Liability of statutory bodies for tax debts in case of breach of due diligence

The Supreme Administrative Court of the Czech Republic (SAC) issued a crucial judgment No. 10 Afs 4/2024-38, which significantly affects the personal liability of members of statutory bodies of companies for tax arrears of their companies. This article, intended for members of corporate management, summarises the key conclusions of the judgment in a clear and understandable manner and explains the practical legal implications for managing directors, members of boards of directors and other elected bodies of legal entities. Particular attention is paid to the newly confirmed right of the tax administrator to independently assess the fulfilment of the conditions of statutory liability of a member of the body for corporate tax debts, independently of the civil court, as well as to the issue of the limitation of such liability in connection with the good morals corrective. The aim is to show what steps statutory representatives should take in practice to avoid the risk of personal liability for tax debts and to motivate them to take early legal precautions and consult experts.

Author of the article: ARROWS (JUDr. Kateřina Müllerová, office@arws.cz, +420 245 007 740)

Background: when a member of an organ of the body is liable for the company's debts

The Czech legal system has long contained a mechanism that can transfer a company's debts to members of its elected bodies if those members seriously breach their duties. Specifically, Section 159(3) of the Civil Code provides that if a member of an elected body (e.g., an executive of a limited liability company or a member of the board of directors of a joint stock company) breaches the duty to act with due care and thereby causes damage to the company that is not repaid within the statutory period, he or she is liable to the company's creditors for the company's debts up to the amount of such unreimbursed damage. In other words, a member of the statutory body may be obliged to pay a debt of the company (including a tax debt) if his negligent or unlawful conduct has caused the company to be unable to pay the debt.

In the area of tax arrears, this liability is further specified in Section 171(1) of the Tax Code, according to which, if the law provides for a third party to be liable for the tax (which Section 159 of the Civil Code does), the tax administrator may call upon the guarantor to pay the tax arrears instead of the company owed. Upon the tax administrator's request, the guarantor (member of the elected body) must then pay the tax arrears or they may be recovered. The statutory liability of members of statutory bodies for tax debts therefore poses a significant risk to anyone involved in the management of the company. Until now, however, there has been some confusion as to how and under what conditions the tax authority may enforce this liability, in particular whether it needs a prior decision of a civil court on the obligation to compensate for damages and the statute of limitations on such liability.

Key conclusions of the judgment of the Supreme Administrative Court No. 10 Afs 4/2024-38

The judgment of the Supreme Administrative Court 10 Afs 4/2024-38 has brought several key clarifications that have an immediate impact on the practice of tax administrators and statutory representatives of companies. Below we summarize the three most important conclusions of the judgment and their significance:

• 1. The tax administrator may assess the liability of a member of the body itself: The SAC clearly confirmed that the tax administrator is entitled to independently assess whether the conditions for the statutory liability of a member of a statutory body under Section 159(3) of the Civil Code in conjunction with Section 171 of the Tax Code have been met. In other words, the tax authority does not have to wait for a judgment of the civil court to establish that the member of the statutory body has breached the duty of care and caused damage to the company. The tax authority is not bound by the civil court's verdict - not even by any decision in which the civil court dismisses or otherwise quantifies the company's claim for damages. The tax administration can independently assess the actions of the statutory body and conclude for itself whether there has been a breach of duty, whether damage has been caused and whether that damage has not been compensated. In practice, this means that the liability of directors for tax debts can be enforced more flexibly and quickly in tax proceedings without the need for lengthy court proceedings for damages.

• 2. Another key point of the judgment is the clarification of what exactly constitutes the "damage" for which a member of an authority is liable. The SAC emphasised that the tax arrears (tax debt) itself is not the damage that the member of the body should have caused. The tax arrears are merely the result of the previous conduct of the company's management. The real damage is the unlawful interference with the company's assets, typically the removal of funds or assets from the company in breach of the law or the duties of the managing director, which then leaves the company without the means to pay the tax. In other words, in order for liability to arise under section 159(3), the executive or other member of the body must, by his or her breach of due care , cause a loss of company assets (e.g. by excessive payments, unfavourable transactions, payment of dividends in spite of debts, embezzlement, etc.) which subsequently makes it difficult or impossible to pay the tax liability. This interpretation has practical significance in that the tax administrator must prove a causal link between the unlawful conduct of the member of the body and the actual damage to the company's assets. The mere existence of unpaid tax is not sufficient - it must be clear that the tax was not paid precisely because of the previous damage caused by the statutory body.

