Disguised legal act in payment of dividend to beneficial owner
In its recent judgment, the Supreme Administrative Court (SAC) dealt with a profit distribution payment to a Cypriot company. After assessing the entire context of previous transactions, the SAC held that the actual status had been disguised and agreed with the conclusions of the tax administrator who had additionally assessed a withholding tax.
In the present case (2 Afs 94/2021), an individual (a natural person) sold their share (ownership interest) in a Czech limited liability company to a Cypriot company. The conditions of the sale were quite specific: first, 25% were transferred at a significantly higher price than the remaining 75% whose gradual transfer was also part of the share transfer agreement. The terms of payment of the purchase price were agreed only in general terms: the purchase price was to be paid within a time horizon of ten years without any further specification of the amount or timing of individual instalments. As such, the sale of the share formally fulfilled the conditions for tax exemption and therefore, the income was not taxed.
In the following taxable period, the limited liability company paid out all dividends to the Cypriot company. As, under tax legislation, this was a payment of a dividend to a parent company, no tax was withheld from the payment. Within days of receiving the payment, the Cypriot company transferred all funds thus obtained to the account of the individual (the original shareholder/member of the limited liability company), arguing that it was an instalment of the purchase price for the share transferred. In a tax inspection, the tax administrator concluded that in the present case, the beneficial owner of the funds paid was not the Cypriot company, but the individual – the original owner of the share, and that the transactions carried out concealed the true legal status, which is the payment of a dividend to the individual. Unlike the payment of dividends to the parent company, payment to an individual is subject to withholding tax.
In agreement with the tax administrator, the SAC described the acts of the entities as purposefully leading to the avoidance of a tax liability, which, in the eyes of the court, was the main purpose of the transactions. The SAC further emphasised that in practice, it is always necessary to assess transactions depending on the economic purpose of the legal relationship and the conduct of its participants.
That judgment confirmed yet again that, in tax inspections, individual transactions are assessed considering all related facts, not just the individual steps and their formal-legal status.