and is free to determine how they are used, when it
concluded that the applicant is not the beneficial owner because of the
applicant's obligation to pass on the royalty income to another person, namely
Avon Products Inc. and Avon Internetional Operations
Inc. It cannot be concluded that the applicant is not the beneficial owner
merely from the fact that the royalty is set as a percentage of net sales, both
for Avon Cosmetics spol. s r.o.,
which is obliged to pay the applicant royalties of xxx%, and for the applicant,
which is obliged to pay Avon Products Inc. and Avon International Operations
Inc. royalties of xxxx%. That does not say anything
about who decides how the funds collected are to be disposed of and who is
responsible for paying them. Furthermore, the amount paid by the applicant to
Avon Products Inc. and Avon International Operations Inc. is only a partial
part of the total royalty payment. Even if the defendant concludes that the
plaintiff is not the owner of the xxx% of the royalties that it is obligated to
pay going forward, the defendant should have awarded the plaintiff beneficial
ownership of at least a portion of the difference in royalties.
6. The applicant
further argued that the interpretation of the Canadian Court of Appeal in
Velcro Canada Inc., in which the concept of beneficial ownership was also
applied and the Canadian Court concluded that the fact that the amount of
royalty payments is derived from the sales of a local company does not preclude
beneficial ownership of royalties being awarded to an entity that also pays
royalties itself to another person.
7. In conclusion,
the applicant submits that the defendant committed further partial errors in
the assessment of the facts in the contested decision, firstly, the defendant
refused to find that the applicant bears a currency risk in relation to the
royalties received and paid, since it is not clear from the invoices submitted
whether Avon Cosmetics spol. s r.o.
pays royalties in crowns or pounds. However, the applicant itself pays the
royalties in US dollars, so there can be no doubt that the applicant bears the
currency risk. Furthermore, the defendant stated in its decision that in the
applicant's annual report for 2017, it is stated that the applicant receives
royalties from other companies in the group and that it accounts for them,
which is not true as this statement is inaccurate. The defendant also refused
to take into account the interpretation of the Canadian court's decision,
arguing that Canadian law is based on a different legal system than the Czech
Republic, which is not a relevant argument, as the Canadian court interpreted
provisions based on the OECD Model Treaty, which was the basis for the drafting
of the Directive.
8. The defendant's
response to the application was first to summarise
the proceedings before the administrative authority at first instance and then
to summarise the appeal proceedings in which it
itself ruled and issued the contested decision which is the subject of the
present proceedings. He further stated that he maintained the legal position
set out in the contested decision on the appeal and referred in full to its
reasoning, since the grounds of appeal and the pleas in law were similar, and
proposed that the action be dismissed. It is clear from the Czech legislation,
as well as from the directive and generally accepted interpretation, that the
beneficial owner of income is not the person who receives it as an agent,
representative or principal for another person, that is to say, as a person
through whom the income merely 'flows' and who does not actually benefit from
that income, since he is bound by an obligation to pass it on to another
entity. The defendant believes that the law requires it to grant an exemption
from income tax on royalties only to those entities that are proven to be the
beneficial owners of the income in question, meaning that they have full right
to dispose of the royalty, have full rights to the benefits derived from that
income, and at the same time those rights are not limited by the obligation to
transfer that income to another person. The concept of beneficial owner cannot
be interpreted to mean that any recipient of income who claims to be the
beneficial owner of the subject income must always be in possession of it,
unless the tax authorities can prove abuse of right or other bad faith on the
part of the claimant. It is therefore entirely consistent with the legislation,
its intent and purpose, if the beneficial owner of royalty income is not
certified to be an entity that lawfully and legitimately carries on an economic
activity, but acts as an agent or trustee in relation to the royalty income and
then passes that income on to another entity. As regards the judgment of the
Court of Justice of the European Union in Joined Cases C-115/16, C-118/16,
C-119/16 and C-299/16, the defendant considers that it acted and ruled in full
accordance with that judgment. Although the CJEU dealt to a large extent in
that decision with abuse of rights in relation to the concept of beneficial owner,
it did not deny that intermediaries and agents are not beneficial owners
either. Moreover, the Directive itself expressly provides for this. The same is
true under the commentary to the articles of the OECD Model Treaty, which
states that the recipient of royalties is the beneficial owner only if he can
use and enjoy them without restriction and is not obliged by law or contract to
pass on the payments to another person.
