SAC: tax-exempt sale of shares covered by tax-exempt dividend payment an abuse of right

The case in question involved a series of transactions. First, a joint-stock company was formed by a demerger by spin-off, to which in effect solely cash in excess of CZK 200 million was transferred. Then the shares were sold by the individuals holding them to an unrelated corporate entity; since the time test was met, the proceeds from the sale of shares were tax exempt. In the next step, the sold company paid dividends to the new owner; since the formal conditions of a parent-subsidiary relationship (holding at least a 10% stake for at least 12 months) were met, the dividend payment was to be exempt from withholding tax. The dividend paid was then used to pay the purchase price to the original shareholders.

The SAC admitted that in the case in question, the Income Tax Act had been complied with. However, the court also assessed whether the transaction had had any economic grounds and whether the application of tax exemption of dividends had been, in this specific case, in accordance with the purpose and meaning of the law. In this respect, the court concluded that there was an abuse of right, as the main objective of the transactions (namely the sale of shares and the subsequent payment of dividend) was to obtain a tax advantage in a form of a de facto tax-exempt payment of dividend to individuals.

In the assessment of the case, several circumstances were considered. The SAC namely pointed out the time sequence of the individual steps: the demerger by spin-off and the formation of the new joint-stock company occurred at the end of May 2010, and the shares were sold at the beginning of June, with the decision on the dividend payment adopted on the same date. The court also pointed out that the sale of shares was effected at a loss of CZK 2.5 million, which made no economic sense in a situation when the company’s assets comprised solely cash. More likely, this ‘loss’ was to serve as commission for the company that realised the transaction. Although the tax administrators failed to prove a connection between the buyer of the shares and the original shareholders, it was clear from the circumstances of the case that the purpose of both parties’ actions was to obtain a tax advantage, according to the SAC.

Once the SAC concluded that there indeed had been an abuse of right, the tax administrator had to determine to whom the additional tax should be assessed. In the case in question, the abuse of right involved two transactions: the sale of shares, and the payment of dividends. The aim of the abuse of right doctrine is restitution, meaning the elimination of the undesirable status of obtaining an unjustified tax advantage. However, the specific manner of recovering such a tax advantage is in the tax administrator’s hands and depends on the circumstances of the case. The tax administrator thus rightly assessed the additional withholding tax on the dividend to the subsidiary as the tax payer.

Although generally nothing prevents taxpayers from minimising their tax liability, obtaining a tax advantage cannot be the main purpose of a transaction or a series of transactions. While the burden of proof that the conditions for invoking the abuse of right concept have been met lies with the tax administrator, taxpayers should have sufficient evidence available to support the economic grounds of transactions providing a more advantageous tax treatment. The abuse of right doctrine, historically formulated by the courts’ decision-making practice, has now been explicitly stipulated in the Tax Procedure Code. Only time will tell whether we will see more such cases in the future.