SAC held issue of one-crown bonds abuse of law
In its recent judgment, the Supreme Administrative Court (SAC) dealt with the issue of one-crown bonds that effectively redirected a portion of funds from a cash pooling structure to one-crown bonds with long-term maturity. The court ruled that the arrangement was an abuse of law and withheld the tax advantage in the form of tax-deductible expenses.
A parent company changed its capital structure by decreasing its registered capital and limited its involvement in group cash pooling. Having considered various cash pooling options, its subsidiary subsequently issued bonds with 10-15 years maturity and a low nominal value. These bonds were underwritten by persons in the management of the parent company, which provided them with interest-free loans to finance them. Because of a planned acquisition, the value of the bond issue was increased. As the acquisition eventually did not come through, the subsidiary redeemed a part of the bonds, and the persons involved used the funds thus obtained to settle the interest-free loans. All these steps took place between October and December 2012. As a result of rounding down, interest on the bonds was not subject to withholding tax upon payment. The tax administrator assessed the series of transactions as abuse of law, seeing an unlawful tax advantage in the tax-deductible expenses for the bonds. The SAC agreed with these conclusions.
Under the abuse of law doctrine, the tax authorities disregard any acts whose predominant purpose is to obtain a tax advantage contrary to the purpose and meaning of the law. The court recapitulated the two-component abuse of law test, which includes an objective and a subjective element. According to the SAC, it did not matter that the regional court did not explicitly separate the two elements – the SAC did not do so either. According to the judges, it was crucial that the case involved a closed circle of mutually and financially directly related transactions creating a cycle of the group's own funds, driven by the effort to obtain a tax advantage. The tax advantage consisted in reducing the tax liability by deducting from the tax base (as an expense) interest on the bonds issued. The fact that the transactions were decided by the same persons who acted once in the position of statutory bodies, the second time as borrowers, and the third time as bond underwriters, also played a role in the court's assessment.
In essence, part of the funds was simply redirected from the cash pooling structure to the issued bonds. The court pointed out that these were still funds flowing from the parent company, only in a different way. The SAC rejected the taxpayer's argument that since interest on cash pooling had not been disputed, it was absurd that the change in funding should be regarded as an abuse of law and lead to the tax non-deductibility of interest. Unfortunately, the SAC provided only a very brief statement of ground for this point, referring to the differences in the manner of funding and the fact that specific circumstances did not exist for cash pooling that did exist for the bond issue. By the circumstances the SAC probably meant the series of transactions leading to the bond issue, which the SAC considered artificial and without economic substance.