24.06.2022

Related parties in the Czech Republic

Supreme Administrative Court’s thoughts on the definition

The Czech Supreme Administrative Court has recently made two important decisions regarding the definition of related parties in the Czech Republic. Accordingly, the tax authority has to examine whether the legal relationship between the related parties was established mainly to reduce the tax base or increase the tax loss. We  have summarised the details below.

Related parties in the Czech Republic according to the Income Tax Act

Transactions between related parties in the Czech Republic are regulated by the requirement to comply with the arm’s length principle. According to the Czech Income Tax Act, related parties in the Czech Republic are understood as follows:

  • persons related through capital (25% threshold),
  • persons otherwise related who are persons
    1. where one person participates in the management or control of another person,
    2. where identical persons or close persons participate in the management or control of other persons, then such other persons are persons otherwise mutually related; if a person is a member of the supervisory boards of two persons, such persons shall not be deemed otherwise related,
    3. controlling and controlled and also persons controlled by the same controlling person,
    4. who are close,
    5. who have created a legal relationship predominantly for the purpose of reducing a tax base or increasing a tax loss.

Based on the precise definition of a related person, the last variant of “otherwise related persons” is the most problematic. For this reason, it is important to examine two judgements of the Czech Supreme Administrative Court, which clarify the definition of related parties in the Czech Republic.

Obligations and difficulties of the tax authority

The Czech Supreme Administrative Court is of the opinion that to adjust the tax base according to the Czech Income Tax Act, it is essential to prove compliance with the related persons’ criterion. This is done by the tax authority. Admittedly, proving a creation of a legal relationship predominantly for the purpose of reducing a tax base or increasing a tax loss is difficult, but it is not sufficient to find that the price is excessive. The only exception could be the case of a clear price overrun for goods or services whose normal price is generally known or available, in the absence of any reasonable explanation for the acquisition of those goods or services, or that it was an artificial transaction (pointless for the real economic functioning of the tax entity), the only explanation for which is the reduction of the tax base. In this case, the company would also not be able to explain the difference between the price paid and the arm’s length price.

Likewise, sufficient evidence of creating related parties in the Czech Republic as defined by that provision would emerge if the buyer accounts for artificially increased tax costs, while the seller takes advantage of the tax loss they would already have available. It is essential, however, that the excessive price must be quite obvious, and the circumstances of the individual case must not offer any reasonable explanation other than the performed transaction being the result of an agreement between two persons to obtain a tax advantage. 

Another judgment of the Supreme Administrative Court on related parties in the Czech Republic

It follows from another judgment of the Czech Supreme Administrative Court (1 Afs 109/2021) that if the recipient of the service actually paid a certain price and at the same time it was not proven that the funds would be returned to them, paying the overpriced service for the purpose of incurring higher expenses would lack any rationality as it would be financially disadvantageous.

Both court decisions therefore mean the tax administrator is obliged to examine the possible existence of other circumstances indicating that such a relationship was established mainly to reduce the tax base or increase the tax loss, i.e. that the companies are otherwise related as defined by Section 23 para. 7 b) of the Czech Income Tax Act.

If you would like to know more about transactions between related parties in the Czech Republic or other transfer pricing issues in the country, please do not hesitate to contact the experts at WTS Alfery, the exclusive representative of WTS Global for the Czech Republic.

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