Substance a benefit test
In the area of transfer pricing, there has been an increasing emphasis on meeting the substance and benefit test, which precedes the actual assessment of the transfer price. Under the substance test, the taxpayer has to be able to demonstrate that the services were actually provided. Under the benefit test, the taxpayer must demonstrate whether the services provided have had a real economic benefit to the company.
Proving that these tests are met was handled by the Supreme Administrative Court of the Czech Republic (“SAC”) in its ruling 4 Afs 135/2019 of 18 February 2022. The ruling concerns a Czech company that received technical assistance services from its parent company in the Republic of Korea. The tax authorities questioned the deductibility of the costs of these services in relation to the fulfilment of the substance and benefit test mentioned above. In the dispute, the company submitted evidence in the form of a technical assistance agreement, copies of the passports of the technicians sent, a roster of the technicians with a calculation of the hours worked and their hourly rates. Among other things, it submitted an invoice for the technical assistance, but it did not show the volume or a specific description of the activities within the scope of the services provided. The mere existence of the technical assistance agreement and the related invoice was not considered by the SAC to be sufficient evidence to show that the transactions had actually taken place. The burden of proving that the costs were incurred for transactions which could have led to an increase in revenue, and at a normal cost, is on the taxpayer. According to the SAC, the taxpayer must be able to prove the actual scope, content and purpose of the services provided. Thus, in this case, the company should have specified for each technical employee exactly what activity the employee performed and whether the activity was actually performed. The Supreme Administrative Court dismissed the appeal and found the costs incurred for technical assistance services to be tax-deductible within the meaning of Section 24(1) of the Income Tax Act.
As stated above, the taxpayer must be able to prove to the tax authorities the actual scope, content and purpose of the services provided. A clear temporal anchorage and a demonstrable link between the provided supply and the tax document is central to the proof of fact. Recommended means of proof include, for example, records of operational documentation in the form of receipts, travel tickets and detailed activity reports. Documentation of the outputs of individual activities should also be an important part of the records.