Direct link between costs and revenues
Section 24(2)(zc) of the Income Tax Act (ITA) allows for the recognition as a tax expense of expenses (costs) that are not primarily incurred to achieve, secure and maintain income (revenue), or are explicitly identified in the ITA as a non-tax deductible expense (Section 25 of the ITA), provided that certain conditions are cumulatively met:
- These are generally expenses that are not primarily tax deductible;
- There is a direct link, or a sufficiently strong and unmediated logical link, between income (revenue) and expenditure (costs);
- The expenditure (cost) is tax deductible only to the extent of the directly related income (revenue);
- The income (revenue) affected the result of the same or previous taxable years.
The Supreme Administrative Court (SAC) was faced with a case in which a legal entity incurred primarily non-tax costs (specifically, travel costs for a third party who was not in an employment relationship, refreshment costs, excess expenses for company meals and non-tax fines and penalties), which it retained in tax costs with reference to the aforementioned Section 24(2)(zc) of the ITA. With this assessment of the procedure, it referred to the direct link between the costs in question and the revenues from software services realised based on its billing model set up among the other members of the group. The basis in the billing model was the actual amount of direct and indirect costs plus a 5% margin. However, the Municipal Court did not find this alleged direct proportionality to be justified, as it was not apparent how the costs incurred were directly related to the company's revenues from the provision of software services within the group.
In its judgment 1 Afs 190/2021 - 30 of 14 October 2021, the SAC concluded that the company had not sufficiently demonstrated a direct link between the costs specified above and its revenues. It thus excluded these from tax deductible costs, assessed a tax liability and imposed the relevant penalties.
It follows from the judgment that the direct link is to be understood as meaning that the costs in question affect the amount of revenue, not only by being recharged to members within the group as revenue for software services provided, but also by the fact that their expenditure contributed to the achievement of revenue in a way other than by automatically increasing it. The direct link in this case cannot therefore be inferred from the company's specific financing model, which was based on a simple mathematical formula in which all costs are automatically increased by a fixed rate and the resulting amount is overcharged.
Proof of destruction of unsaleable stocks
Proper documentation of the volume of inventories (materials, products and goods) destroyed is a necessary condition for a procedure that will not give rise to any tax liability for the VAT payer carrying out the destruction. A destruction report containing a specification of the object and manner of destruction, the reasons for the destruction, the identification of the persons carrying out the destruction, and the time and place of the destruction may be regarded as sufficiently strong evidence. It is also recommended to take testimonial photographic documentation, video footage, etc.
The assessment of sufficient proof of the destruction of stocks, specifically of unsaleable cigarettes, was dealt with by the Supreme Administrative Court (SAC). In its Judgment 5 Afs 199/2020 - 39 of 18 October 2021, it ruled that a company allegedly carrying out the destruction of cigarettes did not sufficiently document the destruction, as it provided the court with "only" witness statements of persons who participated in the destruction (which differed in some passages) and written reports as evidence. Other facts prejudicial to the company were the failure to record the witnesses' journeys to the site of the destruction in the logbook, the failure to record the date of the destruction in the accounts but only in the extraordinary inventory, which was not confirmed by the witnesses as having taken place at all, the failure to take advantage of the opportunity to buy back cigarettes from the original suppliers and the failure to notify the destruction of cigarettes on an open fire to the relevant fire brigade.
The company thus failed to bear the burden of proof, and the SAC reclassified this unproven destruction of the goods (failure to document their fate) as a supply for purposes unrelated to the company's economic activity for VAT purposes. The SAC concluded that in this case the supply of goods, i.e. a taxable supply subject to VAT under Section 13(4)(a) of the VAT Act, was an output VAT and imposed penalties.