9. As regards the
applicant's objection that it wrongly assessed the applicant as not being the
beneficial owner of the royalties, the defendant stated that the documents
submitted by the applicant showed that Avon Cosmetics Ltd. the applicant is
obliged to pay to the applicant as a royalty an amount equal to xxxxx% of its net sales within 30 days of the end of the
quarter and the applicant is subsequently obliged to pay to Avon Products Inc.
and Avon International Operations Inc. an amount equal to xxxx%
of Avon Cosmetics spol. s r.o.'s
net sales, within 60 days of the end of the calendar quarter. The payments are
therefore calculated on the same basis and there is an obvious sequence in
time, with xxxxx% of the payment received by the
applicant as royalty being payable thereafter. The applicant is contractually
responsible for the performance of the obligations of the sub-licensees, from
which it incurs certain risks, and therefore the difference between the
payments made and received appears to be a royalty management fee. The
defendant considered a comparison of the applicant's and the sub-licensee's set
of authorisations, the payment of fees, the bearing
of risks and the designated currency, all of which led the defendant to
conclude that the applicant was not the beneficial owner of the royalty income.
10. Finally, the
defendant submits that, as regards the alleged incorrect assessment of the
currency risk, the defendant could not assess the applicant's allegations as a
circumstance of beneficial ownership, since the applicant did not submit any
evidence showing that the royalties were paid to it by Avon Cosmetics spol s r.o. in Czech crowns or
pounds. According to the contract submitted, all fees were to be paid in US
dollars and the mere submission of an invoice stating the amount in pounds and
Czech crowns does not show in which currency the amount was paid. As regards
the applicant's 2017 annual report, which the defendant alleged was defective,
the defendant insists that it can only show that the applicant receives
royalties from other companies in the group and that it does not charge
anything. Thus, according to the defendant, the applicant's objections are
unfounded.
11. The content of
the file submitted by the defendant to the administrative authority reveals the
following facts which are relevant for the decision on the merits.
12. On 9 October
2017, the applicant submitted an application to the Tax Office for the Capital
City of Prague for a decision on the granting of exemption from royalties for
the period from 1 January 2017 to 31 December 2017, from 1 January 2018 to 31 December
2018 and from 1 January 2019 to 31 December 2019 pursuant to section 19(1)(zj) of the Income Tax Act in connection with section 38nb
of the Income Tax Act. The tax office decided on the application by a
first-instance administrative decision of 11 June 2018, No
4566469/18/2001-53521-102252, rejecting the application. On the applicant's
appeal, the defendant upheld that decision and dismissed the appeal by decision
No 4153/7/20/5200-11431-712136, as it concluded that the applicant was not the
beneficial owner of the royalty income, but only its trustee or agent. The
reasoning in the grounds of the contested decision is similar to that in the
defendant's statement of defence, and the Court
therefore refers to it without repeating it.
13. The Municipal
Court in Prague decided the merits of the case without ordering a hearing, as
the parties consented to that (Article 51(1) of Act No 150/2002 Coll., the
Administrative Procedure Code, as amended, hereinafter referred to as 'the
Administrative Procedure Code').
14. The Court of
First Instance examined the contested decision to the extent of the points of
appeal raised, by which it is bound (Article 75(2), first sentence, of the Code
of Civil Procedure) and, pursuant to Article 75(1) of the Code of Civil Procedure,
based itself on the factual and legal situation that existed at the time of the
administrative authority's decision and concluded that the action was not
well-founded.
15. Pursuant to
Section 19(1)(zj): 'Royalties accruing to a business
corporation which is a tax resident of a Member State of the European Union
other than the Czech Republic from 1. a business corporation which is a tax
resident of the Czech Republic or 2. a permanent establishment of a business
corporation which is a tax resident of a Member State of the European Union
other than the Czech Republic in the territory of the Czech Republic shall be
exempt from tax', paragraph 5(5)(zj) of the Act.
Section 19(6) of the Income Tax Act stipulates the statutory condition for
exemption.
16. The Court then
went on to rely on Article 1(4) of the Directive, which similarly provides that
'a company of a Member State shall be deemed to be the beneficial owner of
interest or royalties only if it receives them for itself and not for another
person as an intermediary, such as an agent, trustee or nominee'.
17. First, the
court addresses the applicant's challenge to the interpretation of the term
beneficial owner, which is crucial to the further consideration of this case.
In accordance with the Czech statutory framework enshrined in the Income Tax
Act and also with EU legislation, namely Council Directive 2003/49/EC, which is
implemented into Czech law by the Income Tax Act, a beneficial owner is not an
entity which receives royalty payments for another person as an intermediary.
Thus, the real owner of the said income must be the entity whose income
increases its assets and enriches it. The beneficial owner uses the income
without restriction and does not pass it on, even in part, to another person.
