SAC opines on frequent tax inspection targets
In its recent judgment (7Afs 472/2018) the Supreme Administrative Court (SAC) confirmed the conclusions of a tax administrator and the Regional Court of Justice in Ústí nad Labem. The SAC opined on supporting the tax deductibility of advisory and consulting services provided between group companies, and on the (un)lawful creation of estimated payables for expected price reductions in the automotive industry.
Proving the provisions of consulting and advisory services
The SAC has confirmed that the burden of proof as regards tax deductibility of expenses for consulting and support services is with the taxpayer. In the case in question, the tax administrator refused to accept expenses incurred on the provided services as tax deductible, mainly on the grounds that under the contract, the provider was supposed to issue an activity report every six months, upon whose approval by the service recipient invoices were to be issued, for a half of the annual fee. The company, however, did not have this crucial piece of evidence, explicitly stipulated by the contract, at their disposal. Furthermore, in the opinion of the tax administrator, and subsequently the court, the pricing of services did not reflect the actual volume of services rendered; the price was calculated from the total planned expenses of the service provider, multiplied by a coefficient determined as a ratio of the service recipient’s planned turnover to the planned turnover of all European group companies.
According to the tax administrator, this manner of setting the fee did not allow to determine whether expenses incurred by the company actually corresponded to services rendered. The same conclusion was then confirmed by the SAC, stating that the taxpayer failed to carry the burden of proof, neither did they prove the benefits of the services received (the ‘benefit test’).
In our experience, this has recently been a common practice in tax inspections and other audits. Existence of an invoice and a contract is no longer accepted as sufficient evidence that services have been rendered, while the tax administrators also increasingly focus on the mentioned benefit test; in other words: there must be a direct and immediate relation between the incurred expenses and the expected income.
(Un)lawfulness of estimated payables for price matching
The SAC also dealt with the (un)lawfulness of estimated payables created for expected future price adjustments. However, neither the tax administrator, the regional court nor the SAC challenged the practice common in the automotive industry whereby prices may be adjusted retrospectively (even with delays spanning over several taxable periods).
In the adjudicated case, a company established estimated payables for expected retrospective changes to prices. In general terms, the procedure was that once the negotiations were closed, a credit note was issued, and the estimated item was to be released. During a tax inspection, the company itself confirmed that unless the price negotiations were completed, a credit note could not be issued.
In the case in question, a credit note was indeed issued, but the estimated payable was only released in one of the subsequent taxable periods. The tax administrator raised the objection of a time mismatch between issuing the credit note and releasing the estimated payable. The company argued that in some cases further price adjustments may need to be done in the periods after a credit note had been issued. This was, however, contrary to their own previous assertion, and no sufficient evidence was produced to support this. The conclusions of the tax administrator and the regional court were also confirmed by the SAC, stating in its judgement that credit notes had already been issued for the products and therefore no longer provided a reason for creating estimated items. The taxpayer’s assertion that prices might be reduced repeatedly over subsequent years were considered unsupported by evidence.
The judgment underlines the necessity to have supporting documentation available for each individual transaction, so that the taxpayer can carry the burden of proof. In our experience, companies often keep estimated items on their books, claiming that price negotiations have not yet been closed. Taxpayers should always be able to support this, while it is important that the reason for not releasing or creating estimated items also be implied by other supporting documentation, and, most importantly, corresponds to the respective contractual or other arrangement. Otherwise it may be difficult for taxpayers to defend their approach to the tax authority or in court.