In recent years (perhaps decades), tax law as a specific, and it must be added fiscally very important, part of public law, has been experiencing strong legislative pressure from the outside. This is mainly at the initiative of EU or OECD institutions, whose efforts are determining the direction of tax systems not only in the Czech Republic, but in all other EU Member States, at the very least. Their aim is mainly to combat the aggressive tax practices of some entities in this territory.
One of the latest measures aiming at the full or at least partial elimination of the tax advantages obtained by businesses that engage in unfair practices is the legislative proposal for the transposition of Article 6 of EU Council Directive 2016/1164, laying down rules against tax evasion practices which have a direct impact on the functioning of the internal market (the “ATAD Directive”). As the title of the article suggests, it is about enshrining the principle of anti-tax avoidance in Czech law.
As the time remaining for Member States to transpose the respective anti-tax avoidance rules is dwindling down, the topic is becoming ever more pressing. By the time this article is published, Member States will have less than two months left to complete the legislative process of transposing the proposed rules into national law. The decisive date for implementation has been set as 31 December 2018.
My aim in the following article is to briefly describe what the anti-tax avoidance rules generally entail and the manner in which the Czech Republic has decided to enshrine this principle in its tax law.
- Anti-tax avoidance – attributes
Tax avoidance as a concept is not perceived in a unified way by the professional public. Some of them consider it an oxymoron, as there cannot at the same time exist conduct that is both permitted and not permitted by law (legally prohibited “avoidance”). Others see anti-tax avoidance as a special legal standard towards any legally permitted conduct.
A starting point for the legislation governing tax avoidance, as I state above, can be Art. 6 of the ATAD: “For the purposes of calculating the corporate tax liability, a Member State shall ignore an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part.“
- Aspects of tax-avoidance – subjective and objective criteria
As it has for the Czech lawmaker, the anti-tax avoidance rules in the ATAD emerge from the testing of so-called subjective and objective criteria of avoidance.
- The subjective element of avoidance is directed at assessing the taxpayer’s motivation. As a rule, the presence of “ill intent” will be examined in connection with the obtaining of a tax advantage. In the end, it is necessary to also evaluate the purpose of the transaction itself (obtaining a tax advantage), which must be (according to the ATAD) the main or one of the main purposes.
- Objective criteria are focused on the evaluation of the intent and purpose of the legal standard which the taxpayer has “abused” with his conduct. Both items must be fulfilled cumulatively[1].
The assessment of whether the taxpayer abused the law falls to the tax administrator. If it concludes that abuse occurred, it bears the burden of proof for its assertion. While apparently insignificant, it is very important in relation to the conduct of tax proceedings and their outcome. Unlike the standard situation, where the taxpayer is obliged to prove facts that correlate with his submitted tax return, the taxpayer does not lose “by default” in tax litigation because tax avoidance was not proven. From the point of view of proof, it is the tax administrator that is the fully liable entity in tax proceedings.
- Aspects of tax avoidance (ultima ratio)
With regard to the interpretation of anti-tax avoidance, whose application considerably increases the uncertainty of the recipient of the legal standards in written law, it is only possible to agree with the opinion of the Supreme Administrative Court, through its decision-making practice, that the anti-tax avoidance principle must be perceived and used as an ultima ratio tool in the fight against unfair tax practices by taxpayers. Karel Šimka, Chairman of the Judicial Panel of the Supreme Administrative Court, points out that: “you can’t use ‘carpet bombing’ methods for anti-tax avoidance whenever as a tax administrator I don’t feel like using ordinary and legally foreseen tools, such as price correction between connected persons or proving that the actual purpose of the expenditure declared by the taxpayer is tax deductible.”
- The history of tax avoidance
The concept of anti-tax avoidance, as it is termed in Art. 6 of the ATAD, has, at least in the Czech Republic, much older roots. Already at the end of 2005, the domestic administrative courts began dealing with a file of cases in which it was possible to recognise the tendentious conduct of taxpayers to obtain an unjustified tax advantage, and that by means of legally permitted conduct. One of the first steps taken by the Supreme Administrative Court, which to a large extent determined the direction of the further development of case law in relation to the assessment of anti-tax avoidance, is decision ref. no. 1 Afs 107/2004-48 dated 10 November 2005, also known as the “Diver”. In the assessed case, the court resolved a situation where the payer had established a civic association, from whose funds he financed the activities exclusively of his family, including scuba diving, whereas the donations received by this association from its members were subsequently deducted from the income tax base.
In the conclusions of the “Diver” judgment, the Supreme Administrative Court subsequently referred to decision ref. no. 1 Afs 73/2004 dated 3 April 2007, or the publicly known judgments in the CTP case. All these decisions perceive the key aspects of anti-tax avoidance, which I discussed above, identically to Art. 6 of the ATAD.
- Differences between abuse of the law, dissimulation, and circumvention of the law
Before moving on to the draft legislative framework for anti-tax avoidance in the Czech Republic, I would like here to clarify the differences due to which conduct demonstrating the characteristics of abuse of law cannot be regarded in the same way as so-called dissimulation or conduct circumventing the law. Each of these categories of conduct has different characteristics, and each is viewed differently from the perspective of the law. In relation to the consequences of the qualification of the conduct of taxpayers in tax law, I believe it is appropriate to examine the difference between dissimulation and abuse in more detail.
