Supreme Administrative Court

1 Afs 109/2021 – 67

18. August 2021

CZECH REPUBLIC

ORDER

ON BEHALF OF THE REPUBLIC

The Supreme Administrative Court (SAC), sitting as a panel composed of the President, JUDr. Lenka Kaniová, and the Judges, JUDr. Josef Baxa and JUDr. Ivo Pospíšil, has given a decision in the legal case of the applicant: L. Ž., represented by JUDr. Petr Langer, Ph.D., LL.M., lawyer, with registered office at Sokolská třída 1331/31, Ostrava, against the defendant: Odvolací finanční ředitelství, with registered office at Masarykova 427/31, Brno, on an action against the defendant's decision of 27 July 2019, No 30040/19/5200-10424-711138, in proceedings concerning the applicant's cassation complaint against the judgment of the Regional Court in Ostrava of 28 January 2021, No 22 Af 41/2019-36,

as follows:

The judgment of the Regional Court in Ostrava of 28 January 2021, Case No 22 Af 41/2019-36, is hereby set aside.

Annuls the decision of the Appellate Financial Directorate of 27 July 2019, No 30040/19/5200-10424-711138, and refers the case back to the defendant for further proceedings.

The defendant is not entitled to the costs of the action or the appeal.

The defendant is ordered to pay to the applicant, at the hands of its representative, JUDr. Petr Langer, Ph.D., LL.M., lawyer, with registered office at Sokolská třída 1331/31, Ostrava, the sum of CZK 26 428, by way of costs, within 30 days of the entry into force of this judgment.

Reasons:

Definition of the case

[1] The subject-matter of the dispute in the present case is the interpretation of Section 23(7)(b)(5) of Act No 586/1992 Coll., on Income Taxes, i.e., firstly, the question whether the applicant and the advertising supplier were otherwise connected persons within the meaning of the cited provision in the relevant period and, secondly, whether the price agreed between them for advertising differed from the prices which would have been agreed between unconnected persons in normal commercial relations under the same or similar conditions.

[2] The Tax Office for the Moravian-Silesian Region ("the tax administrator") carried out a limited audit of the applicant's personal income tax for the 2014 tax year, focusing on the verification of tax documents received relating to advertising and promotion. Since the applicant only declared income from the activities of the company D. D. D. SERVIS OPAVA v. o. s. ('D. D. D. SERVIS'), in which he was a shareholder at the relevant time, the tax administrator audited the accounts of that company. On the basis of the results of the audit, the tax administrator did not recognise as tax-effective the claimant's advertising expenses from the supplier PAMBROKE Media s.r.o. ('PAMBROKE') in the total amount of CZK 720,000 and from the supplier CERS performance s.r.o. in the total amount of CZK 240,000.

[3] By an additional payment assessment dated 18 September 2018, no. 3282419/18/3216-50524/809821, the tax administrator assessed the claimant for personal income tax for the tax period 2014 and assessed a penalty on the assessed tax. Subsequently, on the basis of the claimant's appeal, the tax administrator, by decision of 6 February 2019, no. 313311/19/3216-50524/809821, recognised the costs of advertising by CERS performance s.r.o., and therefore amended the payment order by assessing the claimant's tax in the amount of CZK 41,595 and assessing a penalty of CZK 8,319. By decision of 27 July 2019, No 30040/19/5200-10424-711138 ('the contested decision'), the defendant rejected the applicant's appeal against that decision.

The judgment of the Regional Court

[4] The applicant brought an action against the defendant's decision before the Regional Court in Ostrava, which dismissed it by the judgment specified in the header.

[5] The court first dealt with the interpretation of Section 23(7)(b)(5) of the Income Tax Act. It stated that the existence of a legal relationship between the applicant and his business partners was decisive for the assessment of whether the applicant and his business partners were otherwise connected persons within the meaning of the cited provision. It is clear from the content of the administrative file that the applicant had a duly concluded advertising contract with the supplier company. The Court therefore rejects the applicant's argument that the tax authorities should have proved the existence of a contractual relationship between economically or personally or otherwise related persons. In this respect, it referred to the judgment of the Supreme Administrative Court of 13 June 2013, No 7 Afs 47/2013-30.

[6] The Court also did not consider relevant the objection that there was no so-called "profit spillover" in the applicant's case. It inferred this from the fact that he had increased his tax burden, because while the supplier of the advertisement was obliged to pay value added tax on the supply, he himself was obliged to pay personal income tax. The Court emphasised that the applicant was ultimately the one who reduced his tax base by amounts many times higher than the normal price for similar services.

[7] The Court found speculative and unsubstantiated the allegation that the tax authorities were influenced in their assessment of the case by the publicity given to certain court decisions in the case concerning the provision of advertising by PAMBROKE.

