SAC: standard of loss and tax deductibility

The Income Tax Act considers shortages, i.e. inventory-taking differences where the actual balance of assets is lower than their book balance, to be tax non-deductible costs. However, losses in retail sales (usually losses of goods as a result of unevidenced theft by customers or losses of value of goods as a result of their deterioration, moral obsolescence, or unsalability) up to an economically reasonable amount set by the taxpayer is not considered a shortage and is therefore tax deductible. 

Similarly, manufacturing companies set standards for natural losses of materials (shrinkage), for instance due to drying-up, evaporation, solidification, etc. Such standards must correspond to the nature of the business and be customary in the industry. In both cases, the tax administrator may assess the appropriateness of the standard and adjust the tax base by possibly ascertained differences.

In the case at hand, the taxpayer (a well-known Czech chain of electrical appliance stores) initially set its standard of loss at 0.15% of its turnover, and the tax administrator accepted it. However, during a tax inspection, it was ascertained that the taxpayer had claimed as tax deductible also costs exceeding that standard, as they did not calculate the loss as 0.15% of the turnover but of the difference between shortages and surpluses, while taking into account both cash surpluses and surpluses of goods, thus mixing together different types of assets without distinguishing them. The tax administrator did not accept this and excluded the amounts exceeding the set standard of loss (0.15% of turnover) and the undocumented shortages.

Throughout the proceedings, the taxpayer kept changing the calculation and the amount of the standard of loss, claiming that 0.15% of the deficit (shortages reduced by surpluses) corresponded to 0.60% of turnover, or that the standard of loss was up to 1% of turnover, so that the resulting tax deductible loss corresponded to its original calculation, where they had recognised the tax deductible loss incorrectly above the set standard. The SAC, however, held that this was not a mere recalculation but a factual change to the standard of loss which had not been properly justified.

The taxpayer also referred to a survey of a standard of loss at another entity. The court, however, noted that as the tax administrator had accepted the standard of loss set by the taxpayer, there was no reason to make comparisons with other entities, especially as it was the taxpayer who had retroactively challenged their own standard because of exceeding the limit.

The Supreme Administrative Court dismissed the cassation complaint and confirmed that the standard of loss must be economically justified and unchanging (unless a change is duly justified) and that it is not possible to offset shortages and surpluses between different types of assets. The SAC also pointed out the need of a responsible approach in setting and applying standards of loss in tax practice.