News

Dividend financing is now clear: a landmark ruling of the Supreme Administrative Court

The Supreme Administrative Court significantly affected the long-standing dispute between tax payers and the tax administration by issuing ruling Afs 25/2009-98 on 25 March 2010. The Court confirmed that financial costs for loans drawn for the purposes of dividend payment were tax-deductible; thus emphasising the relationship between these costs and a tax payer’s business activity. There should no longer be tax disadvantages in financing a dividend payout using a loan.

For several years the tax administration had been of the firm opinion that the interest on loans used to finance dividend payouts are companies’ non tax-deductible costs. This view was supported by the Coordination Committee of the Chamber of Tax Advisors and the Ministry of Finance of the Czech Republic.

In our specific case, this legal opinion was also supported by the Regional Court in Ostrava with a ruling issued at the close of 2008 (Ruling of the RC in Ostrava of 19 December 2008, file no. 22 Ca 119/2008-46). However, this was criticised by many tax experts, who raised several arguments against their interpretation. As these issues may have affected a large number of organisations, irrespective of their size or the nature of their business, the decision of the Supreme Administrative Court was eagerly anticipated.

The decision was made at the end of March 2010, and the Supreme Administrative Court was definitely in favour of tax payers and the professional public. Here is a brief summary of the argumentation used by the Court to support its decision.

A story as any other

The actual background of the case in question is rather standard and transferable across the spectrum of tax payers. The general meeting of a joint stock company decided to pay out dividends. As the company did not have enough cash, it accepted a loan and then paid out the dividends. The tax administrator found this out when reviewing the company and excluded the costs for the accepted loan from the tax-deductible costs.

In addition, the tax payer reduced its registered capital. This however, was not subject to dispute with the tax administrator; neither was it affected in any way.

Both the Financial Directorate and the Regional Court identified with the tax administrator’s opinion. As tax legislation does not contain an explicit regulation of the dividend financing issue, only the interpretation of the provision of Section 24 (1) of the Income Tax Act (Act No. 586/1992 Coll., on Income Tax, as amended
) remained the subject of the dispute. The opinion that a dividend payout was not related to taxable income prevailed.

Economy, logic and legal interpretation

According to the Supreme Administrative Court, however, the economic substance of legal relationships must always be taken into account when assessing tax efficiency of costs. Economically, there is basically no difference between a tax payer financing a dividend from its own sources – thus constraining, for example, its further business development – and a tax payer financing a dividend from other sources – using its own free funds to achieve other taxable income.

“There is no rational reason for a company opting for the latter business strategy to be discriminated against in terms of tax …,” states the Supreme Administrative Court in its ruling.

The Court also points out that the interpretation according to which a dividend payout is not related to a tax payer’s activities is pointless. Payment of profit is the principal motivation and a coveted aim of any business activity.

The argument that a dividend payout closes the economic cycle of funds that are no longer used for business activities doesn’t hold up either. By making their contributions, shareholders in fact allow a company to pursue any business activity they like. Their primary objective, in the final analysis, is to achieve profit. According to the Supreme Administrative Court, a profit payment is not a kind of extra addition to (actually unrelated) business activities; on the contrary, it is its integral part and conditional factor.

Dividends, therefore, are directly connected with a tax payer’s business.

What next?

We can therefore summarise that costs to finance dividend payouts through debt will continue to be considered as tax-deductible costs. The tax administration has signified through the Ministry of Finance that it is going to respect the Supreme Administrative Court’s decision.

With this in mind, we recommend that our clients reassess the strategy of paying out shares in the profit of their companies. To finance dividend payouts using other sources may be an economically interesting alternative.

Tax payers who have been financing dividend payouts through loans and classifying the related costs as non tax-deductible in the last three years should also pay particular attention to this news. They may consider filing additional tax returns and claiming these financial costs retrospectively.

If you are interested in more details, do not hesitate to contact us.

Jaromír ZBROJ, Senior Manager, TACOMA Tax
Tel: +420 731 411 268
E-mail: jaromir.zbroj@tacoma.eu  
www.tacoma.eu  

Daniel Kovačovič, Senior Asistent, TACOMA Tax
TEL: +420 226 219 000
E-mail: daniel.kovacovic@tacoma.eu  
www.tacoma.eu