At the end of last year, the Supreme Administrative Court (“the SAC”) dealt with a dispute between the plaintiff ADOZ s.r.o. and the defendant Appellate Financial Directorate regarding additional assessment of withholding tax on personal income at a special tax rate. The subject of the tax was the payment of dividends to a foreign shareholder of the tax entity, KP INDUSTRY, a business corporation with its registered office in Cyprus.

The tax authorities identified the Czech shareholder, Mr Ing. Martin Liska, as the ultimate owner of the dividend. KP INDUSTRY has a Latvian bank account, to which dividends were paid, and these were transferred within two to four working days to the account of Mr Ing. Liška. Mr. Ing. Liška was, moreover, the founder of the bank account in question and was entitled to dispose of it. The same findings applied to the Cyprus account. The plaintiff thus wrongly claimed exemption under Section 19(1)(ze)(1) of the Income Tax Act on the basis of the Double Taxation Treaty between the Czech Republic and Cyprus (the exemption could only be claimed if the ultimate owner of the dividends was KP INDUSTRY).

The plaintiff referred to the document “Agreement of Intent” which, according to the applicant, explains the economic substance of the individual transactions between KP INDUSTRY and Ing. Liška. In the letter of intent, the parties negotiated the terms and conditions under which KP INDUSTRY would acquire an ownership interest in the tax entity from Ing. Liška, who was the owner of the complainant’s trademark, and the agreement included its transfer. KP INDUSTRY will acquire a majority stake at the end of the transaction. Ing. Liška was first to transfer a 25% share for a price of CZK 100,000,000, the remaining 75% share was to be transferred after payment of this amount, for EUR 10,000.

According to the defendant, the amount of the purchase price was set quite illogically in relation to the amount of the share transferred in the individual stages of the transfer. The purchase price for the transfer of the remaining part of the share (75%) in the amount of CZK 265,000 is disproportionately low in relation to the purchase price of CZK 100,000,000 for the transfer of only a quarter of the share. It also points out that if the value of a quarter share were CZK 100,000,000, then the value of the entire shareholding would be CZK 400,000,000, which is more than five times the total value of the equity.

It further pointed to the fact that the price agreement did not contain a specific agreement on the amount and timing of the instalments. It was only stated that the purchase price was to be paid by the end of 2022. A pricing arrangement setting a time frame of ten years for the repayment of the purchase price without any sub-obligations, such as the need to repay at least 50% of the amount within five years, does not bring any economic security, and the long repayment period entails risks, especially since the obligation to repay was on the part of a completely new business entity. If it was the intention of the parties to repay the purchase price out of the profit share, the majority shareholder could have retained the share and offset it against the purchase price and the result would have been identical in terms of income for the next few years. The SAC points to the defendant’s conclusion that if the taxpayer’s claim that payments to the private account of Mr. Ing. Liska were in fact repayments of the business share, it would mean that the liability of the Cyprus corporation arising from the acquisition of the business share was paid from the tax entity’s funds. In such a case, serious doubts would then arise as to the purpose of the capital combination of the corporations in question, since the need for external financing is usually the reason for the decision to bring an external partner into the corporation.

Although the complainant presented the alleged meaning of the individual transactions, they led to the logical conclusion that the entire transaction (not just its partial steps) obscured the real situation, which was the payment of the share to Ing. Liška in an amount corresponding to his position in the company, but at a tax advantage which could not have occurred if the payment of the profit share had been made directly, and this transaction was obscured by the formal state of affairs, whereby the business share was purchased by a Cypriot company, and the Cypriot company was paid (despite its participation in the company) all the profit, which, however, had to be paid by the Cypriot company as an instalment of the purchase price of the business share, the amount of the instalments and their dates not being determined in advance.

The complainant did not succeed with her objections. Since the SAC found no grounds for setting aside the contested judgment even of its own motion (Article 109(4) of the Code of Administrative Procedure), it dismissed the appeal as unfounded (Article 110(1) of the Code of Administrative Procedure).

Author: Roman Burnus