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Artificial structures in Slovak tax law

Since 1 January 2014, the Slovak anti-avoidance regulation has been strengthened up by a new amendment to the Slovak Tax Procedure Act introducing “business substance” clause. More specifically, the tax authorities should disregard fictitious operations having no business substance which at the same time aim at the obtaining of any kind of tax benefit.

In the light of the recent trends in the EU and the OECD member countries, more regulatory emphasis is put on curbing various tax avoidance arrangements in the area of direct taxes in the Slovak Republic. Generally speaking, the regulator tries to stay in touch with modern tax planners, track their creative ideas and attack their tax abusive schemes. From the regulator´s point of view, a simple “substance over form” clause which has always been in place in the Slovak law cannot be entirely relied upon.

What is "business substance" clause?

The “business substance” clause represents a quite new regulatory concept complementing the general principle “substance over form”. In academic terms, whereas “substance over form” serves for artificiality test and allows the tax authorities to look through the legal status of a transaction and either ignore the title or re-characterise it to establish the underlying reality, under the “business substance” which serves for motive test, there must be a commercial purpose in a transaction other than to achieve certain tax advantage.

The “business substance” clause is not of clear-cut nature; there are no clearly delineated borders which would separate tax abuse from tax planning acceptable by the tax authorities. Such borders are generally defined by case law. Since there is no established tax practice in the Slovak Republic so far, it is somewhat questionable how the tax authorities and the Slovak courts will apply the new rule. Generally speaking, although the approach of the Slovak tax authorities appears to be stringent in various cases where anti-avoidance element is present, we have already witnessed many cases held by the Slovak Supreme Court which, while based on sound economic arguments, have been ruled in favour of taxpayers.

Possible interpretation of "business substance" clause

On this note, it is likely that the “business substance” clause will be interpreted in line with the recent tax practice relating to the substantial requirements in the Slovak Republic, rulings of the Court of Justice of the European Union and, above all, with the constitutional principles. The case law of foreign European courts may be also supportive. In the UK, where similar regulation has been in existence for many years, the courts have already widely elaborated on the concept of the motive test. Based on the UK rulings, the motive is a decisive factor and although the transaction may lead to certain tax benefits, there must be a justified business purpose which does have to be necessarily of financial nature (e.g. quicker distribution of profits among group members when using a structure with tax transparent entities involved). In principle, the “business substance” absence concept may kick in where a tax advantage has been the main reason for making a transaction or implementing a legal construction. Therefore, in order not to be trapped by this clause, entities involved in transactions should be able to present arguments that the transaction has been driven by economic needs and not by tax advantages only.

In this context, attention should be drawn to the case law of the Court of Justice of the European Union which has already adjudicated on various cases in relation to the freedom of establishment. According to the established case law of the Court of Justice of the European Union, the anti-avoidance measures cannot be applied where it is demonstrated, on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives, there is at least one genuine economic activity. It therefore follows that formal arrangements cannot be challenged on the basis that they give tax benefits to the involved parties , unless no genuine economic activity is present.

Thus, a national measure restricting freedom of establishment can only be justified where it applies to wholly artificial arrangements aimed at circumventing the law.

Solution?

As there is no discernible safe harbor, the practical risk that the Slovak tax authorities will attempt to challenge arrangements and structures that provide certain tax benefits cannot be ruled out. However, proper legal documentation before and/or in the course of the process of structuring and/or detailed analysis of the individual case spelling out its legitimate economic purpose, in conjunction with the utilization of high-quality legal and tax advice should provide strong arguments in potential proceedings and thus mitigate or eliminate the risk of being administratively sanctioned. Such legal arguments are more likely to be taken on board at the courts. Challenges by the tax authorities of taxpayers’ transaction structures and forms without apparent legal basis are likely to remain unsupported by the courts because of the fact that, among other things stated above, they would constitute a material interference in the rights of taxpayers, which are strongly protected by the Slovak Constitution.

Conclusion

Summarizing the above, the taxpayers should be free to choose the structure and the form of transactions which they consider to be the most appropriate for their economic activities and also for the purposes of mitigating their tax burdens as long as such mitigation of tax is not the sole reason of the transaction structure and form. As regards structures utilizing a third country, a similar rule should apply with respect to free movement of capital.

Publication Information

  • Practice: Tax
  • Location: Slovak Republic
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