[8] Lastly, the Court also found the objection concerning the defendant's evaluation of the contracts submitted by the applicant unfounded. It noted that the defendant had duly justified its action in the contested decision by stating that the contracts submitted were not comparable to the applicant's terms and conditions in terms of the scope of the performance provided or in terms of time. In those circumstances, it was unnecessary for the defendant to compare the contractual prices in those contracts with the price of the performance provided to the applicant.

Content of the appeal

[9] The applicant (the complainant) challenges the judgment of the Regional Court by means of a cassation complaint on the grounds laid down in Article 103(1)(a) and (b) of Act No 150/2002 Coll., the Administrative Procedure Code ('the Code of Administrative Procedure').

[10] First, the complainant alleges incorrect application of Section 23(7)(b)(5) of the Income Tax Act. It maintains that the prerequisite for the fulfilment of the hypothesis of the legal norm concerning the existence of otherwise connected persons is proof of the existence of a relationship the purpose of which was mainly to reduce the tax base or increase the tax loss. It is only then that it is possible to examine whether the prices correspond to those between unrelated persons. The complainant takes the view that a contract cannot in itself prove that there are otherwise related parties. The Court should therefore have examined the existence of other circumstances which might justify the classification of the contractual relationship as a relationship between otherwise related parties. Moreover, in the present case, there was a slight increase in the normal price compared with the other cases examined, and it is therefore clear that the contractual relationship was not entered into with the aim of reducing the tax base or increasing the tax loss.

[11] The complainant also points out that, in the present case, it entered into a contract with an advertising agency which designed, drafted and implemented a complete advertising campaign. It placed the advertisements in lucrative locations in football stadiums and sports grounds, distributed the leaflets at appropriate times and timed the printing of the banner advertisements in magazines. In doing so, it completed the service it supplied to the complainant as a whole, unlike the contracts considered by the defendant. In the judgment under appeal, the Court of First Instance entirely adopted the conclusions of the tax authorities, which, without any further reasoning, assessed the legal relationship in question as a chain, without providing any evidence for that conclusion. The complainant fundamentally disagrees that it was part of a chain.

[12] The Court should also have considered what advantage the complainant received by paying the higher amount. By the alleged increase in the tax loss or reduction in the tax base, the complainant did not receive any money; on the contrary, he spent it on achieving, securing and maintaining taxable income. If the allegation that the complainant paid for an overpriced service (which he denies) were true at all, it would mean that he spent 100 % of the amount but reduced his income tax by only 15 % of that amount. The complainant points out that the conclusion of the contract with the advertising agency in question had a considerable benefit for him, as it kept him in the minds of his customers, which enabled him to continue his business. He had no other reason for concluding the contract.

[13] The administrative authorities, and subsequently the Court, proceeded on the assumption that all the entities which entered into the contract with the advertising agency PRESSTEX MEDIA SE did so only with a view to reducing the tax base or increasing the tax loss. However, that was not the case in the complainant's case, which is reflected in the slight difference between the normal prices, as determined by the tax authorities, and the prices under the contracts concluded with the complainant. In particular, it is three times the established normal price, whereas in the case of other entities the differences were a hundred times or more. However, if the tax authority had established the correct reference sample, the difference would have been minimal or non-existent. The tax authorities used the same entities and relationships in the reference sample in different cases, which the court in the judgment under appeal wrongly approved. A universal reference sample once established cannot be taken into account when assessing different cases, since each case is individual.

[14] Furthermore, the complainant disagrees with the court's conclusions relating to the assessment of the contracts submitted by it in order to demonstrate the reasonableness of the contract prices in the present case. In particular, it objects to the assertion that those contracts did not constitute a comparable sample. The temporal aspect can be dealt with by taking account of inflation in each year, whereas as regards the material scope, only those transactions which occur in all the contracts compared can be taken into account. Lastly, the complainant points out that neither the tax authorities nor the court have commented on all the contracts submitted by the complainant.

[15] For all the reasons set out above, the complainant submits that the Supreme Administrative Court should annul both the judgment of the Regional Court and the contested decision of the defendant.

Statement of the defendant

[16] In its statement of appeal, the defendant first emphasised that the assessment of personal income tax for 2014 did not concern the advertising payments received by the complainant from PRESSTEX, but from PAMBROKE. The incorrect designation of the supplier was apparently the result of carelessly adopting the text of the grounds of the complainant's other cassation complaints lodged with the Supreme Administrative Court under Case Nos 1 Afs 110/2021 and 10 Afs 149/2021.

