Deduction for support of research and development (hereinafter R&D) is an item deductible from the tax base in the sense of article 34(4) of the Income Tax Act (hereinafter the ITA). Subsequent provisions of the Income Tax Act define the specific conditions for claiming this deduction. If the conditions are met, R&D is an interesting item in the calculation of the tax base. This is because it in fact allows deducing the costs incurred for research and development activities twice. It is therefore not surprising that this deductible item is being used by taxpayers and subsequently audited and possibly disputed by the tax administrator.

In this context, we particularly follow the judgments of the Supreme Administrative Court and in the following article we would like to summarise the most recent case law relating to research and development.

A too broad definition of Control and Evaluation of R&D results

(Judgment 8 Afs 169/2020-56 of 22 July 2022)

This judgment dealt with the need to include a specific method for evaluating the results of R&D in an R&D project. An R&D project needs to set out specifically how the criteria will be used to evaluate whether and to what extent the project has been successful. Failure to comply with the formal requirement to define the method of control and evaluation does not only occur if the R&D project does not mention the method of control and evaluation at all, but also if it is insufficiently defined.

In the aforementioned judgment, the taxpayer only stated in general terms in the R&D project that the solution of the R&D project would be inspected and evaluated once a year by a specific person. In addition, the scope of the R&D project was also given outlined only very briefly. The R&D projects were not accompanied by additional documentation prepared at the time of their preparation, which would have further defined the method of control and evaluation.

Neither can it be inferred from the documented R&D interim reports, which in the context of the evaluation of the objectives and outputs achieved essentially only paraphrase the originally defined scope of the individual projects, that the audit was carried out on the basis of predetermined rules, according to which it was to be substantively assessed whether and to what extent the project was successful.

According to the Supreme Administrative Court, this method of control and evaluation is not specific enough and does not meet the statutory conditions. Notwithstanding the fact that it is clear, who was to perform the control, at what intervals and in what manner, nothing specific about the content of the control and evaluation itself emerges from the above, nor are the rules, by which it will be assessed whether and to what extent the project has been successful, specified.

Calculated hourly amount of wage costs

(Judgment 10 Afs 54/2020-77 of 18 August 2020)

That judgment dealt with the question of whether or not the calculated hourly amount of wage costs could be applied for the purposes of the R&D deduction under article 34(3) and (4) of the ITA.  The audited tax entity submitted only tables documenting the calculation of the hourly rate of wage costs to the tax administrator for review of the R&D calculation. The actual costs were not substantiated in the appeal proceeding either.

Thus, the Supreme Administrative Court agreed with the statement of the defendant Regional Court on the appeal in cassation that during the tax audit and in the appeal proceedings, despite the summons, the tax entity did not provide relevant evidence, from which it would be possible to derive the actual and correct amount of wage costs of individual employees, who participated in R&D in a given year.

The interpretation and conclusions of the defendant Regional Court are then followed by the conclusions that while the tax entity kept records of the hours worked by individual employees who participated in the implementation of R&D projects, it did not keep records of the actual personal (wage) costs incurred in relation to individual accounting cases. Therefore, separate records of personnel (wage) costs incurred in the implementation of the R&D project were not kept properly and conclusively.

The Supreme Administrative Court thus rejected the tax administrator’s acceptance of the method of determining wage costs through planned calculations in the tax audit. In compliance with article 49(5) of Decree No. 500/2002 Coll., implementing certain provisions of Act No. 563/1991 Coll., on Accounting, the tax administrator only confirmed that it is possible to use planned calculation when valuing inventories created by own activities. However, he did not confirm that it is possible to calculate R&D costs in this way.

Defining the R&D objective too broadly

(Judgment 6 Afs 161/2021-57 of 10 November 2022)

The subject of the dispute was the need to define a specific objective of the R&D project, so that it would be achievable during the project and evaluable after its completion. Furthermore, if it is possible for the purposes of the R&D deduction not to record attendance broken down into individual sub-projects and then use the average wage of employees (not the real wage) in the calculation.

The Supreme Administrative Court stated that the objective of a project does not necessarily need to always define a measurable target value. This does not mean, though, that the project does not have to define what exactly the R&D activity should aim at. The objectives of R&D can be described in such a way that even a layman can understand them in basic outline. In the project, however, the complainant defined its objectives so broadly and vaguely that even an expert could not describe, what its activities were actually supposed to consist of, without further documents.

Furthermore, the Supreme Administrative Court stated that the tax entity submitted monthly and annual summaries of hours worked by specific employees, which can be considered as records of a similar nature to the percentage of working time that specific employees devoted to work on the project. Next, the court addressed the issue that the average wage of the employees (not the actual/real wage) was used for the calculation. Moreover, it does not appear from the defendant’s decision that the average annual salary of the complainant’s employees differed substantially from the salary paid to them in the months, in which they participated in the project. It is, of course, open to question, if the complainant could prove that the declared wage costs were actually incurred in connection with the research or development activities, in which the individual employees allegedly participated during the periods in question. However, this circumstance was not related to the formalities of the cost records and would therefore have to be proved in the proceedings.

We will continue to follow the case law of the Supreme Administrative Court and inform you about the latest news in the field of deductible items for research and development.

Author: Petra Vaněčková, Miroslav Černík