KPMG’s Tax and Legal Forum: Karel Šimka’s comments on SAC case law re ‘Svarc’ system and transfer pricing

You are one of the key figures in the early case law of the Supreme Administrative Court on the ‘Svarc’ system. Could you comment on it? 

Around 2004 or 2005, Vojtěch Šimíček and I started out from a simple premise. If the nature of an activity allows it to be performed in one form or another, i.e. as an employee or as a self-employed person, then in principle it should be up to the individual to choose one or the other regime, with all its advantages and disadvantages. At first glance, this is a catchy idea, but it is becoming increasingly difficult to defend it against the protectionist argument that says: ‘No, we have two regimes – one more advantageous than the other in terms of taxation and insurance – and if we give too much leeway to the more advantageous one, the state or the pension system will start to have problems obtaining funds to meet public needs’. These two philosophical and value-based views play out in individual cases, and different judges place different emphasis on the basic dividing line – whether these are ambiguous activities, and to what extent self-employed persons are truly independent considering various perspectives: whether they have only one customer, how economically dependent they are on them, how much they have to obey them. To all these arguments, there are very good counterarguments from the other side. In principle, this division into two types of activities is soft: from a number of different angles, we can defend both versions, and in my opinion, it will never be 100% adjudicated because there is a philosophical contradiction here, which leads to different judges assessing the grey areas differently. 

The ‘Svarc’ system issue has recently also come under the scrutiny of the State Labour Inspection Office, as we can see in the decision-making practice of the Supreme Administrative Court. Does tax-related case law also apply to the assessment of employment-related offences, or has there already been a shift in opinion? 

I fear that in the future the assessment of whether work is dependent and the assessment of tax implications may be an area with more uncertainty than clarity. In my opinion, the financial administration has already come to terms with the parameters set by case law and does not challenge the treatment of ambiguous activities. The Ministry of Labour and Social Affairs is approaching the issue from the "other side", but in a similar way: through the concept of dependent work, which is something that is undoubtedly closely related to the tax aspect but may not completely coincide with it. When the defining characteristics of dependent work differ from the tax regulation formed by case law, something may happen that I consider highly undesirable. Namely, that the penalty for dependent work will stand because the definition may be stricter under employment regulations, but additional tax may not be assessed. In my opinion, this is economic nonsense. One situation should be assessed consistently from all possible regulatory perspectives. It is more a matter for political and legislative debate to harmonise this. 

Recently, credit financing has been under scrutiny from the abuse of law perspective. How do you view individual cases and where do you look for the sometimes very fine line between the legitimate optimisation of business relationships and the abuse of law? 

It is important to realise that professional judges gain insight into economic issues mainly through the cases they hear in this area. They are, in a manner of speaking, civil servants whose lives are relatively clearly mapped out and who may encounter risk elsewhere, but certainly not at work. This is a systemic parameter that belongs to the judiciary and is meant to be set this way, but of course it influences judges when they think about business risks. That is why, whenever we talk about an abuse of law, I emphasise that it is necessary to present to the court that your story, which has become the subject of interest of the tax authorities, is essentially honest. That there may be some creative thinking behind it, but in any case, it has a real business reason. And that reason should be to make money, not by gaining tax advantages, but by carrying out fundamental activities for which I need some form of investment, acquisition or reorganisation of assets within the group. The fundamental dispute we have been engaged in for many years is how much a tax advantage can be the main or essential reason for a business arrangement. A trend that I am not very happy about because I would prefer legal certainty and how the state sets it up, is that a tax advantage must not be the predominant factor leading to your decision. As soon as the tax aspect becomes too prominent in your story, there is a great danger that an abuse of law may be investigated. It is hard to describe, and from a business and regulatory risk perspective difficult to eliminate, because you are never completely sure what the tax authorities and subsequently the court will say in a borderline situation. 

We can see digitisation and technological development not only among taxpayers but also in the financial administration, which makes no secret of the fact that it is starting to use advanced analytical tools and algorithms in its inspections and in its selection of the entities for inspection. Where do you think the line should be drawn for the judicial review of such administrative decisions? And will we see courts reviewing decisions that have been generated to a greater or lesser extent by an algorithm? 