[17] The defendant agrees in principle with the assertion that the mere existence of a legal relationship between D.D.D. SERVIS and PAMBROKE is not sufficient for the assessment of the complainant as an otherwise connected person under Section 23(7)(b)(5) of the Income Tax Act. It follows from the constant case law that the application of the cited provision requires the cumulative fulfilment of three conditions: 1) the existence of a contractual relationship between economically, personally or otherwise related persons must be proven, 2) the prices agreed between them must be different from the prices that would have been agreed between independent persons in normal business relations under the same or similar conditions, and 3) this difference has not been satisfactorily documented by the taxpayer. In the present case, all of these conditions were met. On the other hand, it was not for the tax authorities to prove, for example, that the complainant had malicious intent or that the purpose of the legal relationship was primarily to increase the price. On this issue, the defendant referred to the judgment of the Supreme Administrative Court of 13 June 2013, No 7 Afs 47/2013-30.

[18] In the defendant's view, it was duly proved that the price was increased several times, even compared to the upper limit of the range of prices found in normal commercial transactions. In the context of the application of Section 23(7)(b)(5) of the Income Tax Act, the taxpayer has the opportunity to explain the price difference found. However, the burden of proof at this stage was on the complainant. In the case under consideration, the difference was not negligible, as the complainant claims, since the price for the services related to the Golf Arena Ostrava for the first half of 2014 was found by the tax administrator to be CZK 17 850 per month, whereas D.D.D. SERVIS OPAVA had negotiated a price of CZK 120 000 per month for those services in the same period.

[19] The defendant also considered the objection regarding the absence of a chain of tax entities in which the same service was "resold" in order to increase the price to be false. For the application of section 23(7)(b)(5) of the Income Tax Act, the establishment or identification of such a chain is not necessary. Although the formation of such chains is common, price increases can occur even in a closed system of two taxpayers. In the present case, however, the defendant considers that the tax administration properly identified the chains in which the price increases took place, and it was not its duty to prove that the complainant was intentionally involved in the chain.

[20] The defendant also considers the objection that the reference prices were incorrectly set to be unfounded. In the case at hand, normal prices were determined on the basis of the range of prices obtained between unrelated persons in normal commercial relations under the same or similar conditions, ranging from CZK 2 083 to CZK 8 333, or from CZK 409 to CZK 17 850 per month for the provision of advertising services. The tax administrator used the upper limit of the ranges to determine the normal price. The defendant has already dealt with the alleged difference in agency prices in paragraphs 48 to 52 of the contested decision.

[21] The defendant also maintains that it was right to exclude certain contracts submitted by the complainant from being used for the determination of normal prices, since they involved transactions that were not comparable in scope or time period. The complainant's claim that they should be used while separating out the comparable scope and, where appropriate, adding inflation, is completely unworkable.

[22] The defendant also points out that it is not for the court to respond in detail to each of the complainant's sub-arguments. It therefore sees nothing fault with the fact that it did not expressly comment on all the contracts submitted by the complainant.

According to the defendant, it does not have to be established whether D.D.D. SERVIS made a profit by purchasing the services in question at a price higher than the normal price. Such evidence would be appropriate, for example, in criminal proceedings where it would be necessary to prove that the funds paid for the overpriced services are returned in some form to D.D.D. SERVIS or the relevant controlling persons. However, the law does not impose such a standard of proof on the tax administrator. Accordingly, the defendant considers that it was not necessary to prove whether the complainant received any additional advantage as a result of the price increase, since the primary advantage is the mere application of tax-effective expenses at a higher rate than if the advertising services had been supplied at normal prices.

[24] The defendant therefore considers that the appeal is unfounded and requests the Supreme Administrative Court to dismiss it.

The complainant's reply

[25] The complainant responded to the defendant's submissions with a rejoinder in which it stressed that the tax authorities could only proceed to assess whether the agreed prices for advertising services were higher than normal prices if they could prove that the contract was concluded between otherwise connected persons. However, that did not happen in the present case. To do otherwise would lead to the conclusion that the element of 'connectedness' of persons is present in any finding of unusual pricing.

[26] As regards the difference found by the tax authorities between the normal price and the price agreed in the present case, the complainant does not consider it to be so significant that the tax authorities could impose tax on that basis. The decisions of the Supreme Administrative Court cited by the defendant dealt with cases in which the price increase was extreme and apparent at first sight. However, that was not the situation in the present case. The difference between the prices would have been much smaller, if not nonexistent, if the tax authority had compared the services provided by the advertising agency rather than by the direct provider, whose price is logically lower.

[27] The complainant further objected to the defendant's assertion that it had already commented on the issue of the difference in agency prices in the contested decision. In that regard, the defendant merely stated that the company could have entered into a business relationship directly with the sports club. However, it did not provide any evidence to that effect.

[28] Finally, the complainant reiterates that it is not clear what advantage D. D. D. SERVIS, since the evidence does not show that the funds paid to it were returned in any form. The complainant does not agree that those facts should be established only in criminal proceedings. Under Article 92(5) of the Tax Code, legal presumptions and fictions are proved by the tax authorities.

