Nejvyssi spravni soud ke korunovym dluhopisum a zneuziti

Supreme Administrative Court on Crown Bonds and Abuse

We bring you a fresh judgment of the Supreme Administrative Court (SAC) on the topic of abuse and crown bonds.

Situation

• In November 2012, a company asked banks for their opinion on the possibility of granting a loan to finance a photovoltaic power plant (PV plant) project under completion in Romania, and received a negative answer.
• In December 2012, the company's director entered into an agreement with the company for the subscription of the so-called Crown Bonds with a total issue price of EUR 35 million. The company was granted a bond for CZK 35 million.
• In the course of the bond issuance process, the company was asked by the director to repay an interest-free loan totalling CZK 33 million. The company repaid the loan of CZK 33 million, which he had granted to it in 2010.
• Its director then subsequently paid the company the issue price of the subscribed bonds in the total amount of CZK 35 million.
• In March 2013, the director requested the company to prepay the nominal value of the subscribed bonds, including the payment of interest, which took place in April 2013.
• In May 2013, the director granted another interest-free loan to the company in the amount of 35 million CZK.
• The company justified this action by the fact that the investment in the PV plant in Romania was cancelled and did not take place. According to the company, the bond issue was a transparent and standard financial instrument - it intended to enter into a project for the construction of a PV plant in Romania, and immediately after the economic unattractiveness was discovered, the bonds in question matured early.
• The tax authorities refused to recognise the related interest expense on the bonds in question, arguing that these were acts of connected persons pursuing an abuse of law, the only real purpose of the bond issue being to take advantage of the rule at the time that enabled to pay interest not subject to withholding tax to the director of the company, while at the same time reducing the company's corporate tax base by claiming it as a tax deductible expense.
• The Regional Court sided with the tax administrator.

What does the SAC say?

The SAC also sided with the tax administrator - its selected observations:

• According to the SAC, the primary purpose of a bond issue is to secure an external source of financing, i.e. to obtain additional capital for further development or maintenance of the business from external sources. If this purpose is fulfilled, the deduction of interest costs of external financing in determining the income tax base does not in principle contradict the purpose of Section 24(1) of the Income Tax Act (ITA).
• According to the SAC, this purpose was not fulfilled in the present case. According to the SAC, the issuance of the bonds in this case served primarily as a means of securing tax-free interest income of the company's director, and at the same time also to reduce the tax base for the determination of the company's corporate income tax.
• According to the Supreme Administrative Court, the company had not proved its intention to finance, by means of the bond issue in question, the project for the completion of the PV plant in Romania.
• The SAC also pointed out that the company did not even wait for a response from the banks it approached to its request for credit financing for the investment before starting the actual issuance process.
• The SAC also stressed the fact that the company did not intend to use effectively external sources to finance the alleged investment. The SAC held that the subscription of the Crown bonds by third parties would have led to similar tax consequences to those at issue in the present case, i.e. the application of interest costs as deductible expenses in determining the income tax base. In such a case, however, according to the Supreme Administrative Court, the transaction would have an obvious economic purpose other than merely to obtain the tax advantages associated with the koruna bonds, namely to actually finance its economic activities
• According to the SAC, the sequence of steps in question shows an artificially created cycle of own funds. In the present case, if the company had not issued the bonds, its financial situation would not have changed significantly, and it would not have incurred the cost of the interest on the bonds.
• According to the Supreme Administrative Court, the period for which the company's director held the subscribed bonds is irrelevant to the assessment of the case.

If you have any questions, please contact the author of this article or the EY tax team with whom you regularly work.

Author:

Lucie Říhová