SAC rules on tax non-deductibility of interest on intra-group financing

In its initial ruling, the SAC assessed the tax deductibility of interest expenses incurred during a group’s internal restructuring. The tax authorities had concluded that the intra-group restructuring had primarily aimed to obtain a tax advantage (interest as a tax-deductible expense) without any underlying economic rationale, thereby constituting an abuse of law. However, the taxpayer contended that the interest income had been subject to taxation abroad and thus no tax advantage had been obtained. This issue was then subject of subsequent proceedings. In its ruling, the SAC upheld the ruling of the regional court, determining that the taxation abroad had been significantly disproportionate to the tax advantage obtained in the Czech Republic, thereby constituting an abuse of law. 

In our view, the judgment is also significant for certain other observations made by the SAC. Notably, the taxpayer in their defence referred to a judgment on the tax deductibility of interest on a loan used to finance dividend payments. However, the municipal court held that the conclusions formulated in this judgment could not be applied to the matter in question, as, among other things, it did not involve the distribution of previously taxed profits to shareholders and no retained earnings were utilised for operating or other investment or acquisition activities. The SAC upheld this reasoning. 

The municipal court as well as the SAC emphasised that in similar cases, it is crucial to determine whether the debt financing was used for a new acquisition (from the group's perspective) or whether it objectively generated new income or contributed to maintaining existing income.

From a practical standpoint, it is thus necessary to consider the tax implications of internal reorganisations (including payments of dividends and other components of equity) where debt financing from related and unrelated parties is used and interest expenses arise.