Tax deductibility of interest on acquisition loans in intragroup restructuring

The entire restructuring took place with a foreign group establishing a new Czech company (‘A’), to which they provided an intragroup loan. A used the loan to finance the purchase of two operating Czech companies (‘B’ and ‘C’), which, however, had already been owned by the same group. After the acquisition, B and C merged with A, with subsequent conversion to a limited partnership where A was the general partner. A thus effectively deducted interest on the acquisition loan from the tax base taken-over from the ‘newly created’ limited partnership.

The tax administrator assessed the transaction as artificially created (in terms of the abuse of right principle), arguing that its main purpose was to reduce the tax base of the companies in the Czech Republic. The Municipal Court in Prague agreed with the tax administrator's conclusions, the main arguments against the taxable person being as follows:

• The whole restructuring took place within a single group, with no transaction objectively increasing the value of the group (e.g. bringing new revenues beyond the tax advantage obtained or contributing to maintaining existing revenues).
• It was not proven how the general partner’s activities differ from those of the limited partnership. Instead, they appeared to be identical, as the same persons were holding the offices of the relevant bodies; the general partner was therefore assessed as an entity established for the sole purpose of gaining a tax advantage, with no independent economic substance.
• The maturity of the acquisition loan was extended several times by new loans, to the end that only interest was effectively paid, not the principal amount. The limited partnership, which had been profitable before the restructuring, was thus burdened with a debt that did not and could not bring them any additional economic benefit.

The Municipal Court further added that the assessment of the case may have been different had the company in question invested the funds thus obtained for instance to purchase a company operating outside the group and thus constituting newly acquired assets from the group's perspective. The court also rejected the taxpayer’s argument of a similarity to the OKD case; on the contrary, the court found certain similarities between the case under appeal and the CTP case.

The taxpayer, nevertheless, disagreed with the court's view and filed a cassation complaint with the Supreme Administrative Court. We thus have to wait and see whether the Supreme Administrative Court will draw new conclusions on the case or whether it will agree with the previous instances.