To a certain extent, even the judiciary already makes some decisions by machine. The system that generates orders to pay, i.e. simplified court decisions issued in lawsuits for payment of a financial amount, can be an example, even though they are ultimately signed by the person responsible for them. In simple cases, if we can algorithmise them and set up the relevant procedures, we are moving towards more or less machine-supported decision-making, albeit still under the formal guise of a human signature. However, I do not believe that we are far enough along to reach this point in complex cases in the foreseeable future. There, you in fact want the judge not to be algorithmically predictable in a certain respect, so that there is an element of "chance" based on the fact that the judge has ethical preconceptions and ethical values that are subconsciously reflected in their decisions. Ethics and value-based ambiguity can be useful in borderline cases. However, there is nothing wrong with the judiciary or public administration using increasingly sophisticated tools that give them an overview of how the agenda has been decided in the past, as well as arguments. This is a good thing and a natural development.  

And what about the limits of judicial review of administrative decisions?  

Here we have to think in terms of ethics and values. It is difficult for the administrative court to determine this on its own; if anything, it should be up to the Constitutional Court. We can imagine a "Chinese" world in which we will label all transactions and monitor them in real time. They will have certain characteristics that will be saved and evaluated. Essentially, a system will be created that at first glance will almost flawlessly detect tax fraud and prevent it. Personally, I think that countermeasures would eventually be found to label transactions so that they appear differently. Human ingenuity is endless. But what bothers me the most is the amount of information that the state will collect about individuals in this way. I think there should be a limit to this, even if it may lead to less effective public control systems. In my opinion, it is more important to protect the autonomy of the individual, their privacy, and that they can be at least reasonably sure that the state does not know everything about them. Some might say that they would rather have order, even at the cost of the state having a very close look into their lives. Personally, I will always vote for a little more chaos and unpredictability and a little less powerful state. 

One area where we are still looking for more specific limits to case law is transfer pricing. The Supreme Administrative Court has recently issued an interesting ruling on who should bear the costs of setting up production. How do you view the position of foreign investors and where is the line between their strategic decisions whose economic consequences should be borne by a Czech subsidiary, and where it is an order from the parent company for which the subsidiary should be compensated? 

Transfer pricing is based on a simple logic: Let's look at dependent transactions from an arm’s length perspective. In other words, what would the subsidiary do if it were not in the position of a subsidiary? It's very difficult because it would probably do something significantly different. Therefore, any such modelling is necessarily somewhat hypothetical. When there is a parameter that the costs of the transformation were borne by the subsidiary without a reasonable investment horizon in which its investment would pay off, this can only be perceived as a situation where the parent company wanted to create costs that would prevent the company from achieving a profit that could be reasonably taxed. In the 1990s, when we were starting out with foreign capital, it was logical that when a company came to the Czech Republic, it wanted to have a higher return than in its home countries because it was entering a situation with greater risk. However, developments are moving forward, and what was possible then is now indefensible from the arm’s length perspective.  

How do you want to build public trust in the judiciary? 

Through our daily work. We strive to make decisions professionally, i.e. in accordance with the law and in a fair manner. Although I am not always happy with the laws that I have to base my decisions on, my role is to respect them. For example, I have never liked the law restricting shops’ opening hours during public holidays, but it is a law that has been legitimately agreed upon by the majority of this country's legislators, and it is not up to a judge to change it. If we think that laws are unconstitutional, we have the option of submitting them to the Constitutional Court with a proposal for repeal, and we should do so. The rest is the normal routine of a SAC judge: to decide within reasonable time. I am pleased that over the last four years, in cooperation with the executive power, we have managed to shorten the length of proceedings. When I took up the position of president in 2022, we had 3,400 unfinished cases. Today, we have around 1,450, which is equivalent to less than half a year of the Supreme Administrative Court's activity. We have improved significantly in terms of speed, and now it is a matter of maintaining quality in a relatively stable legal system, which is increasingly shaped by case law. For me, trust in the judiciary is about small, everyday work. We must strive to do it well, talk about it to an appropriate extent, and cultivate the Czech justice system in the same way that an English lawn is cultivated – by watering and mowing. Over and over again. 

Are there any specific decisions that have significantly strengthened legal certainty or ones that have brought new challenges? 

I have been working at the Supreme Administrative Court for 21 years, so I see it from a longer perspective. The formative years of the court were mainly in its first decade. At that time, we made significant changes to the functioning of public administration, especially tax administration. I think we made it more humane, more professional and more respectful of legal rules. Today, it is a solid and dignified partner for taxpayers. On the other hand, taxpayers have to get used to the fact that professional tax administration cannot be easily fooled. In my opinion, this is quite a good result. There are also specific court rulings – the issue of the ‘Svarc system’, the review of tax inspections and their repetition, and case law concerning securing orders. We have also made a solid mark to administrative punishment principles. I do feel a certain deficit in the rules for the running of time limits and events that suspend it – however, it is not within the power of the court to change this or speed it up significantly through case law.