Creation of a holding structure and legitimacy of tax optimisation achieved

Holding structures are increasingly becoming the subject of tax audits, particularly with regard to potential tax advantages that interested parties may derive from the relationships established. Financial authorities often view such cases through the lens of abuse of law, a concept that has specific consequences in tax law, which are negative for taxpayers. Whether the creation of a holding structure meets the parameters of abuse of law in the field of taxation depends on the specific circumstances of each case. In this article, we will take a closer look at the tax advantages mentioned above.

The importance of holding structures

Holding structures are a way of structuring a business in which a parent company controls subsidiaries that carry out the main economic activity. This arrangement allows for better centralized management and control over the group's business entities, which can bring significant benefits, such as risk diversification - a holding company allows business risks to be spread across several subsidiaries, so if one of the subsidiaries faces financial problems, the other companies in the holding company can continue to operate without any significant threat to their own stability, and the stability of the group as a whole is also greater; effective management and control - centralized management allows for better coordination and control over the activities of individual subsidiaries, as well as the unification or simplification of procedures for setting up and implementing processes, which also leads to cost reductions; better protection of assets; optimization of tax obligations - holding structures usually also lead to optimization of tax obligations; easier entry and exit of partners and changes in structures; flexibility or even better access to financing, and many others.

What is abuse of rights in the field of taxation?

Abuse of tax law means a situation where, despite formal compliance with the requirements of the law, its purpose and meaning have not been fulfilled (objective condition) and, at the same time, the main or predominant purpose of the taxpayer's conduct was to obtain a tax advantage (subjective condition) without there being a genuine commercial or economic purpose. In order for the financial authorities to establish abuse of rights, both objective and subjective conditions must be met in a specific case. The consequences of abuse of rights include the invalidity of the transaction for tax purposes, with the tax administrator treating the transaction as if it had not taken place. This then leads to additional tax liability.

Individual assessment of cases

However, a conclusion of abuse of rights cannot be made automatically in any case. As is clear from the case law of the Court of Justice of the European Union, each case must always be assessed individually and comprehensively by examining the objective and subjective conditions. The burden of proof for establishing abuse of rights lies with the competent national authorities. In the field of tax administration, this means that the tax administrator must prove that the main purpose of the transaction was to obtain a tax advantage and that there was no other significant economic or commercial reason for the transaction as claimed by the taxpayer. Particularly in such cases, the assessment of whether the taxpayer acted in a permissible manner will often depend on the details of the specific transactions and the surrounding circumstances.

Let us also look at the issue from the perspective of case law.

Judgment of the Supreme Administrative Court of the Czech Republic (NSS ČR) ref. no.: 10 Afs 16/2023–78

The recent judgment of the NSS ČR, ref. no.: 10 Afs 16/2023–78, dated July 23, 2024, is an important example where the court ruled in favor of entrepreneurs and did not find abuse of law in the creation of a holding structure. In this case, based on an individual assessment of the facts of the case, the court recognized that the creation of a holding structure had legitimate economic and legal reasons, which the taxpayer had sufficiently demonstrated.

In the aforementioned judgment, the court emphasized that a holding company is a way of structuring a business in which the parent company controls subsidiaries engaged in the main economic activity and that this is a commonly used and legitimate form of organization in business practice. If such an arrangement constitutes an abuse of law, the tax administrator must demonstrate the meaning and purpose of the individual transactions in order to determine their main objective.

If the taxpayer gives several reasons for setting up a holding company, the tax authority must thoroughly examine the facts of each individual reason and demonstrate that none of these reasons, or any combination thereof, was the main or sufficiently significant purpose of obtaining a tax advantage.

Details of the judgment

The judgment dealt with the case of FPPV s.r.o. (the plaintiff as the entity to which the tax office imposed an additional tax liability on withholding tax), which became a 100% subsidiary of the newly established company KEB-EGE Holding s.r.o. (hereinafter referred to as the "holding company"). Subsequently, a decision was made to pay out a share of the profits from FPPV to the sole shareholder, the holding company, which used this payment to pay part of the price for the sale of shares to the former shareholders of FPPV. The remaining part of the purchase price was paid with funds obtained from an investment loan.

The Czech Financial Authority imposed an obligation on FPPV to pay additional tax of just under CZK 900,000. The authority based this procedure on the fact that the establishment of the holding company had no objective justification, as it did not carry out any economic activity. FFPV did not succeed with its arguments either in the appeal proceedings or before the regional court of first instance, which upheld the arguments of the tax authorities.

In the proceedings, FFPV argued that the establishment of the holding company was rational for reasons such as the integration of FPPV and KEB-EGE under a single ownership structure, the creation of space for new acquisitions, enabling one partner to leave the company and another to join, and the restructuring of the shareholdings in both companies. These arguments were supported by the facts and circumstances that were ongoing in real time as part of the optimization of the companies' structure.

The main reasons why the Supreme Administrative Court of the Czech Republic overturned the decisions of the financial authorities can be summarized as follows:

Insufficient proof of abuse of rights by the tax authority – the court found that the tax authorities had not proven that the main purpose of establishing the holding company was to obtain a tax advantage. If the taxpayer provided specific reasons for its establishment, supported by proven facts, the conclusion of the tax authority was untenable from this point of view. The tax authority did not address the reasons given for the establishment of the holding company and did not pay attention to or give importance to them.

Economic justification of the holding company – the court recognized that the holding structure had legitimate economic reasons, such as the restructuring of business shares, the withdrawal of one partner from the companies, and the entry of a new partner. These reasons were actually established, i.e. proven, and were sufficiently significant, outweighing the tax purpose. The tax office was obliged to address and deal with them.