The Court of Justice of the European Union came to the same conclusion in its
judgment of 26 February 2019 in Joined Cases C-115/16, C-118/16, C-119/16 and
C-299/19, where it stated that 'The concept of "beneficial owner of
interest" within the meaning of the Directive must therefore be
interpreted as referring to the entity which actually benefits from the
interest paid to it. Article 1(4) of the same directive supports that reference
to economic reality by specifying that a company of a Member State is to be
regarded as the beneficial owner of interest or royalties only if it receives
them for itself and not for another person as an intermediary, such as an
agent, trustee or principal', to which the applicant referred in its
application. The Supreme Administrative Court also commented on this issue in
its decision of 12 November 2019, No. 10 Afs 140/2018-32, where it stated that
"The recipient of (sub)royalties is the beneficial owner of the royalties
only if he can use and enjoy them without limitation and is not obliged by law
or contract to pass the payments to another person (Article 19(6) of Act No.
586/1992 Coll., on Income Taxes)". Although the applicant refers to those
decisions in support of its argument, in the Court's view those decisions
support the interpretation relied on by the defendant and the court in this
case. Nowhere in the reasoning of the decisions does it appear that the
applicant's conclusion, which is strongly simplistic, is that the only
criterion is whether the recipient of the royalties has an obligation to pass
them on to another person. In that regard, the Court refers to the specific
reasoning of the contested decision, from which it is clear that the defendant
assessed the entire factual situation more broadly.
18. In so far as
the applicant argues that it exercised other rights and obligations vis-ŕ-vis
the individual local companies after taking over the licence
rights, which also involved the applicant's liability for the acts and
omissions of the sub-licence holders, and that it is
not merely a 'flow-through' company, and then ties its argumentation to a
possible abuse of rights, the Court observes that the above-mentioned decision
of the Court of Justice of the European Union cannot be interpreted as meaning
that, unless an abuse of rights is proved, the defendant is obliged to grant
the applicant an exemption from royalty tax. Both the law and the
above-mentioned case-law define the concept of beneficial owner, which the
applicant has failed to prove in the proceedings (the Court refers in detail to
the detailed reasoning of the contested decision). Thus, it is not relevant
whether the applicant legitimately carries on an economic activity in the more
general sense or whether it receives royalties on its own account, but whether
it is the beneficial owner of the royalties (it benefits from them itself),
which are two different facts. It is therefore relevant to the assessment of
the case what the nature of the applicant's activity is, not whether an abuse
of rights is established. In the Court's view, the applicant's activity does not
satisfy the condition of beneficial owner of the royalties as defined by the
case-law referred to above.
19. The applicant
further points out that it collects royalties from Avon Cosmetics spol. s r.o. in the amount of xxxxx % of net sales for the grant of the sub-licence, whereas it only pays to Avon Products Inc. and
Avon International Operations Inc. an amount equivalent to xxxxx
% of net sales. In assessing this point of claim, the Court agrees with the
defendant, which concludes that the applicant does not derive any real benefit
from the royalty income and is not entitled to take a free decision on it,
since it is obliged to pay almost all of it to the above-mentioned companies.
That conclusion is also supported by other facts on which the defendant bases
its conclusion, which are based on the contractual documentation submitted and
with the assessment of which the Court agrees (e.g. the payability
of the royalty received and the sub-licence fee paid,
which is set at a similar level; the fact that ownership of the property rights
remains with Avon Products Inc. and Avon International Operations Inc., which,
moreover, have reserved the right to carry out inspections not only of the
applicant but also of the sub-licence holders). What
is relevant for this assessment is not the determination of the applicant's
income from which it pays royalties to Avon Products Inc. and Avon
International Operations Inc., but the fact that the applicant receives
royalties in a fixed amount from net sales and is then contractually obliged to
remit part of those payments to other companies. The difference between the
payments of xxxxx % which remains to the applicant
cannot then be regarded as royalty income in that factual situation, but only
as remuneration for the management of the royalties collected by the applicant
for Avon Products Inc. and Avon International Operations Inc., when otherwise
the applicant is contractually obliged to remit a substantial part of that
income and thus does not benefit from it. However, the predominant nature of
the applicant's business as set out above is not materially affected by this
fact; it is still the case that the royalties are predominantly paid by the
applicant to other companies and are thus not beneficially owned by the applicant
and thus do not satisfy the relevant statutory condition. The applicant does
not have that benefit even if it carries out other activities which it mentions
in the application (e.g. marketing or research and development), which,
however, in the Court's view, was not demonstrated in any detail by the
applicant in the tax proceedings and thus remained merely an allegation, since
it is not the beneficial owner of the royalties received, since it is
contractually obliged to pay them to the beneficial owner.
