SAC comments on invoicing services containing tax non-deductible expenses

Section 24(2)(zc) of the Income Tax Act (ITA) in the wording before the amendment dated 1 January 2015 stipulates that expenses non-deductible pursuant to Section 25 may, under certain conditions, be included in tax deductible expenses up to the amount of the income (revenues) directly related to them. The condition is that the expenses must have affected the result of operations in the same or previous taxable periods. 

In the case before the SAC, the taxpayer treated certain expenses (travel expenses of an affiliated company’s employees, refreshment expenses, over-the-limit expenses for employee catering, other fines and penalties) in their tax return as tax deductible, arguing that they were a part of the total price for the provision of the software services to the parent company. The total price of the services was determined on the basis of the costs incurred (even tax non-deductible ones) plus a mark-up. As the transaction involved related parties, the mark-up was set at 5%. The taxpayer believed that the conditions for applying the above provision of the ITA had been met.

The crucial question was whether the expenses were directly related to revenues from services. The SAC concluded that while there was a proportion between the expenses and the revenues as an increase in expenses by CZK 1 lead to an increase in revenues by CZK 1.05, in the court’s opinion a direct relation between these expenses and revenues had not been demonstrated, i.e., the taxpayer had failed to support how the expenses (e.g., for refreshments) related to the provision of software services. The SAC thus confirmed the tax administrator’s approach excluding these amounts from the tax deductible expenses and assessing additional tax.

For the sake of completeness, please note that after the amendment effective 1 January 2015, the above provision only applies to expenses that are determined to be cross-charged to another entity or that another entity has to pay, and only up to the amount of such cross-charging.  According to current interpretations, the expenses have to be demonstrably cross-charged (for instance itemised in the invoice), so that the character of the expenses is maintained on the recipient’s part, i.e., it must be clear that these are refreshment expenses rather than expenses for the provision of services. In our opinion, in the case at hand, the expenses could not have been treated as tax deductible even after the amendment.