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Tax deductibility of costs for financing payout of shares in profit

This special issue of Tax News is to inform you of the latest judgement by the Supreme Administrative Court of the Czech Republic (the “SAC”) No. 5 Afs 25/2009 – 98 dated 25 March 2010. We believe the ruling to be a substantial breakthrough for further review of, and dealing with, costs in terms of determining the tax base. The judgment is available at the SAC’s website: http://www.nssoud.cz/main.aspx?cls=anonymZneni&id=22401&mark=

The costs of loans to finance the payout of dividends have so far been deemed not to be tax deductible in administrative practice based on published opinions. However, the SAC decided in favour of the claimant and ruled that such costs shall be tax effective. The appellate complaint was drafted by KSB.

The SAC consented to the argumentation raised in the appellate complaint – that the costs spent by a public limited company to receive a loan to finance the payout of dividends to its shareholders constitute costs incurred to generate, assure and maintain taxable income.

Among other things, the SAC’s argumentation included the following:

  • interests and any other necessary costs associated with loans to finance the payout of dividends have an immediate relation to the expected taxable income since they enable the company to use free cash for investment or coverage of operating expenses incurred to generate, assure and maintain taxable income,
  • the payout of dividends is directly associated with the claimant’s business (it is the very substance of public limited companies) and the right to receive dividends is one of the shareholders’ fundamental rights as the primary incentive for shareholders who invest funds in a public limited company,
  • it is up to the company to decide whether to cover the payout of dividends from its own or third-party resources and such business decision depends on which alternative is better and more beneficial at any given moment, especially with regards to maintaining the company’s cash flow on a steady basis.

The SAC arrived at a very favourable conclusion: interest and other costs legitimately spent by a commercial company on financing of the payout of shares in profit (dividends in case of public limited companies) to its members (shareholders), provided that the decision on the payout is made in compliance with the Commercial Code and other legislation and therefore constitutes an existing obligation of the company due to its members (shareholders), must be deemed to constitute costs incurred to generate, assure and maintain taxable income of commercial companies as per Section 24 (1) of the Income Tax Act.

Companies which eliminated certain costs incurred to payout dividends or shares in profit in the past can now consider the possibility of recovering at least a portion of such costs by reducing the income tax costs or, as the case may be, increasing the tax-deductible loss which they will be able to apply to reduce their income tax base.

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