- Dissimulation can be perceived as a condition where conduct is wilfully (intentionally) disguised as conduct pursuing a different purpose. However, such conduct is merely formally pursuing a single goal – to cover up the actual conduct. An example of dissimulation may be a gift instead of tuition in the decision of the Supreme Administrative Court ref. no. 1 Afs 24/2009-71. For the purposes of tax proceedings, the principle of the priority of content over form entitles the tax administrator to base its decision only on the legal act that has been obscured.
- On the other hand, abuse of law consists in deliberate conduct which does not seek to hide anything. The will (internal subjective motive – intention) of the taxpayer is therefore fully in accordance with the manifestation of will (external conduct).
Draft codification into Czech tax law
- State of the legislative process
The legislative draft law incorporating the anti-tax avoidance principles into domestic law is now in the Chamber of Deputies, where it awaits a second reading. In addition to anti-tax avoidance, Parliamentary Bulletin 206 also includes an amendment to other tax laws (for example, the Income Tax Act, Value Added Tax Act). In light of the current state of the legislative process, the proposed date of effectiveness of 1 January 2019 appears to be at risk. In any case, I do not think that the Czech Parliament or the president will veto the “anti-tax avoidance package” as a result. At most, the effectiveness of the law will be postponed until 2019.
- Where will the anti-tax avoidance principle be enshrined?
The submitter of the newly proposed legislation (the Czech Government, and by extension the Ministry of Finance of the Czech Republic) is counting on the anti-tax avoidance principle being enshrined in the general procedural rules governing tax administration – the Tax Code (new Section 8 (4)). The lawmaker elaborated on the reasons for choosing this approach in the explanatory report to the proposed amendment to the law, specifically: “…the proposed amendment of Section 8 (4) of the Tax Code is not aimed only at income tax, but is designed so that anti-tax avoidance is applied in principle the same way to all types of tax. For this reason, a supplement to the general regulation is proposed for all such monetary performance, mainly for the sake of the uniformity and internal consistency of the law and for the purpose of maintaining certainty.” The submitter is aware that enshrining the anti-tax avoidance principle in the general regulations means an extension of the scope of this principle beyond the obligatory implementation of Art. 6 of the ATAD Directive, which only affects corporate income tax. Besides these reasons, the submitter added that with regard to current administrative and judicial practice, which I discussed above, in essence this is merely a legislative expression of the current state of this practice.
From the information available to me, the views on this issue within EU Member States are not uniform. A side-by-side comparison will certainly be interesting and enlightening.
- Legislative draft of anti-tax avoidance text
The draft amendment of the Tax Code reads: “In tax administration, legal acts and other factors decisive for the administration of taxes, the overriding purpose of which is to obtain a tax advantage contrary to the intention and purpose of the tax legislation, are not taken into account.“
In its proposal, the Czech Republic honours the foundation of Art. 6 of the ATAD Directive (subjective and objective criteria). Where small differences can be perceived is in the definition of subjective criteria – the “purpose” of the conduct. The ATAD Directive discusses the “main or one of the main” purposes (obtain a tax advantage), whereas the Czech draft uses the word “prevailing“. The Czech lawmaker opted for the wording “prevailing purpose” so that the draft of the law adheres to the case law, which uses it in this way without further addition. The effort is therefore to preserve continuity with the terminology used in the case law, as any new attempt to express the rules in other words raises the risk of a different interpretation.
Concurrently with the material enshrinement of anti-tax avoidance in Section 8 (4) of the Tax Code, the lawmaker acceded to the express enshrinement of the obligation to prove facts decisive for the assessment of tax avoidance to the tax administrator. Now, not only is the burden of proof on the tax administrator to prove tax avoidance by the taxable person derived from the case law, but newly it will be explicitly enshrined in the Tax Code.
- Where the principle does not apply
Neither tax avoidance as interpreted by Czech courts, nor the newly proposed codified regulation, address situations where the law allows a taxable person to choose between several paths leading to the realisation of his goals and he chooses one of the paths because its tax advantage is foreseen by law. If, therefore, the taxable person uses an advantage offered him in accordance with the intent and purpose of the tax regulation, this cannot under any circumstances be considered tax avoidance (absent objective criteria – conduct contrary to the intent and purpose of legal standards). Finally, the above is also supported by recital no. 11 of the ATAD Directive, which states that unless a case of tax avoidance is concerned, the taxable person should retain the opportunity to “choose the most effective tax structure for his business”.
- Concerns about future application
Let me express my concerns about possible developments after the codification of the anti-tax avoidance principle in the Tax Code.
The lawmaker’s planned step should incorporate the principle, which today is “present” in tax law only from the pens of judges in administrative courts, among one of the overarching principles of tax collection. Not only will it become part of statutory law, it will also be “within reach” of all tax administrators. My concern is that tools which are, and mainly should be, used merely and only as a last resort, do not become systematically applied by the tax administrator when collecting taxes. In my opinion, this would introduce a significant degree of uncertainty into statutory law, thus weakening the legal system, as one of society’s key value systems.
My second concern is related to the decision-making practice of the administrative courts after the codification of the anti-tax avoidance principle and its links to previous case law. Even though the explanatory report to the amendment emphasises the consistency of the new law with existing decision-making practice, it remains to be seen if this will indeed be the case.
Food for thought
By way of conclusion, allow me to pose a question that I have been thinking about for some time in connection with our clients’ cases. It is related to the ever-stronger pressure to defend the economic rationality of individual decisions made by businesses (see evaluation of subjective criteria).
Can a business, under the constitutionally guaranteed autonomy of will, act in the way it believes to be appropriate – i.e. with the possibility of error – or must it act purely rationally? Which then raises the question: Is the tax administrator authorised to assess whether this or that conduct (decision) was or was not rational?
