Czech Republic: Determining whether income and expenses are “related” (court decisions)

Two courts recently addressed whether expenses and income are “related” for purposes of applying rules allowing non-deductible expenses to be considered deductible up to the amount of the related income, or income to be considered non-taxable if it is related to non-deductible expenses. The court decisions establish that there must be a “direct” link, and merely an economic link is not sufficient.

• The Municipal Court in Prague held (3 Af 4/2020 48) that a pharmaceutical distribution company could not deduct typically non-deductible expenses (e.g., entertainment costs and non-deductible gifts) simply because the expenses were directly included in the calculation of its income (i.e., the company's pricing model consisted of the sum of its direct and indirect operating expenses plus a margin of 5%). The court found that the company must establish a direct link between expense and income, which could not be inferred merely from its direct inclusion in the price calculation. Rather, the company must show that had it not been for the expenses in question, the customer would not have purchased the goods or would not have done so on the given terms.
• The Supreme Administrative Court held (10 Afs 221/2022 - 70) that a company could not treat interest income from a loan agreement as non-taxable on the grounds that it was related to interest expense from issuing bonds that was non-deductible under the thin capitalization rules test simply because the receivable arising from the subscribed bonds and the payable from the loan agreement were offset. The court found that the relationship between the receivable and the payable must be examined individually, and in determining whether there is in fact a direct link, it is always relevant to consider whether the taxpayer would have received the income without incurring the non-deductible expense.

Read a February 2024 report prepared by the KPMG member firm in the Czech Republic