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Dispute over the retroactive application of royalty exemptions

We bring you an interesting update on the conditions for claiming the exemption under the EU Interest-Royalty Directive (EU I-R Directive).

What is the issue?

• A company has applied for a ruling on the granting of an exemption from income tax on royalties under section 38nb of the Income Tax Act (ITA) implementing the exemption under the EU I-R Directive for the tax years 2014, 2015, 2016, 2017 and 2018.

The tax administrator's view

• The tax administrator granted the right to this exemption for the 2017 and 2018 tax years, and rejected the claims in relation to the other periods. In fact, the company had applied for the exemption during June 2019, which, according to the tax administrator, was beyond the two-year period for the years 2014, 2015 and 2016.

The municipal court's view

• The company defended itself against the tax administrator's decision by filing a lawsuit, which was rejected by the Municipal Court in Prague. According to the Municipal Court, the tax administrator correctly applied the two-year time limit when assessing the applications.
• Since no time limit was laid down in national law in that respect, the Municipal Court held that, in accordance with the case-law of the Court of Justice of the European Union (CJEU), the direct effect of the directive was applicable - the time limit for submitting an application for a decision granting an exemption was therefore two years.

Company view

• The company filed a cassation complaint with the Supreme Administrative Court (SAC) against the judgment of the Municipal Court.
• The company disagrees, inter alia, with the application of the vertical direct effect of Article 1(15) of the Directive, as it is applied in its case in a descending manner contrary to the case-law of the CJEU and to its disadvantage.

The view of the SAC

• The SAC has doubts about the interpretation of the EU I-R Directive and has therefore decided to refer a preliminary question to the CJEU.
• The first question referred is whether the EU I-R Directive can be interpreted as allowing the source State, on the basis of a decision under Article 1(12), to grant an exemption also for a period prior to the time of submission of such certificates and supporting information as the source State may reasonably require or the time of the decision itself.
• Should the CJEU answer the first preliminary question in the affirmative (which the SAC doubts), the SAC asks a second, follow-up question. The question is whether the EU I-R Directive implies, either directly or indirectly, any time limit for the submission of an application for an exemption decision under Article 1(12) of the EU I-R Directive, or any time limit as to the period preceding the submission of an application for an exemption decision for which an exemption may be granted.

What do you take from this?

• The possibility to retrospectively request the tax administrator to issue a decision on granting an exemption from income tax on royalties was previously generally allowed by the Supreme Administrative Court (3 Afs 250/2016 - 40). The newly submitted preliminary question can be understood as a clarification for which period the retroactive application can be made or - depending on the view of the CJEU - unfortunately also as a closure of this possibility. 
• Thus, there is both potentially good news and possibly bad news in play for taxpayers in relation to the application of the exemption under the EU I-R Directive. We look forward to the resolution of this matter and in the meantime, we would be happy to discuss with you practical recommendations for your particular situation.
• For a more detailed discussion on this topic, please see our December Tax and Legal News.

If you are interested in this area, please contact the authors of this article or the EY advisory team with whom you are working.

Authors:

Radek Matuštík

Jakub Tměj