• 3. The SAC also addressed the question of whether and how the statute of limitations applies to the liability of a member of the body and the possibility for members of the body to object to the statute of limitations. The Court's conclusion is twofold: firstly, a member of an elected body may raise a limitation objection against the tax authority, i.e. argue that his claim for liability (or compensation for damages) is already time-barred if the relevant period has elapsed since the damage occurred. Secondly, the Supreme Administrative Court has stated that the tax authority may reject this objection if it is contrary to good morals. Under civil law, the invocation of a limitation objection must not constitute a manifest abuse of rights or be contrary to the principles of honesty and decency. Typically, this would be the case where a member of the body arbitrarily or deliberately waits until the limitation period has expired or where he himself has, by his own dishonest conduct, contributed to the failure to assert a claim in time. The assessment of whether a particular limitation objection is contrary to good morals is a matter for the tax administration and not for the court - the tax authority therefore also considers the moral aspect of the guarantor's conduct when deciding on the guarantee. If the tax authority finds the statute of limitations objection to be immoral (for example, because the statutory agent deliberately caused the damage and is now trying to hide behind the passage of time), it will disregard the objection. In such a case, the body member cannot rely on the limitation and will have to pay the tax arrears.

Practical implications for the statutory representatives of companies

The above conclusions of the Supreme Administrative Court have important practical implications for members of statutory bodies. Every managing director, board member or other senior officer should understand how this decision changes the landscape of their liability:

• Personal financial risk: the judgment confirms that the personal assets of directors may be at risk if their actions put the company in a position where it cannot pay its taxes. The Revenue will now be more confident in pursuing tax arrears directly against the directors if it finds that there has been a breach of the duty of care. For the members of the statutory bodies, this means that not only private creditors (suppliers, banks) but also the state as a creditor may target their personal assets.

• Faster action by the tax authorities: since the tax authorities do not have to wait for a verdict of the civil court on damages, they can initiate liability proceedings immediately after they have established the relevant facts. In practice, this may occur, for example, in a tax audit or in a company insolvency proceeding where it becomes apparent that the company's management has diverted assets and incurred tax arrears. The members of the authorities may thus be surprised by a quick call for payment of the tax debt without any litigation for damages in court. The defence against such a notice will be to argue directly in the tax proceedings and possibly in an action in the Administrative Court, rather than in a separate civil proceeding.

• The need to prove fair dealing: the court has made it clear that tax underpayment alone is not enough - the damage caused by the unlawful conduct of the member of the body must be proved. This gives honest directors some chance of a defence: if the tax debt was incurred despite the fact that they acted diligently and did not siphon off any assets (e.g. due to external circumstances or business risk), they should not be held liable. On the other hand, members of the body who negligently disregarded mounting debts while paying out money to shareholders or themselves will face an evidential situation that is significantly worsened for them. Any management decision that worsens a company's solvency vis-à-vis the state may come under scrutiny ex post.
• Limited scope for "escape" by limitation: The possibility of relying on the statute of limitations has narrowed. The formal lapse of time may not protect the statutory body if its conduct is assessed by a court (or the tax authorities) as dishonest or purposeful. Thus, directors cannot strategically rely on the notion that they need only hold out until claims "pass the statute of limitations." It is far more responsible to deal with the problems that arise proactively - for example, if new management discovers that a former executive has caused damage to the company, they should address the situation (seek compensation or remedy the financial situation) before the tax authorities get involved.

Model example: when liability for tax arrears is imminent

To better understand how the principles described above may look in practice, here is a simplified model scenario:

