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Lenka Kočerová | May 21, 2024

Does the tax authority have to follow established procedures for the benefit of the taxpayer, even if they are later found to be unlawful?

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In its judgment No. 1 Afs 10/2024-33 of 9 April 2024, the Supreme Administrative Court (hereinafter the “SAC”) decided on the issue of legitimate expectations of a taxpayer in the event of a change in administrative practice due to its contradiction with the law.

Factual circumstances of the case

In the present case, the issue was the running of the limitation period for the assessment of tax in a situation, where the company filed additional corporate income tax returns in January and March 2020 for the tax years 2008, 2009 and 2010, in which it reported a lower tax loss or claimed a tax loss deduction from 2007. The company also reported a tax loss from 2011 to 2014. According to the administrative practice at the time, based on the generally applied methodology of the General Financial Directorate (“GFD”) regarding the extension of the limitation period under Section 38r of the Income Tax Act (“ITA”) in the case of so-called loss chaining[1], the company assumed that the tax assessment period for the tax years 2008 to 2010 was based on the tax assessment period for the tax year 2014 and was due to expire on 1 July 2023.

In January 2021, the Tax Administrator discontinued the proceedings regarding the additional tax returns. The reason was that they were filed after the time for tax assessment had expired. In doing so, the tax administrator relied on a new and groundbreaking judgment of the Supreme Administrative Court in the Heidrive case of 13 May 2020[2], in which the Supreme Administrative Court explicitly described the existing administrative practice of so-called loss chaining as unlawful. We have discussed this groundbreaking judgment of the Supreme Administrative Court in our article. Further rulings of the Supreme Administrative Court followed, on the basis of which the tax administration issued information in November 2020 on new administrative practice[3] respecting the maximum ten-year period for tax assessment even in the case of tax losses.

The company defended itself against the decision to discontinue the proceedings by bringing an action before the Municipal Court in Prague and was successful. According to the court’s conclusion, the tax administrator should have completed the proceedings on the company’s additional tax returns in accordance with the administrative practice applied by the tax administration authorities at the time before the Supreme Administrative Court issued its judgment in the Heidrive case.

The SAC then upheld the conclusion of the Municipal Court in Prague.

Protection of legitimate expectations according to the SAC

Although, according to the case-law of the Court of Cassation, an administrative practice contrary to the law does not in principle give rise to legitimate expectations, it is necessary to examine whether that administrative practice (albeit later found to be contrary to the law) gave rise to expectations in the plaintiff, which were worthy of protection.

In the present case, it was the 2016 methodology of the GFD, as "in the case under consideration, there was an established administrative practice, of which the plaintiff was aware and in reliance on the actions of the tax authorities in accordance with this practice (i.e. in causal connection with the established practice) he made his submissions – additional tax returns for the tax years 2008 to 2010. It is significant that he did so several months before the Supreme Administrative Court issued its judgment in Heidrive, at a time when he could not have foreseen that this administrative practice would be prohibited. For the sake of completeness, it may be noted that the contradiction of the previous administrative practice of the tax administration with the law was not so obvious; it was a persistent interpretation of the law advocated by the tax authorities, which was only later found incorrect by the Supreme Administrative Court.”

The SAC concluded that the plaintiff’s previous administrative practice had established legitimate expectations and the tax administrator should have acted in accordance with this administrative practice, regardless of its illegality, as the principle of legitimate expectations prevailed over the principle of legality in this case.

[1] Methodological tool of the General Financial Directorate No. 19513/16/7100-10111-010509 of 8 June 2016.

[2] Judgment of the Supreme Administrative Court (SAC) No. 8 Afs 58/2019-48 of 13 May 2020 (Collection of Decisions 7/2020 No. 4023/2020 Coll. of the SAC) in the case of the company Heidrive, s.r.o. annulled the contested judgment of the Regional Court in Pilsen on the grounds that its interpretation of the stipulation of section 38r(2) of the Income Tax Act, which allowed for the so-called chaining of tax losses, did not respect the meaning and text of the Act and disproportionately interfered with the legal certainty of taxpayers.

[3]INFORMATION on the determination of the tax assessment period (limitation period) in the reporting and application of tax losses and the assessment of the running of this period and the change of its running in relation to the judgments of the Supreme Administrative Court” No. 66358/20/7100-40110-207203 of 25 November 2020.