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The issue of taxation of foreign permanent establishment is the area, in which the tax administrators are focusing on more and more during the tax controls. In the past, we have informed you about the judgments Afs 8/2014-174 and 10 Afs 147/2016-45. The reason of this higher interest is the fact when allocating the profits of foreign permanent establishments, the company may violate the arm’s length principle.
The obligations with respect to the arm´s length principle follow from Article 7 § 2 of Agreements about preventing double taxation. According to this article, the profits assigned to the foreign permanent establishment, which the separate establishment could reach if it was doing the same or similar activities under the same or similar conditions and being independent to the company, whose permanent establishment it is.
The implementation of this rule causes potentially large problems in practice. Because from the point of view of the law, the founder and its foreign permanent establishment are one and the same entity. However, the fiction constructed by international and national regulations evaluates the economic activities as a relationship between two separate subjects.
The newly proposed amendment § 38 nd of the Income Tax Law can help solve this issue. On the basis of this amendment, the foreign founder of a permanent establishment in the Czech Republic could ask the Czech Tax Administrator for an obligatory evaluation on how to determine the tax base of the permanent establishment located in the Czech Republic. The new amendment is a part of the government’s proposals related to the changes to the Income Tax Law (parliamentary publication 873), which was passed by the House of Representatives on the 13th of January, 2017.
We consider it being wise to mention the obligatory evaluations related to foreign permanent establishments. These obligatory evaluations will be the subject of an automatic information exchange with foreign tax administrations. The proposed amendment to the law about international cooperation brought about this change in reaction to the necessary implementation of some BEPS action plans. The House of Representatives passed the amendment on the 11th of January, 2017.
Given the fact that the essential part of the application for a binding ruling should be the description and documentation of how the revenue and expenditure have been assigned to the foreign permanent establishment, we recommend that you be ready for this situation. It will be possible to submit the request for the obligatory evaluation after the 1st of January, 2018.