Assessment of the case by the Supreme Administrative Court

[29] In assessing the appeal, the Supreme Administrative Court assessed whether the conditions for the proceedings were met. It concluded that the appeal had the requisite elements and was admissible. It assessed the merits of the appeal within the limits of its scope and the grounds relied on (Article 109(3) and (4) of the Code of Civil Procedure), examining whether the judgment under appeal was vitiated by any defects which it would have been obliged to consider even if it had not been brought.

[30] The appeal is well-founded.

[31] First of all, the Supreme Administrative Court points out that in the present case it is not disputed that PAMBROKE provided D. D. D. SERVIS provided advertising services (i.e. that the advertising was actually carried out) and the price for the advertising was paid (see p. 29 of the tax inspection report or pp. 6-7 of the contested decision). Thus, the reason for the tax assessment was only the fact that, in the opinion of the tax administrator and the defendant, the contract for the provision of advertising services was concluded between persons who were otherwise related within the meaning of Article 23(7)(b)(5) of the Income Tax Act, and the agreed price was several times higher than the normal price. According to the tax authorities, the complainant has not been able to explain the difference between the price agreed in the present case and the normal price to the satisfaction of the tax authorities.

[32] According to the first sentence of Section 23(7) of the Income Tax Act, '[i]f the prices agreed between related parties differ from the prices that would have been agreed between unrelated parties in normal business relations under the same or similar conditions, and if this difference is not satisfactorily documented, the taxpayer's tax base shall be adjusted by the difference found.' Connected persons include otherwise connected persons, which, according to Section 23(7)(b)(5) of the Income Tax Act, are "persons who have formed a legal relationship principally for the purpose of reducing the tax base or increasing a tax loss."

[33] Therefore, in order for the tax administrator to be able to adjust the tax base pursuant to Section 23(7) of the Income Tax Act, it must first of all prove that the case involves related persons within the meaning of the quoted provision. The second condition for that procedure is that it must establish that the prices agreed between those persons differ from those which would have been agreed between independent persons in normal commercial relations under the same or similar conditions. In relation to both of these facts, the tax authority bears the burden of proof. If it is established that the parties to the relevant legal transaction are related parties and that they have agreed on prices different from normal prices, it must furthermore give the taxpayer the opportunity to explain the difference between the prices to its satisfaction. At this stage, the tax subject bears the burden of proof, unlike the previous two conditions for adjusting the tax base (see, for example, the judgments of the Supreme Administrative Court of 23 January 2013, No 1 Afs 101/2012-31, or of 26 November 2020, No 4 Afs 343/2018-61).

[34] In its judgment of 26 March 2014, no. 9 Afs 87/2012 - 50, the Supreme Administrative Court explained that '[t]he purpose of the provision in question is to prevent unwanted shifting of a part of the income tax base between individual income taxpayers and to enable the sanctioning of abusive price speculation in business relations. This includes the so-called "profit shifting" between persons with different tax burdens, which usually occurs when these persons charge each other prices in their transactions that are lower or higher than the prices used between independent persons in normal business relations, and the result of such transactions is an increase in costs or a decrease in sales for the company with the higher tax burden and a siphoning off of part of the profits to the company with the lower or zero income tax rate." He then went on to summarise that "a material difference from normal prices occurs when it is sold too cheaply or bought too dearly; in such a case, such a difference must always be satisfactorily documented."

[35] In the present case, it was necessary, as a first step, for the tax authorities to bear the burden of proof in relation to establishing that the complainant and PAMBROKE were otherwise connected persons within the meaning of section 23(7)(b)(5) of the Income Tax Act. The Supreme Administrative Court has repeatedly dealt with the interpretation of the concept of otherwise related persons in its decision-making in the past, inter alia, in its judgment of 13 June 2013, No 7 Afs 47/2013-30, to which the Regional Court and the defendant also referred. In that decision, the Court held that 'connected persons within the meaning of Section 23(7)(b)(5) of the Income Tax Act are not only persons who have directly created a legal relationship mainly for the purpose of reducing the tax base or increasing the tax loss, but 'all persons' who participated in a chain of business transactions aimed at reducing the tax base or increasing the tax loss. (...) The wording of Section 23(7)(b)(5) of the Income Tax Act does not apply 'solely and exclusively' to persons who actually and directly (...) created a legal relationship for the purpose of reducing the tax base or increasing the tax loss. (...) It applies to all persons who, directly or indirectly, participated in and benefited from such a relationship." The circumstance from which the creation of a relationship for the purpose of reducing the tax base or increasing the tax loss is inferred is the economic irrationality of such conduct, or the absence of a motive other than tax-depriving for the relationship (cf. judgments of this Court of 22 March 2013, no. 5 Afs 34/2012-65, 25 September 2014, no. 7 Afs 39/2014-48, or 18 July 2018, no. 6 Afs 129/2018-29).