Further acquisition activity of the holding company – the court accepted that the holding company had planned to carry out acquisition activity and that negotiations on acquisitions were ongoing. The tax authorities did not prove that these negotiations were purposeful or economically unjustified.

Principle of restraint – the court emphasized that the financial authorities violated the principle of restraint by interfering with the taxpayer's freedom of enterprise, discretion, and decisions on the economic aspects of its business, as long as these had a legitimate economic purpose and were not aimed solely at obtaining a tax advantage, when they did not prove that the taxpayer's conduct was purposeful and economically unjustified.

Significant in this case was the court's conclusion that the tax authorities must prove that the main purpose of the transaction was to obtain a tax advantage and that there was no other significant economic or commercial reason for the transaction. In this particular case, taking into account the specific facts and circumstances, the court found that the taxpayer had sufficiently explained the legitimate legal and economic purpose of establishing the holding company, which was not solely or primarily to obtain a tax advantage.

The Czech Supreme Administrative Court overturned the regional court's judgment and the tax office's decision in favor of the taxpayer.

The court found that the taxpayer had sufficiently explained the legitimate and economic purpose of establishing the holding company, which was not merely a tax intention. The tax authorities did not prove that the establishment and operation of the holding company lacked a real economic purpose.

Although this is a decision of a Czech court, we are of the opinion that the judgment analyzed provides an important legal basis for taxpayers in the Slovak Republic, given the similar legal and case law environment and the principles applied in the area in question.

For further information, we refer to another case dealt with by the financial authorities and courts in the Slovak Republic concerning the taxpayer Slovenský plynárenský priemysel, a.s. (SPP, a.s.), in which, on the contrary, neither the financial authorities nor the courts accepted the taxpayer's arguments defending the establishment of a holding company in the Netherlands. The Supreme Administrative Court of the Slovak Republic (NSS SR) agreed with the decision of the financial authorities, which resulted in an additional tax assessment of almost EUR 15.5 million on tax collected at source from dividends for the 2003 tax period. This case was only recently concluded by a final decision of the Constitutional Court of the Slovak Republic in preliminary proceedings, ref. no.: IV. ÚS 553/2024 of 5 November 2024, rejecting the constitutional complaint of SPP, a.s. The courts also examined in detail the facts and circumstances surrounding the creation of the holding structure, but concluded that the creation of a holding company in the Netherlands had no real economic justification and was in fact merely a "letterbox company" but was established primarily for tax purposes, namely to obtain a tax advantage from a double taxation agreement. According to the conclusions of the financial authorities and the courts, the tax entity and its shareholders had acted with the intention of creating legal acts for a specific purpose, i.e. an abuse of law, as a result of which they did not recognize the right to benefit from the double taxation agreement in relation to the (non-)taxation of dividends of the German and French shareholders. When creating the holding structure in this case, neither the tax authorities nor the courts took into account any facts that would justify a purpose other than tax optimization of income tax paid on dividends. A more detailed justification of the conclusions of the Supreme Administrative Court of the Slovak Republic in its judgment ref. no. 8Sžfk/54/2017 of 24 August 2023 and the resolution of the Constitutional Court of the Slovak Republic can be found directly in the reasoning of the individual decisions.

Conclusion

Holding structures can be an effective means of managing a business and optimizing tax obligations. However, taxpayers must ensure that holding structures are created in accordance with legislation and that they have a real economic purpose. A key aspect in the creation of a holding structure, acquisition or other similar transaction that also brings tax advantages is that it should have a clear and demonstrable commercial, business and economic purpose. It is not enough to merely fulfill formal requirements "on the surface"; the transaction must not be aimed exclusively or primarily at obtaining tax advantages. If this were the case, the tax authorities could impose additional tax liability on the taxpayer as if the transaction had not taken place, finding that there had been an abuse of tax law. At the same time, such findings by the financial authorities could lead to additional liability for the entities, possibly even at the criminal level.

However, when assessing transactions, the financial authorities must take into account the individual circumstances of each case and may not automatically consider the fact that an entity has obtained a certain tax advantage through the creation of a holding company, acquisition or other similar transaction as an abuse of rights.

However, we would like to emphasize the requirement to prove the actual economic and legal purpose of the transaction to the supervisory authorities, which is the responsibility of the taxpayers and, in the event of an audit, the burden of proof lies with them. Therefore, participants in such transactions should ensure that they properly document each step and that the holding company serves genuine business purposes, for which they will be able to provide adequate records.

If you are considering setting up a holding structure, we will be happy to assist you with expert advice and tailor-made solutions. We help create legal, tax and organizational solutions that support long-term stability and growth. You can learn more about our expertise in holding structures and family businesses and their specific needs in our other articles:

Sources:

Judgment of the Supreme Administrative Court of the Czech Republic (NSS ČR) ref. no.: 10 Afs 16/2023–78

Judgment of the Supreme Administrative Court of the Slovak Republic, ref. no. 8Sžfk/54/2017 of August 24, 2023

Finding of the Constitutional Court of the Slovak Republic, ref. no. IV. ÚS 553/2024-20 of November 5, 2024

This article is for informational purposes only and does not constitute legal advice. The legal opinions expressed in this article are not binding, and courts or other public authorities may reach different legal conclusions. For specific legal advice, please contact our law firm Hronček & Partners, which also specializes in tax issues and business structuring advice, including advice specifically tailored to family businesses. We have extensive experience in this area and also work closely with tax advisors, so we can provide you with expert and comprehensive advice.

Article