Establishment of a holding structure and the legitimacy of the tax optimization achieved

Holding structures are increasingly becoming the subject of tax audits, particularly with regard to potential tax benefits that interested parties may derive from the relationships established. Tax authorities often view these cases through the lens of abuse of rights, a concept that has specific consequences in tax law, which are negative for taxpayers. Whether the creation of a holding structure meets the criteria for abuse of rights in the tax sphere depends on the specific circumstances of each case. In this article, we will examine the aspect of these tax benefits in greater detail.

The Significance of Holding Structures

Holding structures represent a way of organizing a business in which a parent company controls subsidiaries focused on carrying out the main economic activity. This organizational structure enables more 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 multiple subsidiaries, so that if one of the subsidiaries faces financial difficulties, the other companies in the holding can continue their operations without significantly jeopardizing their own stability, thereby enhancing the stability of the group as a whole; effective management and control—centralized management enables better coordination and control over the activities of individual subsidiaries, as well as the standardization 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 generally also lead to the optimization of tax obligations; easier entry and exit of partners and changes in structures; flexibility, or even better access to financing, and many other benefits.

What is tax abuse?

Tax abuse refers to a situation where, despite formal compliance with legal requirements, the purpose and intent of the law have not been fulfilled (objective condition), and at the same time, the primary or predominant purpose of the taxpayer’s actions was to obtain a tax advantage (subjective condition) without there being a genuine commercial or economic purpose. For tax authorities to establish abuse of law, both the objective and subjective conditions must be met in a specific case. The consequences of an abuse of rights also include the invalidity of the transaction for tax purposes, whereby the tax authority treats the transaction as if it had not taken place. This subsequently leads to the additional assessment of tax liability.

Individual Assessment of Cases

However, a finding of abuse of rights cannot under any circumstances be made automatically. As is also evident from the case law of the Court of Justice of the European Union, each case must always be assessed individually and comprehensively by examining objective and subjective conditions. Proving the conclusion of an abuse of rights is the burden of proof and the obligation of the relevant state authorities. In the field of tax administration, this means that the tax authority must demonstrate that the primary purpose of the transaction was to obtain a tax advantage, and that no other significant economic or commercial reason for the transaction, as claimed by the taxpayer, actually existed. Particularly in these cases, the assessment of whether the taxpayer acted in a permissible manner will often depend on the details of specific transactions and related circumstances.

Let us also examine the issue from the perspective of judicial case law.

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

A recent judgment of the NSS ČR, Case No. 10 Afs 16/2023–78, dated July 23, 2024, is a significant example where the court ruled in favor of the entrepreneurs and did not find any abuse of rights in the creation of a holding structure. In this case, based on an individual assessment of the established facts of the case, the court recognized that the creation of a holding structure had legitimate economic and legal grounds, which the taxpayer had sufficiently demonstrated.

In the aforementioned judgment, the court emphasized that a holding company represents a method of structuring a business in which the parent company controls subsidiaries focused on performing the main economic activity, and that this is a commonly used and legitimate method of organization in business practice. If such an arrangement were to constitute an abuse of rights, the tax administrator must demonstrate the meaning and purpose of each individual transaction in order to determine their primary objective.

If the taxpayer cites multiple reasons for establishing the holding company, the tax authority must thoroughly examine the facts regarding each individual reason and demonstrably justify that none of these reasons, nor their combination, was the primary or sufficiently significant purpose that would constitute the obtaining of a tax advantage.

Details of the Judgment

The judgment addressed the case of FPPV s.r.o. (the plaintiff, as the entity to which the tax authority assessed an additional withholding tax liability), which became a 100% subsidiary of the newly established company KEB-EGE Holding s.r.o. (hereinafter the “holding company”). Subsequently, a decision was made to distribute a share of profits from FPPV to the sole shareholder—the holding company—which used this payment to cover part of the purchase price for the sale of business shares to former FPPV shareholders. The remaining portion of the purchase price was paid using funds obtained from an investment loan.

The Czech Tax Office imposed an obligation on FPPV to pay additional tax in the amount of just under CZK 900,000. The Office based this decision on the fact that the establishment of the holding company had no objective justification, as it does not engage in any economic activity. FFPV’s arguments were unsuccessful both in the appeal proceedings and before the Regional Court in the first instance of administrative adjudication, which adopted the arguments of the tax authorities.

In the proceedings, FPPV argued that the establishment of the holding company was rational for reasons such as integrating FPPV and KEB-EGE under a single ownership structure, creating room for new acquisitions, allowing one shareholder to exit the company and another to join, and restructuring the ownership interests in both companies. These arguments were supported by the facts and circumstances that were unfolding 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 tax 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 primary purpose of establishing the holding company was to obtain a tax advantage. To the extent that the taxpayer cited specific reasons for its establishment, supported by proven facts, the tax authority’s conclusion was untenable from this perspective. The tax authority failed to address the argued reasons for establishing the holding company and did not give them due consideration or importance.

