Tax and Legal News - March 2022

Editorial: At the crossroads of taxation

The world is standing at several strategic crossroads at once. Energy, sustainability, the European order, etc. But, like a good cobbler, I'll stick to my last and only talk about the crossroads of taxation and the directions in which the tax world and Czech taxation will go.

The latest report on tax administration activities says most tax evasion occurs in transfer prices, deductible items (i.e. non-deductible costs including services) and so called crown bonds. I’ll leave aside crown bonds as a historically insignificant legislative, practical and control anomaly. Logically, the state administration and taxpayers spend the most time where there are the most assessments. We all spend tens, hundreds, thousands .... of hours to produce documentation and play with more or less comparable numbers with the sole aim of determining whether we’ll be paying tax in one country or the other. At best. Here at home, I might even just be deciding whether I’ll pay the same tax to the same state budget in Teplice or Karviná. That’s why I produce dozens or hundreds of pages of documentation and follow a methodology that is itself hundreds of pages long and constantly growing. From today’s perspective, it certainly makes sense, because the economy and business are getting more complex and tax collection has to respond accordingly.

The second of the greatest hits of tax audits – proving the cost of services – offers a similar adventure. A cost must be incurred to generate, assure and maintain income. There must be a direct and immediate link between expense and income. The cost must be reasonable. I have to prove I received the service, when and how exactly, what I did with it, what I used it for and convince the tax authorities it was of use to me. Nice theory, makes sense; some taxpayers try to abuse the system, and the tax administrator needs to be strict. Practice is evolving, tax administrators are getting tougher and the courts – through the lens of the here and now – are backing them. The courts say a contract and an invoice are not enough, nor is a general description of services; they’d like to see specific time worked and a specific price for a specific part of services. The unfortunate taxpayer with 1000+ pages of documentation in several binders is told they didn't provide enough proof because the documentation is too general.

So we should already be expending substantial resources and time just to prove our tax statements. There’s no other added value to this activity. If I try to extrapolate from current developments, we must logically reach a point down the road in (many? few?) years when the whole thing is no longer worthwhile. The cost of proof will exceed the tax paid.

So isn't it time to draw a line somehow and start all over again in a different way? Wouldn't the current two-pillar reform of the OECD be that line? Initially, it will only affect big taxpayers, but we have to start somehow. Pillar One could be a forward-looking solution. I’ll calculate the profit for the whole group and distribute it around the world by consumption/end customers. I completely ignore transfer prices and services within the group because they fall away in consolidation anyway. The right direction, a light at the end of the tunnel, an end to the production of monstrous useless documentation. It needs to be brought to a close. The format proposed today provides for such a distribution of only a part of profit, the rest is still to be treated in the old way.

Pillar Two goes in the opposite direction. Let's first tackle profit and tax paid by companies in each country with conventional weapons (and masses of documentation), and then make someone in the group pay the tax if it’s insufficient for the jurisdiction. This won’t rid us of transfer pricing and the production of proof. But maybe it's just an interim measure to help us bridge the period until Pillar One is completed.

The future will show whether we’ll make the increasingly complex world even more complex for taxes or look for a way to simplify and spend the time saved on something more useful. We’re standing at that crossroads now.