Essential expenses and the possibility of using them in tax procedures

In March 2024, the Supreme Administrative Court (SAC) issued a judgment concerning the use of essential expenses in evidence in tax proceedings. So far, the SAC's statements on the issue of essential expenses have been rather contradictory. Therefore, this time the issue has been addressed by the extended chamber. 
What are essential expenses?
The company is obliged to prove the information provided in its tax return, usually by providing supporting documents such as accounting documents, invoices or commercial contracts. The use of the essential expenses method is a way of proving expenses in the absence of accounting documents, when they are incorrect or when the accounting records are completely inconclusive. To give you an idea, this could be, for example, incorrect bookkeeping, destruction of accounting records or 'just' lost individual invoices and contracts. In such a case, the taxpayer has the possibility to try to prove in other ways that, from an objective point of view, such costs must have been incurred. For example, imagine a situation where a building has been repaired, the accounting documents are not available but it is obvious that the work has been carried out.
Essential expenses are not a substitute for accounting documents, but allow the tax deductibility of expenses that were strictly necessary for the acquisition of goods or services. The necessity of such expenditure must also be proven.
Proving tax according to aids
So far, essential expenses could only be used if the tax administrator proceeded to determine the tax according to the aids, not in the context of normal evidence during a tax audit. However, it was only possible to determine the tax according to the aids in cases where most of the accounting records were inconclusive. In practice, this meant that the use of the essential expenditure argument was not admissible in a dispute over a minor part of the costs.
Change thanks to the judgment
The Enlarged Chamber of the SAC concluded that essential expenses can be used already in the process of evidence. This considerably expanded the taxpayer's defence during the tax audit and subsequent proceedings.
In its judgment, the SAC found that a taxpayer may prove its expenses by means other than the usual accounting documents, by virtually any means, except those obtained in violation of the law. For example, expert reports, price lists in force at the time of the expenditure, orders, photographs and the like may be produced. Which means the taxpayer chooses and which are appropriate will always depend on the circumstances of the particular case. This can be used to prove both expenditure for which the supporting documents are completely missing and expenditure for which the supporting documents are incorrect (incorrect supplier or other details).
It should be borne in mind that it is very unlikely that the company will be able to prove 100% of the costs in this way, as the SAC in its judgments has always considered essential expenses to be the minimum necessary expenses, not optional or non-essential expenses.
The use of proof by means of essential expenses represents an extreme situation and is unlikely to allow the recognition of all expenses, while the burden of proof remains with the taxpayer. However, in situations where accounting documents are not available, it may be an interesting way to reduce the financial impact of the tax assessment on the company and achieve at least partial tax recovery of the actual costs incurred.

Autor: Michala Modrá (Mrazíková)