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Czech Republic: High court decision, interpreting tax treaty provisions

Czech Republic: High court decision, tax treaty

The Supreme Administrative Court held that if an income taxation treaty can be applied to a taxpayer’s situation, the tax administrator cannot automatically use domestic law or regulations to interpret a treaty’s concepts, but must apply international law principles and the commentaries to the OECD’s Model Convention.


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The case concerned credit transactions between a Czech (domestic) and foreign company belonging to the same group of companies. The Czech taxpayer paid an appropriate amount of interest on loans and withheld 15% in tax pursuant to Czech tax law.  Subsequently, the taxpayer filed a refund claim for the withheld tax, and referred to a provision of the income tax treaty between the Czech Republic and Great Britain that allows taxation of interest only by the tax resident’s state. 

The refund was denied. The tax administrator regarded the parties as “related parties” under Czech tax law, and in applying the Czech thin capitalisation rules and the treaty provision on dividends, the interest payment was effectively recast in part as a dividend and thus was subject to the less advantageous article of the income tax treaty relating to dividends.

The court did not agree with this treatment, and stressed that the tax authority cannot interpret the concepts of an income tax treaty by imposing domestic tax law provisions. While the court found that there was a special relationship in this case involving, inter alia, cash pooling between the companies, this relationship may not be applied automatically to all inter-company transactions. According to the court, the tax administrator incorrectly treated the amount of interest that was non-deductible, as a result of application of the thin capitalisation rules, as interest that would have never been agreed between the creditor and the debtor under ordinary circumstances (without a special relationship).  

KPMG observation

In summary, the key message from the court’s decision is that concepts in an income tax treaty must primarily be interpreted in accordance with the appropriate income tax treaty and certain “tools” including the interpretation principles of the Vienna Convention on the Law of Treaties or the OECD’s Model Convention. The concepts and definitions in Czech domestic tax law are relevant when interpreting uncertain concepts of an income tax treaty, but nevertheless cannot automatically replace the meaning of the concept being interpreted. The purpose of the treaty’s provisions and any related context must always be taken into account.


Read a November 2018 report prepared by the KPMG member firm in the Czech Republic

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