Czech Republic: Additional tax assessment based on overall profitability for unrelated-party transactions

Case concerning transactions with an unrelated party may be regarded as controlled transactions, if they are influenced by a related party

Concerning transactions with an unrelated party may be regarded as controlled transactions

The Supreme Administrative Court held in judgment 7 Afs 398/2019 – 49 that tax administrators may assess additional tax based on overall profitability not just for related-party transactions, but also for transactions with unrelated parties.

Background

The Income Tax Act, which regulates transfer pricing, provides that the tax administrator may adjust the taxpayer's tax base if there is an unsubstantiated difference between the prices agreed with related parties and the prices that would be agreed with unrelated parties in normal business relations under the same or similar conditions. Thus, tax administrators generally have adjusted a taxpayer’s tax base only if the tax administrator identifies transactions with related parties that differ from standard market conditions. This approach has been confirmed by prior case law.

Summary of case

In this case, the court concluded that even transactions with an unrelated party may be regarded as controlled transactions, if they are influenced by a related party. Such transactions do not have to be examined on an individual basis, but they may be considered on an aggregate basis.

In particular, the court held that if transactions with an unrelated party that cannot be considered at arm’s-length are identified, the unrelated party (in this case a contract manufacturer) must be compensated for risks such unrelated party cannot control. 

KPMG observation

The court’s decision significantly widens the burden of proof on taxpayers who must now have to prove the absence of a “service to the group” for transactions with unrelated parties as well.

Given the fact that the court’s decision is a significant departure from prior case law, it remains to be seen whether the decision will be upheld.

Read a May 2022 report prepared by the KPMG member firm in the Czech Republic 

 

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