20. The Court also
finds no merit in the applicant's objections that the defendant failed to take
into account the fact that it collects royalties in Czech crowns or pounds and
pays royalties in US dollars, which shows that the applicant bears the currency
risk. In view of the fact that the licensing agreement sets the currency of all
fees at US dollars and the applicant has not demonstrated to a sufficient
degree that it collects payments in another currency and for what reason, when
the contractual documentation does not support such a conclusion, the Court
agrees with the defendant that such a broadly worded objection could not be
considered more specifically on appeal. It was therefore for the applicant to
explain that issue on appeal so that the defendant could respond to it in a
concrete manner. If she failed to do so, she cannot plead that the defendant
failed to consider that issue or assessed it differently. It must therefore be
concluded that, if the contractual documentation submitted by the applicant to
the tax authorities provided for payments in US dollars, it was for the
applicant to explain why that was not the case and why the invoice to ACS
showed Czech crowns and pounds and, in that state of affairs, in what currency
that payment was actually made.
21. To the extent
that the applicant argues that the legal opinion of the Canadian Court's
decision in Velcro should have been applied in the case, in the Court's view,
the clearly articulated legal opinion of both the CJEU and the Supreme Administrative
Court, which disregards the Canadian Court's interpretation, prevails in the
present case. For the Czech tax administrator, the case law of European and
national courts is more relevant when assessing the concept established by
European and national law. This was the case in the present case and therefore
the court found no illegality in such a procedure. As regards the allegedly
defective assessment of the applicant's annual report for 2017, the Court finds
no fault on the part of the defendant here either, since the defendant took the
view that the applicant had failed to prove that fact, since it had submitted a
part of the annual report showing only that it received royalties and accounted
for them. Nowhere in the applicant's submissions does it indicate why that
should be otherwise, particularly in the light of the defendant's assessment of
the contractual documentation submitted. In these tax proceedings, it is the
applicant who must prove the relevant facts. The Court sees nothing in the
applicant's annual report, nor in the parts of the applicant's annual report
cited by the applicant in the application, which is intended to contradict the
above conclusion drawn from the contractual documentation submitted by the
applicant in the proceedings, or which is intended to supplement or contradict
that contractual documentation. The applicant's detailed arguments in relation
to the entire procedure and the assessment of the evidence are not pursued by
the Court and therefore cannot be dealt with in detail in the grounds of this
judgment.
22. For the
reasons set out above, the Municipal Court in Prague concluded that the action
was not well-founded and therefore dismissed it pursuant to Article 78(7) of
the Code of Civil Procedure.
23. The court
decided on the costs of the proceedings in accordance with Article 60(1) of the
Code of Civil Procedure, according to which the unsuccessful applicant is not
entitled to reimbursement of the costs reasonably incurred in the proceedings
and the defendant administrative authority, which would be entitled to
reimbursement of the costs reasonably incurred according to the outcome of the
proceedings, did not declare or claim any costs of the proceedings beyond the
normal activities of the administrative authority. For that reason, the
Municipal Court in Prague held that neither party was entitled to the costs of
the proceedings.
Instructions:
A cassation appeal
may be lodged against this decision within two weeks of the date of its
notification. The appeal must be lodged in two (more) copies with the Supreme
Administrative Court, Moravské náměstí
6, Brno. The Supreme Administrative Court shall decide on the cassation
complaint.
The time limit for
lodging a cassation complaint ends on the expiry of the day which coincides
with the day which determined the beginning of the time limit (the day of
delivery of the decision). If the last day of the period falls on a Saturday,
Sunday or public holiday, the last day of the period shall be the next working
day. The time-limit for lodging an appeal may not be waived.
A cassation
complaint may be lodged only on the grounds set out in Article 103(1) of the
Civil Procedure Code and, in addition to the general requirements of a
complaint, must contain a statement of the decision against which it is
directed, the extent to which and the grounds on which the complainant
challenges it, and the date on which the decision was notified to the
complainant.
In the appeal
proceedings, the applicant must be represented by a lawyer; this does not apply
if the applicant, his employee or a member acting for him or representing him
has a university degree in law required by special laws for the practice of the
profession of lawyer.
The Supreme
Administrative Court shall collect the court fee for the appeal. The variable
symbol for payment of the court fee to the account of the Supreme
Administrative Court can be obtained on its website: www.nssoud.cz.
Prague, 3 February
2022
JUDr. Ladislav Hejtmánek
Chairman of the
Chamber