Construction work on tangible property in the SAC judgment: acquisition of new property or repair?

In its judgment of 14 September 2022 (7 Afs 132/2022 -22), the Supreme Administrative Court confirmed that when assessing the costs incurred in connection with the reconstruction of a hayloft destroyed by fire, the identification of what was removed as a result of the insured event and whether the drainage walls of the first floor were destroyed are important for determining the demise of the original building.

In 2014, the company claimed a one-off expense (in the nature of construction work) in its tax-effective costs, which in its view represented the cost of repairing a hayloft that had been damaged by fire due to a technical defect. The cost of repairing the hayloft was covered by an insurance payment received by the company from the insurance company as compensation for the damage and constituted taxable income for the company.

The tax administrator challenged the classification of the one-off expenditure as the repair of the hayloft and argued that it was the cost of acquiring new tangible assets (a new hayloft), since in its assessment the hayloft had been lost as an asset in the legal sense due to the fire. The depreciated cost of the hayloft can be regarded as a tax expense in the taxable year of the event in accordance with Article 24(2)(b) of Act No. 586/1992 Coll., on Income Tax (the "ITA"). As a result, it reclassified the identified "repair" costs as expenses for the acquisition of new tangible assets, which can be applied to tax expenses gradually by way of tax depreciation.

To reach this conclusion, the tax administrator also had the following documents from the company:

  • An expert report prepared for the purpose of determining the amount of the insurance claim for the resulting damage, which showed that it was a so-called total loss, in which the structure was in a state of disrepair due to the fire and had to be removed.
  • Contract for work with a construction company, under which works of the following nature were agreed: demolition of the hayloft, earthworks, foundations, vertical structures, cladding, roof, plumbing elements, floor, gates ...

The SAC upheld the conclusions of the tax administration and in its decision referred to the decision-making practice of the SAC, which shows that a construction as an independent thing in the legal sense "comes into existence at the moment when it is built at least to such a state from which all further construction works are directed towards the completion of such a thing determined in kind and individually". The concept of the demise of a building is then similar, as an above-ground building is rendered demised by the destruction of the external masonry below the level of the ceiling above the first floor.

The SAC also argued that the costs of acquiring new property cannot be conceptually subsumed under the concept of damage as defined in Section 25(2) of the ITA - "physical depreciation (damage or destruction) of property owned by the taxpayer" - as the essence of the costs was the restoration of the property or the elimination of the consequences of the damage that had already occurred, while it is irrelevant that the expenses were incurred in connection with the fire and covered by compensation from the insurance company in the form of an insurance benefit.