[36] In the judgment under review, the Regional Court stated in relation to the fulfilment of the characteristic of a relationship between otherwise related persons that "[for] otherwise related persons within the meaning of section 23(7)(b)(5) of the ITA, the existence of a legal relationship between these persons is decisive, for proof of which a concluded contract or otherwise proven legal relationship is sufficient. The contents of the administrative file show that the applicant had a duly concluded contract with the supplier company for the provision of advertising, which has not been disputed in any way. The mere existence of a contractual relationship was therefore quite sufficient for the tax authorities and no further connection between supplier and customer needed to be examined."

[37] However, that assessment is in stark contradiction with the meaning and purpose of section 23(7)(b)(5) of the Income Tax Act and with settled case law. A prerequisite for the assessment of tax under that provision is, first of all, a finding that the commercial transaction involved persons who "created a legal relationship primarily for the purpose of reducing the tax base or increasing the tax loss." The existence of a legal relationship is therefore only one (but not the only) of the conditions which must be met in order to be able to speak of otherwise connected persons. However, the tax authorities must also prove the presence of unusual circumstances which lead to the conclusion that the purpose of the legal relationship is to obtain an unjustified tax advantage. The Regional Court's interpretation would mean (as the complainant also correctly argued) that the existence of otherwise connected persons under the above-mentioned provision would apply in all cases where there is a legal relationship between taxpayers (whether that relationship is based on a formalised act or merely in fact). In principle, therefore, all tax entities involved in legal relations could be considered to be otherwise connected persons, which is, at first sight, a completely absurd conclusion that goes beyond the intention expressed in Article 23(7) of the Income Tax Act.

[38] The interpretation put forward by the Regional Court was also rejected by the defendant itself, which nevertheless insists that the characteristic of 'otherwise connected persons' was fulfilled in the case under consideration. In the contested decision, the defendant identified the prerequisites for the assessment of tax in essentially the same way as the Court of Cassation in paragraph [33] of this judgment. With regard to the first condition, i.e. whether they were connected persons within the meaning of Section 23(7)(b)(5) of the Income Tax Act, it stated that the tax authority had established the normal price for the placement of advertising in the relevant sports stadiums (ranging from CZK 409 to CZK 17 850 per month), whereas the complainant had paid CZK 720 000 for the advertising (i.e. CZK 120 000 per month). "The difference in prices thus shows that the taxpayer reduced its tax liability by establishing a business relationship with PAMBROKE Media s.r.o., with which it negotiated a high price for advertising services, which was not economically rational for the taxpayer. It can therefore be concluded that in the present case the tax entity and PAMBROKE Media s.r.o. are connected persons within the meaning of Section 23(7)(b) of the Income Tax Act (persons who have established a legal relationship primarily for the purpose of reducing the tax base or increasing the tax loss)."

[39] However, the Supreme Administrative Court does not agree with this assessment either. The determination of whether the agreed price differs from the normal price, or from the price that would have been agreed under similar conditions between unrelated persons, is only relevant if the tax administrator bears the burden of allegation and the burden of proof in relation to proving that the legal relationship in the case under consideration is a legal relationship created between related persons (in this case, between so-called otherwise related persons). The conditions for the application of section 23(7) of the Income Tax Act, as described in paragraph [33] of this judgment, constitute an algorithm in which the order of the steps must necessarily be followed. Only if the tax administrator finds that the entities concerned are connected persons can it assess whether the price agreed between them exceeded the normal price. The contrary is unacceptable, since the mere fact that the normal price has been exceeded (even though it may be a significant overrun) does not necessarily mean that the taxpayer is acting in an unlawful manner or that the purpose of the existing legal relationship is to obtain a prohibited tax advantage or to deprive the State of taxes. The taxpayer has a wide contractual discretion as to with whom and under what conditions (i.e. at what price) he purchases the goods or services. While this does not mean that the State is obliged to recognise every expenditure (in any amount) as tax-effective, the tax authorities are not, in principle, entitled to assess whether it exceeds the normal cost, but in determining whether it is a tax-deductible expenditure, they only ascertain whether it was incurred for the purpose of obtaining, securing and maintaining income (section 24(1) of the Income Tax Act). This may also involve an assessment of the reasonableness of the expenditure, which is, however, a much more benevolent category than the comparison with the normal price required by law in the case of a price agreed between related parties. This is because, in the case of otherwise related parties under Section 23(7)(b)(5) of the Income Tax Act, the parties to the business relationship are already presumed to be involved in the unlawful optimisation of the tax (this presumption is already contained in the hypothesis of the legal norm), so it is then up to the tax subject to rebut it, i.e. to explain rationally the difference in price from the normal price (see the last point of the algorithm). However, this implies that, in the first stage, the tax administration must bear the burden of proof both in relation to the existence of a relationship between related parties and in relation to the price increase compared to the normal price.

