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Accruals for Damage Compensation

In today's alert, we would like to highlight the recent judgment (ref. no. 15 Af 8/2024-83), which addresses the legitimacy of creating accruals for damage compensation.

In the supplementary corporate income tax return, the taxpayer released an active accrual (i.e., an expense was recorded) that had been created for damage compensation due to a breach of contractual obligations by a business partner. The taxpayer justified the release of the accrualby citing the statute of limitations on the claim for damage compensation.

The tax authority deemed the taxpayer's pactions illegal, arguing that the conditions for creating accruals in the previous tax period were not met. Consequently, the release of the accrual could not reduce the tax base.

The contractual documentation included an arbitration clause stipulating that any disputes between the supplier and the customer (the taxpayer) would be resolved through arbitration. Active accruals were created during the ongoing arbitration proceedings. According to the tax authority, there could not be a legal claim for damage compensation while arbitration was still in progress; therefore, accruals could not be created.

The taxpayer's intriguing argument that"confirmation of the existence of a claim by a court or other authority does not establish the claim for damage compensation at the date of the decision, but rather confirms whether a legal claim for damage compensation arose in the past based on the breach of the contractual relationship" did not hold up in court.

Furthermore, the taxpayer attempted to argue legitimate expectations based on a local investigation  conducted during the period when the active accrual was created.. Despite the submission of documents and information regarding the accrual's creation to the tax authority during the local investigation, the court found this insufficient to establish legitimate expectations.

What to take away from this? The auditor's statement "without reservations" alone does not guarantee the correct accounting of accruals.We recommend exercising increased caution regarding the creation and release of accruals during closing accounting operations.

For completeness, we add that no cassation complaint was filed against the judgment, so a review by the Supreme Administrative Court is not expected.

We would like to emphasize that this brief comment cannot replace a detailed tax assessment of the specific situation.If you have any questions, please reach out to the authors of the article or the EY tax team  with whom you regularly collaborate.

Authors:

Ivan Zhurkin

Barbora Ptošková

Lukáš Vimr