Mayer & Cie is one of the world’s leading suppliers of industrial knitting machines. Following an audit, the tax authorities disallowed a tax deduction of CZK 4,066,097 in FY2014, which Mayer & Cie. had incurred as a result of the disposal of unusable material. According to the tax authorities, the disposal was made on the basis of a controlled transaction in the form of an order from the parent company to cease production of certain knitting machines. Mayer & Cie. appealed to the Regional Court, which ruled in its favour. The court concluded that the Czech arm’s length principle did not apply to the transaction in question, as it did not involve a price agreed between related parties. The tax authorities then appealed to the Supreme Administrative Court. Judgement of the court The Supreme Administrative Court upheld the decision of the Regional Court and ruled in favour of Mayer & Cie. However, the Court’s reasoning was very different with regard to the application of the arm’s length principle. Excerpts “[26] Section 23(7) of the Income Tax Act or Article 9(1) of the Double Taxation Treaty apply to contractual obligations. Section 23(7) of the Income Tax Act refers to ordinary commercial relations and Article 9(1) of the Double Taxation Treaty to conditions in commercial or financial relations which are nothing other than contractual obligations. In the present case, however, in the view of the SAC, no multilateral legal transaction (commercial or financial relationship) and no fixed (agreed) price or non-standard terms can be identified in the parent company’s decision to liquidate the stock, which was made in the course of the applicant’s business management. [27] The parent company’s order against the applicant did not constitute any contractual obligation, since it was merely a decision by the parent company on the commercial management of the applicant’s subsidiary. It should be emphasised that a distinction must be drawn between ‘direct or indirect participation in the management, control or assets of an undertaking’ as a feature of associated persons and ‘a commercial or financial relationship’, or ‘a business relationship’, as the case may be. “In such a case, it is usually based on a decision by the controlling (parent) entity on the commercial management of the dependent (subsidiary) entity (this will typically be, for example, a decision on with whom and under what conditions a contractual relationship is to be entered into in the future, as in the case of the Seventh Chamber cited in paragraph [37]). A decision on the commercial management of a company does not, as a rule, in itself have the effect of creating, modifying or terminating a contractual obligation (transaction) without more. Simply put, it is an expression of the ‘internal will’ of the entity concerned, which may not, however, be fulfilled (e.g. the intended contractual transaction fails to be concluded for various reasons). The decisive transaction in this case is not, then, also seen by the tax authorities as any transaction (contractual obligations) relating to the implementation of the cessation of production or the disposal of materials (stocks). [28] The SAC observes that the tax authorities saw the parent company’s order against the subsidiary (the applicant) as something of a hypothetical service. However, it was not an obligation within the meaning of section 23(7) of the Income Tax Act, but the normal business management of the company (the applicant). It is certainly a feature of a related party relationship between a parent company and a subsidiary that the parent company decides on the production direction of its subsidiary. [29] However, as the Regional Court pointed out in paragraph [30], it should be emphasised that section 23(7) of the Income Tax Act could be applied, for example, to the assessment of the prices of inventories (materials) purchased from the parent company (and subsequently in conjunction with the parent company’s decision in question). However, this is a different transaction from the conduct now at issue, where the price of the stock transferred or other circumstances were not called into question by the tax authorities. [30] In the present case, it is also relevant to the assessment of the economic rationality of the case that the applicant, as a subsidiary, purchased stock (material) for the production of knitting machines from the parent company in 2011 and disposed of that stock in 2014 on the basis of the parent company’s decision (order), as the production of the knitting machines in question was loss-making. [31] In that connection, the SAC observes, in relation to the applicant’s cassation objections, that it is not true that the Regional Court disregarded the relationship between the parent company and the applicant and the functions and risks which they bore. The Regional Court dealt with that issue, for example, in paragraphs [29] et seq. of the judgment under appeal. [32] Furthermore, the SAC observes that throughout the proceedings no one questioned the rationality of the decisions taken by the parent company in the context of the applicant’s business management. Only in the applicant’s view was the parent company obliged to compensate the applicant for the damage suffered. The complainant also considers that the parent company made a profit by its actions. [33] It is always necessary to weigh carefully and objectively the circumstances of a particular case. In the present case, its circumstances suggest that, as a result of its decision (the order), the parent company merely avoided the negative consequences that would have been associated with the continuation of unprofitable production. Those negative consequences (increasing losses) would have been suffered by the applicant in the first place. The parent company did not receive any direct profit as a result of that decision alone. Nor is there any indication to date that the conduct of the parent company now under review constitutes conduct which would have caused the applicant damage without further delay. Furthermore, in the present case, it cannot yet be concluded that the parent company, and hence the applicant, for example, sought (unjustifiably) to reduce its tax base. Three years elapsed between the purchase of the material, the cessation of production ...

A request for an interpretation was submitted by a company in regards to financial transactions (loans and guarantees) with related parties. The requested interpretation was relevant in determining the amount of the controlled transactions and on that basis whether the taxpayer was required to prepare TP documentation or not. The company held that in determining the value of a loan transaction, only the value of interest should be taken into account. The tax authorities held that both the amount of interest and the amount of capital were to be included in amount of the transaction. Judgement of the Supreme Administrative Court The Court decided in favour of the tax authorities. Applying a linguistic interpretation, the court found no support for excluding the capital part of a loan transaction from the amount of the transaction. Click here for English Translation Click here for other translation ...