[40] The Supreme Administrative Court therefore summarises that the first and second conditions for the assessment of tax under Section 23(7) of the Income Tax Act cannot be confused, since the price increase alone does not lead to an inference of a connection between the taxpayers concerned. The Court of Cassation is aware from its decision-making that the defendant has already in the past (in other proceedings) inferred the element of interconnectedness from the finding of an overestimated advertising price (see, for example, judgment of 13 February 2020, no. 7 Afs 176/2019-26). However, it did so in a situation where the increase was quite obvious at first sight (e.g. more than 200 times the price increase) and at the same time other suspicious circumstances (non-standard content of the contracts, negligible benefit of the advertisement for the activity of the tax entity, etc.) added to it. However, in the present case, the defendant did not put forward any similar argumentation in the contested decision and, in assessing whether the taxpayer was otherwise connected, based itself only on the finding that the price was higher than the normal price. However, such a procedure is wholly insufficient, since it effectively merges the first and second conditions of the algorithm. The Supreme Administrative Court does not dispute that a high price (if it is obvious at first sight) may constitute an initial indication for the tax authorities to examine whether there are related parties in the case. It cannot, however, constitute the only clue, as was the case in the present case, or, as the defendant stated in the contested decision.

[41] In this connection, the Court of Cassation adds, in passing, that the conclusions of the Regional Court and the defendant are not supported by the judgment of 13 June 2013, 7 Afs 47/2013-30, to which they repeatedly refer. Both the Regional Court and the defendant somewhat misinterpret the conclusions set out in the judgment cited, or rather, they do not generalise appropriately. In that judgment, the Supreme Administrative Court dealt with a different legal issue than in the present case, as it considered whether Section 23(7)(b)(5) applies only to persons who actually and directly created a legal relationship for the purpose of reducing the tax base or increasing the tax loss. It concluded that it did not, since that provision affected all persons in the chain who participated in and benefited from such a relationship (by reducing the tax base or increasing the tax loss). The situation now at issue is therefore substantially different from the case considered in the judgment cited above, since it does not involve a chain of taxable persons in which a resale of a service takes place. However, in that decision, too, the Supreme Administrative Court proceeded from the fact that there must primarily be a legal relationship which has been created for the purpose of reducing the tax base or increasing the tax loss. However, the defendant did not prove this and it is not clear from the content of the contested decision how the complainant was to profit from the matter. In that connection, the Regional Court's assertion that the complainant reduced its tax base by amounts many times higher than the normal price for similar services does not stand up. If the complainant (D.D.D. SERVIS) had actually paid the price and it was not proven that the funds were returned to it, the payment of an overpriced service solely for the purpose of claiming higher expenses would lack any rationality, since it would be financially disadvantageous (the complainant would have spent more on advertising than it subsequently reduced its tax burden by). For this reason, too, the burden of proof must be borne by the tax administration (the defendant) in relation to proving that the complainant and PAMBROKE were otherwise connected persons within the meaning of section 23(7)(b) of the Income Tax Act. In the case of connected persons, the creation of a legal relationship for the purpose of tax evasion is presumed (or, more precisely, this circumstance is one of the characteristics of otherwise connected persons), and it would then be for the complainant to prove otherwise.

[42] The Supreme Administrative Court therefore upheld the complainant's first appeal objection that it was the defendant's duty to investigate the possible existence of other circumstances which would indicate that there was a legal relationship which had been established mainly for the purpose of reducing the tax base or increasing the tax loss, i.e. that the complainant and PAMBROKE were otherwise connected persons within the meaning of section 23(7)(b) of the Income Tax Act. However, the defendant did not carry the burden of proof in this respect and the Regional Court therefore misjudged the case when it concluded that the existence of a relationship between otherwise connected persons had been established by the tax authorities.

[43] Although the findings so far would be sufficient to annul the judgment of the Regional Court under review and, consequently, the decision of the defendant, the Supreme Administrative Court considers it appropriate to deal with the remaining objections to the cassation, which relate in particular to the second condition for the application of Section 23(7) of the Income Tax Act, i.e. the establishment of the difference between the agreed price and the normal price.

