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Legal newsletter November 2020

Another way to resolve transfer price tax disputes

According to the information available from the Financial Administration, one of the most common offence of multinational group taxpayers is the incorrect determination of transfer prices between the group companies. This applies also to cases where the provision of management services in the Czech Republic by a foreign company gave rise to the profit of its permanent establishment and its taxation. It is evident that the number of inspections in this area is also growing, especially in connection with the provision of services in a group setting, companies in loss, or companies with a limited functional profile.

The financial administration proceeds primarily pursuant to the Tax Code and focuses on compliance with the rules of the OECD Guidelines on Transfer Pricing for Multinational Enterprises and Tax Administrations, or more precisely the compliance with market distance rule. If it discovers an irregularity, finding out the actual (market) price and calculating the difference will follow. The tax subject then has the opportunity to explain and defend its choice of price determination. The consequence of the taxpayer's offence is an additional tax assessment, imposition of penalty, or loss of eligibility for drawing various incentives and benefits.

The current procedure for resolving disputes related to this process is governed by the procedure set out in the individual double taxation treaties and the Arbitration Convention of 1990 (No. 93/2006 Coll. of International Treaties). However, this procedure in many cases is associated with a number of administrative obstacles, often time consuming, and also burdened by disagreements in interpretation of applicable treaty provisions.

The new legal regulation sets forth the rules of the so-called harmonized process, whereby the taxpayer will be able to file an application for conciliation proceedings within the specified time limits (regardless of any appeals submitted in the foregoing tax procedure). If the dispute is not resolved through the conciliation procedure within two years, there is a possibility to initiate an international tax arbitration. The law applies to disputes related to tax proceedings occurring in the EU commencing from the tax period beginning on 1 January 2018.

In addition to the current bilateral treaty regime, this legislation should provide easier access to tax disputes for small and medium-sized entities and provide taxpayers with an effective defence tool with a more definite dispute resolution perspective.


New obligation of legal entities acting as a capital company and cooperative body member

The amendment to the Act on Business Corporations changes the conditions under which another legal entity may be appointed as a member of an elected body of a capital company or cooperative. The current regulation allows a legal entity to be a member of a company elected body without having specific obligations regarding the authorization of its representative. It is now possible to have zero or to the contrary several authorized representatives. In practice, therefore, there may be situations where it is not possible to identify a specific natural person who should actually exercise the function in the company body.

The amendment aims to prevent this situation that is considered undesirable by the legislator. Therefore, it newly stipulates that a legal entity that is to become, or already is, a member of an elected body of another capital company or cooperative is obliged to authorize one specific natural person to represent it in this body. Relatively strict current demands placed on such a representative remain in place. First of all, such representative must meet the requirements and preconditions for the performance of the function stipulated by law for a member of the given body. Next, this representative must not have a conflict of interest with the company in whose body he exercises his representative authority, may not engage in competitive activities against it, and is obliged to act with due diligence. In addition, the representative is liable for any damage caused by his actions, together with the legal entity he represents. The appointed representative thus in fact has the status of a member of the given body, although the legal entity he represents is formally the body member.

The representative of a legal entity in a given body must be registered in the Commercial Register within 3 months from the date on which the legal entity became member of elected body of the company; otherwise the function of this legal entity will expire by the operation of law. In practice, a legal entity will probably not be able to be registered as a member of an elected body without an elected representative.

The amendment does not directly imply an obligation for all capital companies and cooperatives that currently are members of other company elected bodies to authorize their representatives to these bodies and have them registered in the Commercial Register. However, we recommend that in 2021 clients do so and bring their company entry in the Commercial Register in compliance with the current status of legal regulation.


Employee Poaching as Unfair Competition

In general, the legislator promotes healthy competition between market participants. It protects the competition only from conduct which is generally contrary to its good morals and which is capable of causing harm to other competitors or customers. To this end, the Civil Code also contains a list of certain typical unfair competition practices. But the list is not exhaustive. Employee poaching belongs among practices not directly listed in the law but meeting the characteristics of unfair competition.

The employee poaching is considered unfair only if it is driven by an obvious attempt to damage the company or an effort to seize the trade secrets or client base of a competing company through these employees. Without fulfilling these preconditions, employee poaching is detrimental, but not in conflict with the good morals of the competition.

 In practice, there are very few cases where the courts would find unfair competition in the employee poaching, even in cases where the activities of a competing company clearly drain both the workforce and clientele of the original employer to a large extent. In a case where the defendant's two former employees set up a competing company, to which several of the plaintiff 's employees gradually moved, which paralyzed the plaintiff's agrochemicals and also resulted in the loss of customers, the court did not find unfair competition (decision of the Supreme Court of the Czech Republic, file no. 23 Cdo 2085/2007). The court stated that the information on trade and pricing policy was not a trade secret because it was publicly available, and at the same time the departure of employees to the rival business was not accompanied by any excessive conduct on the part of the defendant.

Thus, protection against unfair competition is not an effective tool against routine employee raiding. It is therefore necessary to protect your business interests in a different way. The possibility to negotiate a competition clause with an important employee should be considered. Confidentiality of information important in competition or conclusion of confidentiality agreements with employees and keeping client/supplier databases in privacy may also help. By disclosing the database, the employee would then not only violate the clause, but also infringe the copyright to the database.  However, the optimal protection tool is always to ensure employee satisfaction.