Principles of tax administration: material truth
Honesty gets you the furthest, and lies don’t travel far. With a bit of exaggeration, it could seem that these sayings were an inspiration for the Tax Procedure Code, as it enshrines the principle of material truth. In this article, we explain what this principle means, how it is applied, and how the courts view it.
The essence of the principle
The principle of material truth means that the tax administration must base its decision on the actual content of a legal act or other relevant facts. In other words, the tax authorities must not be only interested in how something is formally recorded on paper but also in what actually happened.
The application of the principle
In practice, the principle of material truth is most often applicable when an entity tries to hide the true substance of a transaction to reduce its tax liability or avoid it altogether. The task of the tax authorities is therefore to establish the true state of affairs and to support their conclusions with concrete evidence.
Example from court practice
For example, the Supreme Administrative Court has recently dealt with several cases of disguised association activity where taxpayers provided their members with internet access in exchange for membership fees. Under the guise of association activities, they obtained tax benefits intended only for associations, i.e., the exemption from income tax of membership fees and the exemption from value added tax of the provision of services in return for membership fees. The tax administrator carried out extensive procedures to provide evidence in each case, which contributed substantially to proving simulated conduct - association activity. The tax administrator discovered, e.g., that these 'associations' had dramatically increased their profits even though they were primarily intended to carry out non-profit activities. Witness testimonies confirmed that the vast majority of memberships had the sole purpose of obtaining a favourable internet connection. Even the consequences of non-payment of membership fees were indicative of a wholly commercial approach, as members were immediately cut off from the internet or contacted to prevent them from leaving for a competitor. Based on the extensive evidence provided by the tax authorities, the Supreme Administrative Court confirmed that the "associations" only pretended to carry out association activities but in reality provided services for consideration. The application of tax benefits intended only for associations was therefore excluded in the cases under examination.
Implications
For the purposes of tax proceedings, it is the actual substance of the conduct that is decisive, not its formal recording. However, it is the tax administrator who must not only reveal what actually happened but also explain how they came to these conclusions, and provide the evidence on which their decision was based. Therefore, we recommend that all steps be properly supported with evidence and justified in case the tax authority has doubts as to whether there is any disguised activity.