[44] There is a rich decision-making practice of the Supreme Administrative Court on this issue (see, for example, judgments of 31 March 2009, no. 8 Afs 80/2007-105, published under No. 1852/2009 Coll. No. 7 Afs 74/2010-81 of 27 January 2011, or No. 9 Afs 92/2013-27 of 22 November 2014), which this Court summarised in its judgment of 19 September 2019, No. 5 Afs 341/2017-47. In it, the Court stated that if it is "proven that they are related persons within the meaning of Section 23(7) of the Income Tax Act, it is for the tax administrator to prove that the prices agreed between these persons differ from the prices that would have been agreed between independent persons in normal commercial relations under the same or similar conditions. (...) The tax administration must therefore make a comparison, in which it must establish both the price agreed between the related parties and the normal price (compared with the average of prices, the so-called reference price) at which independent persons trade in a comparable commodity. A necessary (but not sufficient) condition for the adjustment of the tax base under Section 23(7) of the Income Tax Act is the existence of a price difference. In order to establish the 'normal' nature of the price, the administrator must be able to bear the burden of proof in relation to all relevant aspects. The tax authorities can, and normally will, determine the normal price by comparing the prices actually obtained for the same or similar commodity between genuine independent operators. However, it may determine it, in particular because of the absence or unavailability of data on such prices, only as a hypothetical estimate based on logical and rational reasoning and economic experience. As the Supreme Administrative Court (SAC) has already stated in its judgment of 27 January 2011 (Case No. 7 Afs 74/2010 - 81, No. 2548/2012 Coll. of the SAC) - the reference (usual) price is essentially a simulation of a price created on the basis of a consideration of what price these persons would have negotiated in a situation identical to that of related persons if they were not related and if they had normal business relations with each other. Where the tax administration establishes a reference price on the basis of data on actual prices achieved for an identical or similar commodity between genuinely existing independent operators, it must carefully examine the extent to which those prices were achieved under the same or similar conditions as those under which the price was negotiated by the connected persons and, if those conditions differ, make an appropriate adjustment to the reference price.

[45] In the present case, the tax administrator, in determining the normal price, included in the reference sample both contracts concluded by other entities directly with the sports venues in question (Andrův stadion, Golf Aréna Ostrava) and, at the same time, relied on the official price lists of those venues for any interested party for the placement of advertising. Last but not least, he also added the estimated price for the production of the advertising panel. In this way, the tax authority concluded that there had been an increase of 335 % over the normal price for the relevant tax period.

[46] However, the Supreme Administrative Court did not overlook the fact that the complainant had consistently argued throughout the tax proceedings that PAMBROKE's services were a complete service (turnkey advertising), so that the prices for renting space directly from sports venues did not constitute a comparable sample. He also raised that objection in the proceedings before the Regional Court, which, however, did not deal with it further. To that extent, the judgment of the Regional Court is therefore unreviewable.

[47] Although it is not the role of the Court of Cassation to replace the Regional Court, it considers it appropriate to comment briefly on this issue. The defendant dealt with a similar objection raised by the complainant in the appeal proceedings by stating, in a somewhat sketchy manner, that D.D.D. SERVIS could have obtained advertising (and at a significantly lower cost) directly from the supplier of the advertising space. At the same time, it found that the complainant had not demonstrated any added value in the intermediation of advertising by PAMBROKE compared to the situation where it would have secured advertising directly from the sports venue. However, in this context, the Supreme Administrative Court notes that this added value may be represented by the mediation of advertising itself, consisting in the fact that the customer is not forced to actively communicate with the advertising space provider or, for example, to supervise the production of the advertisement and its placement.

[48] Therefore, the Court of Cassation finds nothing unusual in the fact that D.D.D. SERVIS did not take over the advertising directly at the sports venues in question, but contracted with an intermediary to carry out the advertising. This is a perfectly normal practice, which should also be taken into account by the tax authorities when determining the reference sample. Therefore, for the purposes of determining the normal price, they should base themselves precisely on the prices which would have been agreed in normal commercial relations between the purchaser of the advertising and the advertising intermediary, not the final provider of the advertising. Since the tax authority did not do so in the present case, the normal price established by the tax authority does not reflect the specific conditions of the commercial transaction under examination. It is obvious that the prices of the intermediary will differ from those of the direct supplier (they will generally be higher). However, it is not the duty of the taxable person to seek the most advantageous offer and the defendant cannot therefore require the complainant or D. D. D. SERVIS to enter into a contract directly with the sports venues in question, since it is a matter of its free choice as to how it secures the advertising services, i.e. whether directly or through an intermediary. Moreover, if the tax authority discovers a non-standard price without being able to prove that the persons concerned are connected within the meaning of Article 23(7) of the Income Tax Act, it is always possible for it to verify the payment of the tax with the recipient of the funds and, if necessary, to follow up the payment of the tax to the State budget. Any finding that the recipient of the funds has not remitted the tax cannot be blamed on the recipient of the transaction. In the present case, there was no chain of entities in which the same service was sold several times, since the chain defined by the tax authorities consisted only of the supplier of the rental space, PAMBROKE and D. D. D. SERVIS, i.e. the customer. In those circumstances, the Court considers that no chain can be said to exist in reality, since the basic outline is a normal business model, and the defendant did not draw attention to any non-standard circumstances, apart from the price increase, in the contested decision.