Example: the company ABC, s.r.o. is in financial difficulties. Its managing director, Mr. Karel, knew that the company owed hundreds of thousands of crowns in VAT and income tax, yet he decided to pay himself an extraordinary bonus and transfer part of the company's money to his other related company. This reduced the balance sheet of ABC, s.r.o. so much that there were no funds left to pay the taxes. The tax office turned its attention to Mr. Karl after a futile appeal to the company to pay the arrears. The tax authority assesses that the managing director has violated the care of a good manager - he acted against the interests of the company and its creditors by siphoning off the money needed to pay the known tax debts. The damage in this case is not the mere fact that the tax was not paid, but the amount corresponding to the remuneration and the transfer that Mr Karel siphoned off the company's assets for his own benefit. To the extent of that amount, Mr Karel will now be liable for the tax arrears owed by ABC, Ltd. Mr. Karel will defend himself on the grounds that 3 years have passed since the controversial transaction and that his obligation to pay compensation is time-barred. However, the tax authority will reject the statute of limitations objection on the grounds of good morals - Mr. Karel acted dishonestly, knowingly harmed the company and the state, and therefore cannot absolve himself of liability by waiting. If Mr Karel does not pay voluntarily, the tax office will recover the tax arrears from his personal assets.

This example illustrates that the risky behaviour of statutory officers is not without consequences. Following the Supreme Administrative Court's ruling, the tax authorities are in a stronger position to recover the tax from the persons whose actions contributed to the fact that the tax could not be paid.

Recommendation.

The SAC judgment 10 Afs 4/2024-38 should serve as a warning and an impetus for preventive measures for all statutory representatives of companies. Below are some recommendations to minimize the risk of personal liability for tax debts:

• Act with due care: This general rule takes on acute importance. Always consider whether your decision will jeopardize the firm's ability to meet its legal obligations, especially to pay taxes. Avoid actions that could be judged in hindsight to be negligent or purposeful to the detriment of the company (e.g. asset stripping, wasteful spending, preferring your own interests over those of creditors).

• Be careful with payments and disbursements in times of tax debts: if the company owes the government taxes, be particularly cautious with any transfer of money outside the company (whether it is payment of profits, management fees or payment of liabilities to related parties). Prioritising other payments at the expense of tax may be classed as a breach of your duty of loyalty and care.

• Document your decisions: it is a good idea to have proof that you acted in an informed and good faith manner in case of disputes. Minutes of the authorities' deliberations should reflect your reasoning, your efforts to resolve the company's situation and the reasons why a particular decision was made. Such documentation can then help to demonstrate that you have tried to act properly and have not acted recklessly.

• Proactively remedy the damage: If you discover that there has been an unlawful drain on company assets (even under previous management) that threatens to jeopardise the payment of debts, act quickly. Consider pursuing damages against the culprit or taking other steps to replenish capital so that the company can meet its tax obligations. Voluntary payment of damages by a member of the body (e.g. returning money wrongly paid to the firm's treasury) may prevent the tax authority from claiming liability against the member - the damages would be compensated and the conditions of section 159(3) would not be met.

• Don't treat limitation as a salvage strategy: relying on "it will blow over" and the claim will be time-barred is dangerous. As the SAC has shown, a plea of limitation may be found inadmissible if it would be contrary to good morals. Instead of waiting passively, we recommend solving the problem proactively - for example, negotiating a repayment schedule with the tax office, a settlement agreement, or initiating a restructuring of the company to enable payment of debts.

• Consult with ARROWS experts: the legislation on directors' liability is complex and constantly evolving through court decisions. In case of doubt (e.g. before deciding on a disputed transaction, when insolvency is imminent, or when receiving a summons from the tax authorities to pay an outstanding amount) , do not hesitate to contact a lawyer specialised in corporate and tax law. Early consultation can prevent actions that could expose you to liability later or help you choose a strategy that mitigates personal risks.

Conclusion

The Supreme Court's ruling in 10 Afs 4/2024-38 represents a milestone in the interplay between statutory body liability and tax law. It confirms that members of elected bodies bear real responsibility for the consequences of their actions, and that the state has effective tools to make them pay tax debts if they have contributed to their unlawful conduct. The lesson for the statutory representatives of companies is clear: acting prudently, transparently and in the best interests of the company (and their creditors) is not just an empty phrase, but a prerequisite for avoiding personal sanctions. At the same time, it is important not to neglect preventive action and legal assistance while there is still time - by the time the tax office comes knocking with a demand for payment, it is too late to take any rescue measures.

Members of statutory bodies should see this decision as a warning and a motivation: a warning of the consequences of ill-considered or dishonest actions, but also a motivation to lead the company responsibly and to seek professional advice in difficult situations. Only in this way can they minimise the risk that their personal assets will have to cover the company's debts to the state and ensure that their business is conducted in accordance with the law and the principles of integrity.