Supreme Administrative Court of Lithuania: Key Insights on Income Tax Relief for Companies

Let us examine the key points of the decisions of the Supreme Administrative Court of Lithuania (hereinafter referred to as the SACL) on income tax relief, which have recently been the subject of various discussions.

Profit tax relief relevant to companies.

In tax dispute practice, courts have repeatedly explained that profit tax relief cannot be interpreted either too narrowly or too broadly, i.e., relief must be applied specifically in accordance with the conditions of the Profit Tax Law.

When completing the annual income tax return, companies must also fill in the relevant fields of the return with information on the income tax relief applied during the year, which reduces the taxable income. Companies that apply income tax relief correctly can significantly reduce their income tax. Companies must submit their annual income tax returns to the tax administrator and pay income tax for the previous year by June 15.

The Income Tax Act provides for many relevant income tax reliefs, for example A company implementing an investment project may reduce its taxable income. In such a case, the company may reduce its taxable income for the tax period for which the taxable income was calculated by the amount of the actual expenses incurred for the acquisition of assets for the investment project. Companies that invest in R&D (research and development) in their activities may take advantage of the applicable income tax relief to reduce their taxable income. There are many other examples. However, the SACL provides explanations that are relevant to all reliefs. In other words, these explanations can be used in relation to the application of income tax relief for all companies, so we will review the court's explanations in this article. They can be adapted to your company in specific situations where income tax relief is applied.

SACL on income tax relief

The SACL has repeatedly explained that the obligation to justify the application of income tax relief always lies first and foremost with the income tax payer applying it, and only if the tax administrator disagrees with the application must they justify their disagreement. The SACL has also repeatedly explained that the costs eligible for relief, which reduce income tax, must also be justified by the taxpayer first. When the taxpayer fulfills this obligation, the tax administrator, if it disagrees with the application, must justify its disagreement. Of course, this must be proven based only on objective data: contracts, invoices, primary financial accounting documents, and other data.

The courts have ruled that the burden of proving the correctness of the income tax calculation should be shared equally between the tax administrator (the State Tax Inspectorate or the Lithuanian Customs) and the taxpayer, and the tax administrator must justify the tax and related amounts calculated for the taxpayer, i.e., provide all facts, circumstances, and documents confirming that those amounts have been calculated reasonably and correctly.

As explained by the Supreme Administrative Court of Lithuania, the presentation of facts in administrative proceedings is at the discretion of the parties to the case. When filing a complaint with the court, the applicant sets out the facts on which he bases his claim and thus formulates the grounds for the complaint. Meanwhile, the defendant, in responding to the complaint, may indicate other facts that were not mentioned by the applicant (Article 72 of the Law on Administrative Proceedings). In certain cases, the administrative court goes beyond the factual circumstances indicated by the parties and, on its own initiative, investigates facts that were not mentioned by the parties.

In addition, the Supreme Administrative Court of Lithuania explains in its practice that the need for an active role of the administrative court is also linked to the principle of the supremacy of law applicable to the activities of public administration entities, which means, inter alia, that administrative acts relating to the exercise of individuals' rights and obligations must in all cases be based on laws (Article 3(1) of the Public Administration Act). The Supreme Administrative Court of Lithuania explains that the active role of the court in examining administrative cases, including tax disputes concerning the application of income tax relief, means that not only the circumstances of the case indicated by the parties to the proceedings may be examined and assessed, but also those circumstances which the court considers important.

However, the active role of the judge (court) does not in any way mean that he is obliged in all cases to put forward versions and prove or refute them in order to determine whether there are any additional circumstances not indicated by the parties that could affect the legality of the contested administrative act, if the totality of the circumstances indicated does not suggest such a possibility.

Practical example based on SACL practice

Let us return to the fact that in tax dispute practice, the courts have repeatedly explained that income tax relief cannot be interpreted either too narrowly or too broadly, i.e., relief must be applied specifically in accordance with the conditions of the Income Tax Act.

Based on these explanations, the tax administrator forms the relevant practice. For example, legal entities whose income from their own production accounts for more than 50% of their total income and which employ persons with limited working capacity reduce the calculated income tax, taking into account the proportion of persons with limited working capacity among their employees. of their total income and which employ persons with reduced working capacity, reduce their calculated income tax by taking into account the proportion of persons with reduced working capacity among all employees, as provided for in Article 58(16)(3) of the Income Tax Act.

This income tax relief applies only to manufacturing companies, but the question arises as to whether the relief would apply if, for example, the customer entrusts part of the manufacturing process to a contractor. This is a relevant question, which is answered on the basis of the aforementioned general explanations of the Supreme Administrative Court of Lithuania on the application of the relief.

After all, the products sold by a company are usually understood as tangible, physical items, but do not include intangible assets that may be subject to exclusive rights, such as the creation of various computer programs or online stores, etc.

It is important to note here that the classification of activities is carried out in accordance with the ERVK approved by Order No. DĮ-226 of the Director General of the Statistics Department under the Government of the Republic of Lithuania, prepared in accordance with the classification "Nomenclatures des Activities de Communite Europeene" prepared by the Statistical Office of the European Union (EUROSTAT).

Based on this regulation and in order to accurately classify the activities carried out as services or production, as explained by the Supreme Administrative Court of Lithuania, it should be disclosed that the specific conditions for income tax relief to be analyzed must be determined in each case, taking into account whether the company owns the main raw materials from which the products are manufactured and other circumstances. Therefore, when deciding on the classification of activities, it is very important to have a clear and precise description of the activities carried out or intended to be carried out.

This is because, according to the provisions of Annex 2 to theEVRK, where part of the manufacturing process is subcontracted by the customer to a contractor, the customer is considered to be carrying out the entire manufacturing process. However, when another entity is entrusted with the entire manufacturing process, two provisions are relevant for classification. Where the customer, who owns both the main raw materials and the final product, has contracted with contractors to carry out the production process (in its entirety), such customer is classified in the class of Section C (Manufacturing) to which the entire production process is assigned. However, if the customer, who does not own the basic raw materials has concluded a contract with another entity for the production process, depending on the activity and the specific goods sold, such a customer is classified in Section G (Wholesale and retail trade) as a service provider if it only carries out this activity.

It should also be noted that, for example, with regard to the application of the relief provided for in Article 58(16)(3) of the PMĮ, this relief does not apply to an enterprise if it is engaged only in activities classified under the EVRK activity types, such as 62. 01 "Computer programming activities" or 74.90 "Other professional, scientific and technical activities not elsewhere classified" and other cases.

In addition, a manufacturing company is a company that processes raw materials and materials (including using assembly products) and obtains products that it sells. Raw materials may be products of agriculture, forestry, fishing, mining or quarrying, as well as other types of manufacturing activities, etc. The literature explains that a fundamental change, renewal, or reconstruction of items is classified as manufacturing, which may include processing, recycling, etc., depending on the field of activity. Newly manufactured products may be finished products ready for use or consumption, or semi-finished products suitable for further processing as raw materials.

Thus, this article has been prepared to show how the general explanations of the SACL decisions can help to understand the application of very specific income tax relief.