Implementation of the ATAD directive into the tax laws of the Czech Republic
The Ministry of Finance of the Czech Republic sent a draft amendment of the tax laws to implement the EU directive against tax evasion (so-called ATAD). These amendments with a planned effective date 2019 and 2020 significantly change some areas.
Probably the most significant one is a change in the condition of deductibility of tax-efficient borrowing costs. That is why I recommend large and consolidated companies to audit the scope of their financial business activities from foreign sources. How does ATAD touch the daily life of companies?
- In the amendment to the income tax law, the petitioner suggests to limit the eligibility of excessive borrowing costs. Excessive borrowing costs are considered to be expenses exceeding 80 million CZK or 30 % of the tax operating profit before interest, taxation and depreciation (EBITDA). Due to these large sums, this new amendment will especially affect large legal entities.
Borrowing expenses are not only finance expenses such as the interests from borrowing and loans, but also include related exchange differences, interest included into the cost of the assets or the interest included in a leasing contract. A part of the previously tax-deductible borrowing expenses may become non-tax-deductible in the course of 2019.
One should consider, not only setting the amount of the interest´s expenses, but one should be interested in the prediction of profit development. By mitigating the impact of the new rule, it is possible to reduce the tax base in the following periods by the amount of the borrowing costs, which cannot be tax effectively applied in the last tax period. At the same time, the revision of the limitation of the tax deductibility of the interest´s costs (low capitalisation rules § 25, article 1, letter w) concerning the economically connected persons are still remaining in the law. The new rule related to all of the interest-based foreign sources, not only from the connected persons, will be applied irrespective of whether the financial instrument itself, from which the borrowing costs arise, was negotiated before the effective date of the Act. An exception to the rule applies to financial institutions like banks or insurance companies.
- The amendment takes the taxation of the asset transferred without the ownership adjustment from the Czech Republic in the foreign countries into account (the so-called exit taxation). Such a transfer can be a transfer of the asset into the permanent establishment (i.e. through the transfer of a profitable project abroad, I tax the future profits of the project in the Czech Republic at the transfer date). Alternatively, if the Czech legal person changes their tax residence abroad and the Czech tax rules cannot touch the subsequent transfer of the asset. The transfer will be taxed in the Czech Republic in the same way as though selling the assets. For tax purposes, the crucial difference will be between the market price and the tax residual value of the transferred asset. In order to mitigate the impacts of this, in some cases, harsh measure, it is possible to agree a tax repayment scheme.
- The draft law with effect from 2020 incorporates the European directive request for solving hybrid incongruities with transactions between connected persons. These are cases when the same expense would be taxed effectively more than once by affiliates with different tax residence. The amendment implements a new revision into the law and prevents the application of the expense into effect in the situation when the expense will be tax-deductible in one state, but the income will be not taxed in another state.
- Another important principle is the taxation of income of international companies dominated by a Czech controlling company if the international company does not carry out any essential economic activity or is subject to taxation, which is lower than a half of the tax, which would be determined for the Czech company (the so-called CFC rule). In this case, the income of this foreign company is attracted to the tax base of the controlling company. At the same time, it depends on the form of income, which especially are: the borrowing income, income from the licence fees or profit sharing, income from the selling goods and services from the affiliates or income from insurance, banking or other financing related activities. It is possible to reduce the tax of the controlling company by a tax, which is similar to corporate tax paid abroad from this income.
It is important to realise that other EU states are obliged to implement the European ATAD directive. That is why it is important to take inventory of the level and structure of the borrowing costs for the whole setting in the groups of the international companies, burdened by that Czech company today. Furthermore, it is necessary to analyse the contractual relationships with the connected companies and find out if there are some similar expenses that are applied in more states and the probability of the potential inclusion of the income of the international subject into the income of the Czech company. Equally, it can happen that the Czech company has to take an adjustment into account in other country. For this, the cooperation of the people in the whole group of companies is very important.
The amendment text contains other changes, i.e. the change of the tax rates for individuals. For the tax base, the tax rate increases from all types of incomes from the original 15 % to 19 % to the income amount of 1.5 million CZK and similarly to 24 % of the income exceeding this limit. Vice versa, the new rates assume the cancellation of the existing 7% of the solid tax increase and adding a premium to the tax base.
A big change will be the possibility to refund VAT on unpaid receivables.
This is the first draft of the law. We will observe its development and prepare specific examples for you to be ready on time.
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