Establishment of a holding structure – abuse of law

The cassation appeal concerned a situation where the taxpayer was dealing with changes in the composition of shareholders—individuals, their shares sizes, and the associated risks. Specifically, the taxpayer was addressing how to facilitate the exit of one of the shareholders (whose share was tied to securing a loan for the company), the entry of a new shareholder, and the balancing of shares and risks in such a way that would simplify the entry of new shareholders into the company in the future. 

The taxpayer decided to establish a holding structure consisting of a parent company and two subsidiaries. This option was chosen because it was not possible to find a buyer for the shares of the outgoing shareholder for an extended period, and the remaining shareholders did not have sufficient financial resources to purchase the shares (it was practically impossible for individuals to obtain a bank loan for such a transaction). By setting up the holding structure, it was possible to gather necessary financial resources to buy out the outgoing shareholder, adjust the size of the shares and associated risks and establish less administratively demanding conditions for the disposition of shares. The taxpayer also highlighted other general advantages of the holding structure. Besides holding and managing the shares, the holding company planned to expand the business by acquiring other companies. 

Subsequently, the shareholders sold their shares in the participating companies to a newly established holding company. Due to insufficient financial resources to pay the purchase price, the holding company recognized a liability to the shareholders. It was then decided to distribute profits from the subsidiaries to the holding company. In the case of these profit distributions, the formal requirements for tax exemption were met. The distribution of profit from the subsidiaries was primarily financed by bank loans obtained for this purpose. The holding company used the received finances to repay the liabilities incurred form the acquisition of the shares. The income of individuals from the sale of shares satisfied the time test for tax exemption.

According to the tax administrator, the primary purpose of the described transactions was to obtain tax-free income. The tax administrator viewed the entire transaction as a hidden profit distribution, which should have been subject to withholding tax on personal income. The tax administrator considered the taxpayer‘s actions as an abuse of law, concluding that both the objective test (conflict with the legislator’s intention, where the exemption in the parent-subsidiary relationship is meant to prevent double taxation of income but assumes taxation at the level of the ultimate recipient) and the subjective test (intention to obtain a tax advantage through artificially creating conditions for its achievement) of abuse of law were fulfilled.

According to the SAC, although the tax advantage was achieved contrary to the legislator‘s intention, the subjective test was not fulfilled. The administrative authorities incorrectly assessed the fulfilment of the subjective test, assuming that the predominant reason for establishing the holding structure was to obtain a tax advantage, while all other stated and documented reasons were either considered marginal or inadequately disregarded. The SAC agreed with the taxpayer‘s objections noting the insufficient examination of the economic, financial, legal and other business considerations that led to the establishment of the holding structure.

The SAC stated that the administrative authorities had failed to bear their burden of proof and to prove that the method and circumstances of financing the payment of profit were intentional and economically unjustified. Additionally, they did not refute the taxpayer‘s statement that the other shareholders lacked sufficient financial resources to buy out the outgoing shareholder and would not have been able to obtain a bank loan for this purpose. Furthermore, the SAC noted that if the holding company is still in the process of being established and its activities are being developed gradually, this cannot be a basis for concluding that there was an abuse of law or intentionality in its establishment. Entrepreneurs cannot be expected to make their business immediately successful and fully developed. Moreover, in the present case, the sole reason for setting up the holding structure was not merely to unified accounting and simplify administration.

If the taxpayer provides a full justification for the establishment of the holding company, it is the duty of the tax administrator to prove that the tax advantage outweighs and is the primary reason for the transaction, i.e. that the reasons for the transaction are purely intentional and economically unjustified. 

Court case 10 Afs 16-2023-78

Author: Eliška Stránská, Tax Manager