Parent companies are required to prove the costs of holding ownership interests in subsidiaries, both direct and indirect (overhead). Such costs are always not tax deductible.

For indirect holding costs, parent companies have a choice of two possible options, namely:

1. substantiating the actual amount of indirect costs associated with holding ownership interests in a subsidiary, or
2. if the parent company is unable to prove a different amount of indirect costs, the law establishes a fiction that these costs amount to 5% of the dividend received.

Therefore, if the parent company wants to avoid taxation of up to 5% of the dividend received, it must prove that the actual indirect costs were lower than the 5%. However, the law does not contain any clear way to report these costs correctly and to meet the burden of proof in situations where the tax administrator questions the method of calculation and demonstrability.

The Supreme Administrative Court of the Czech Republic (hereinafter “the SAC”) has dealt with the issue of proving indirect costs associated with holding ownership interests in subsidiaries on several occasions. In recent days, it has added another one to his earlier opinions, stressing in particular the need for the parent company to prove all indirect costs, not only some of them, including how it arrived at its result. If the company applies any coefficient or algorithm to certain costs to determine only a portion of the cost as non-tax deductible (e.g., a total “head office” cost that it attributes only partially to holding ownership interests), it must also explain these procedures in detail. In its judgment, the Supreme Administrative Court also reproached the tax entity for changing its claims during the proceedings, for quantifying the costs but failing to provide any evidence of their conclusiveness when asked to do so, and for failing to explain the individual steps of the calculation.

Although the SAC acknowledges that it is difficult to ascertain the exact amount of indirect costs, it requires that taxpayers are always able to explain, on what economic criterion they have based their calculation. In this context, various types of costs need to be tested, whether they are salary costs of management or e.g. economists and accountants, costs of audit, preparation of financial statements and tax returns or other general consultancy, telephones, rent of premises, etc.

It follows from the above that thorough accounting of the indirect costs associated with holding ownership interests in subsidiaries is key to sustaining the burden of proof. In addition, companies may be negatively affected if they do not account for indirect costs in the regular tax return, but only after a tax audit has been initiated.

If you are hesitant about the methodology of determining and recording indirect costs so that the tax authorities cannot challenge your calculations, please contact us and we will be happy to help you prepare the necessary documents.

Author: Zuzana Kalincová, Kristýna Bardonová