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Regional Court on deductibility of interest on acquisition loan and abuse of law

In judgment 55 Af 4/2020–137, the Regional Court in Prague dealt with a company that claimed interest on a bank loan for the purchase of a share in a Czech company with which it was subsequently to merge by acquisition. The loan was provided by an independent consortium of banks at the level of the entire investment group, and the debt was then transferred to a Czech company that made the purchase. The tax authority denied the deductibility of interest on the bank loan, as it considered the restructuring transaction to have been carried out for the sole purpose of obtaining a tax advantage. However, the Regional Court assessed the situation differently and also stated that the tax administrator had incorrectly assessed the fulfilment of the objective condition for the application of the abuse of law concept.

The situation of the corporate group to which the company belonged was bad, both in terms of liquidity and financial position. It was not possible to start negotiations with Czech banks because they would not have seen any positive potential in the company in the Czech Republic. The entry of an investor at the global level aimed to support the company and other group companies and ensure their further development. The subsequent transfer of the loan to operating entities in all countries was the only solution, as it is precisely at operating entities that revenues are generated and assets are managed.

The transfer of the debt to the Czech company was the main requirement of the consortium of banks, otherwise the transaction would not have been financed. The banks found it more acceptable to charge the loan to an operating entity generating active income from business activities and managing assets, as it was more likely for such an entity to make regular interest payments and easier for banks to recover any outstanding amounts.

The tax administrator pointed to the manner in which the obligation to repay the loan and related costs was transferred to the Czech company that had purchased a share in a functioning company with the knowledge that a merger by acquisition would take place in the near future and that this merger could have occurred even without the purchase of the business share, as both companies were managed by the same company or investment group. The company did not carry out any business activity nor did it dispose of any assets or funds. Foreign related parties had sold it the share in a Czech company, which would not have been possible if these parties had not been related to it. According to the tax administrator, the company did not prove that it had incurred the interest and financial costs related to the loan for the purchase of the business share in accordance with the law, thereby unduly reducing its tax base. At the same time, the tax administrator claimed that there had been an abuse of law involved.

The Regional Court stated that drawing the loan indeed appeared to have been irrational: the purpose could not have been to develop the company’s own business activity, as the company did not carry out any such activity at that time. However, the court saw the main economic reason for the described transactions in allowing the takeover of the group by a new investment group. The court also pointed out that the conditions for granting the loan were set by the lending banks, so that it could hardly be assumed that the banks would have deliberately set the conditions so as to create an artificial structure. The Regional Court therefore annulled the tax administrator's decision for unlawfulness. It also concluded that the decision incorrectly assessed the fulfilment of the conditions for the application of the abuse of law concept.

However, the Appellate Financial Directorate has filed a cassation complaint with the Supreme Administrative Court.