[49] Emphasis on the proper determination of the reference sample, i.e. on the inclusion of prices from intermediaries (not final providers) and, where appropriate, on the corresponding adjustment of the price found to take account of the difference from the commercial transaction between D. D. D. SERVIS and PAMBROKE is all the stronger since the price difference found in the present case was not very significant (335 % of the normal price). Thus, if the reference sample were adjusted accordingly, it cannot be excluded that the difference between the agreed price and the normal price would be rather negligible. The Supreme Administrative Court therefore also found merit in the complainant's objection to the incorrect determination of the reference sample for the purpose of price comparison.

[50] On the other hand, the Court of Cassation considers the argument that the tax administrator should have relied on the contracts submitted by the complainant to be unfounded. It refers to paragraph 19 of the judgment of the Regional Court and paragraphs 53 to 57 of the contested decision, in which the Regional Court and the defendant dealt with a similar issue, and the Court of Cassation agrees with their assessment. In particular, the defendant has pointed out that the performance in the contracts submitted is not comparable to the terms and conditions of the complainant, both in terms of scope (the contracts concerned, for example, the right to use the logo of the sports club, the provision of VIP admission to matches, etc., in addition to the placement of advertising hoardings) and time (a completely different tax period). The Court agrees with the defendant in particular that the performance defined in the contracts is inseparable, i.e. it is not possible to see from them what the price would have been if the subject of the contract had been only the placement of an advertising panel, as in the present case.

[51] The Supreme Administrative Court therefore concludes that the judgment of the Regional Court is partly unlawful and partly unreviewable (Article 103(1)(a) and (d) of Kodeks Rechie S.A.). Since, in view of the nature of the errors found, the Regional Court would have had no alternative but to annul the contested decision, this Court does not consider it appropriate to refer the case back to it for further consideration, but proceeds without further delay to annul the contested decision of the defendant.

Conclusion and costs

[52] The Supreme Administrative Court found the appeal to be well-founded and therefore annulled the judgment of the Regional Court (Article 110(1) of the Code of Civil Procedure) and, at the same time, in application of Article 110(2)(a) of the Code of Civil Procedure, annulled the contested decision and referred the case back to the defendant for further proceedings (Article 78(3) and (4) of the Code of Civil Procedure). The defendant is bound by the legal opinion expressed by the Supreme Administrative Court in the annulled decision (Article 110(2) of the Code of Civil Procedure in conjunction with Article 78(5) of the Code of Civil Procedure).

[53] The Supreme Administrative Court is the last court to rule on the case and must therefore determine the costs of the proceedings. It is then necessary to assess the procedural success of the parties in relation to the outcome of the proceedings as a whole. Pursuant to Article 60(1) of the Code of Civil Procedure in conjunction with Article 120 of the Code of Civil Procedure, a successful party is entitled to reimbursement of costs reasonably incurred against a party who was unsuccessful. The complainant was successful in the case, and the Supreme Administrative Court therefore awarded him the costs of the proceedings.

[54] The costs of the proceedings consist, first of all, in the reimbursement of the court fee of CZK 3 000 in the proceedings on the action and CZK 5 000 in the proceedings on the appeal.

[55] The applicant was represented in the action by Mgr. Ing. Drahomír Foltan, a tax consultant, who performed two acts of legal service in the proceedings, consisting of taking over and preparing the representation and drafting the application (Article 11(1)(a) and (d) and Decree No 177/1996 Coll., on lawyers' fees and lawyers' remuneration for the provision of legal services (Advocates' Tariff)). For these acts, a fee of 2 x CZK 3,100 (§ 7, § 9(4)(d) of the Advocates' Tariff) and a lump sum of 2 x CZK 300 (§ 13(4) of the Advocates' Tariff) is payable. As the tax advisor was a VAT payer, the court increased the amount of the fee by the relevant tax. The total amount of the fee at this stage of the proceedings is CZK 8,228.

[56] In the proceedings on the cassation complaint, the complainant is represented by the advocate JUDr. Petr Langer, Ph.D., LL.M., who performed three acts of legal service in the proceedings - accepting and preparing the representation, drafting the cassation complaint and drafting the reply [i.e. acts pursuant to Article 11(1)(a) and (d) of the Lawyer's Tariff]. For these acts, the fees for the above-mentioned acts amount to 3 x CZK 3,100 and a lump sum of 3 x CZK 300. The applicant's representative did not prove that he was a VAT payer (and did not request an increase in the fee by VAT), therefore the amount of the fee in the appeal proceedings is CZK 10 200. In total, therefore, the defendant is obliged to pay the complainant's costs in the amount of CZK 26 428.

C o n c l u s i o n : No appeal is admissible against this decision.

Done at Brno, 18 August 2021.

JUDr. Lenka Kaniová

President of the Chamber