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

Further acquisition activity of the holding company—the court accepted that the holding company planned to engage in acquisition activity and that negotiations regarding acquisitions were underway. The tax authorities failed to demonstrate that these negotiations were contrived or economically unjustified.

Principle of restraint—the court emphasized that the tax authorities violated the principle of restraint by interfering with the freedom of enterprise, the taxpayer’s discretion and decisions regarding the economic aspects of its business, provided that these had legitimate economic purpose and were not aimed exclusively at obtaining a tax advantage, since they failed to 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 specific case, taking into account the specific factual findings and circumstances, the court acknowledged that the taxpayer had sufficiently explained the legitimate legal and economic rationale for establishing the holding company, which was not solely or primarily to obtain a tax advantage.

The Supreme Administrative Court of the Czech Republic overturned both 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 rationale for establishing the holding company, which was not merely a tax-driven intention. The tax authorities failed to demonstrate that the creation and operation of the holding company lacked a genuine economic purpose.

Although this is a decision by a Czech court, we believe that the analyzed judgment provides an important legal basis for taxpayers in the Slovak Republic as well, given the similar legal and jurisprudential environment and the principles applied in this area.

To supplement this, we refer to another case handled by tax authorities and courts in the Slovak Republic concerning the taxpayer Slovenský plynárenský priemysel, a.s. (SPP, a.s.), in which, conversely, neither the tax 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) concurred with the decision of the tax authorities, which resulted in an additional tax assessment of nearly EUR 15.5 million on withholding tax on dividends for the 2003 tax period. This case was recently concluded by a final and binding Resolution of the Constitutional Court of the Slovak Republic from preliminary proceedings, file no.: IV. ÚS 553/2024, dated November 5, 2024, rejecting the constitutional complaint filed by SPP, a.s. The courts also examined in detail the facts and circumstances surrounding the creation of the holding structure, but concluded that the establishment of the holding company in the Netherlands had no real economic justification, it was in fact merely a “shell company” but was established primarily for tax purposes, namely to obtain a tax advantage under the double taxation treaty. According to the conclusion of the tax authorities and the courts, this constituted, on the part of the taxpayer and its shareholders, the purposeful creation of legal acts, i.e., an abuse of law, as a result of which they did not recognize the right to claim benefits under the double taxation treaty regarding the (non-)taxation of dividends of the German and French shareholders. In this case, neither the tax authorities nor the courts identified any facts in the creation of the holding structure that would justify a purpose other than tax optimization of income tax on paid dividends. A more detailed justification of the conclusions of the Supreme Court of the Slovak Republic from the judgment ref. no. 8Sžfk/54/2017 dated August 24, 2023, as well as 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 tool for business management as well as for optimizing tax obligations. However, taxpayers must ensure that holding structures are established in accordance with the law and, at the same time, that they have genuine economic purpose. A key aspect in establishing a holding structure, during an acquisition, or in other similar transactions that also entail tax benefits, is that these must 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 predominantly at obtaining tax benefits. If this were the case, the tax authorities could retroactively assess a tax liability on the taxpayer as if the transaction had not taken place, finding an abuse of rights in the tax sphere. At the same time, such findings by the tax authorities could lead to the imposition of additional liability on the entities, potentially even under criminal law.

However, when assessing transactions, tax authorities must take into account the individual circumstances of each case and may under no circumstances automatically conclude that the creation of a holding company, an acquisition, or another similar transaction constitutes an abuse of rights merely because the taxpayer obtained a certain tax advantage.

We wish to emphasize, however, the requirement to demonstrate the actual economic and legal purpose of the transaction to the tax authorities, which rests on the shoulders of the taxpayers and constitutes their burden of proof in the event of an audit. Therefore, participants in such transactions should ensure that they properly document each step and ensure that the holding company serves genuine business objectives for which they can provide adequate records.

If you are considering establishing a holding structure, we would be happy to assist you with expert advice and the design of a tailored solution. We help create legal, tax, and organizational solutions that support long-term stability and growth. You can learn more about our expertise in the area of 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), Case No.: 10 Afs 16/2023–78

Judgment of the Supreme Administrative Court of the Slovak Republic, Case No. 8Sžfk/54/2017, dated August 24, 2023

Decision of the Constitutional Court of the Slovak Republic, Case No. IV. ÚS 553/2024-20, dated 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, through its dedicated department, specializes in tax matters and business structuring advice, including advice specifically tailored for 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.

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