Since 1 January 1993, the tax system in the Czech Republic (CR) has evolved rapidly. The following outlines a number of issues now being encountered.
For foreign entities trading or investing directly into the Czech Republic, many sources of income arising in the CR are subject to Czech taxation at the withholding tax rate of 25 %. Sources include payments by Czech persons of royalties, technical know-how fees, interest and dividends. A wide network of treaties exists with the CR, which reduce the underlying rate of withholding from 25 % on such sources. A special withholding regime for cross border leasing also exists for financial types of lease where withholding is 1% of leasing payments.
The Czech tax net is widened by the inclusion of legislation deeming that income from provision of services of a technical and consulting nature by a foreign entity in the CR is a source of Czech income. Furthermore, if carried out for a period of more than six months, the activity is deemed to cause a taxable presence (a "permanent establishment") of the foreign entity to arise. The profit attributable to such a presence is taxable therefore at the corporate income tax (CIT) rate (41% in 1995, 39% in 1996). This provision is very wide and common structures, such as secondment of foreign management personnel to the CR, can be caught. This has caused numerous practical problems, as secondment has always been the preferred route taken by foreign investors when starting up operations, owing to the substantial individual tax and social security benefits available from such structuring.
The classical "group" structure of Czech holding company with Czech subsidiaries and joint venture holdings can be very disadvantageous. There are currently no forms of tax consolidation of profits and losses of group companies, and only limited relief for intra-group dividends. Also, foreign shareholders are actively discriminated against by domestic legislation when taking profits in the form of dividends. This has inevitably led to groups finding ways to reduce the tax burden of their structure, including either merging group companies under domestic legislation, or transforming entities into structures such as partnerships which can be transparent for Czech tax purposes. These processes are, however, not specifically addressed in the tax legislation, and there are therefore uncertainties attendant to such procedures.
Financial markets and financial instruments in CR have evolved rapidly, and a number of taxation factors have shaped the markets. These include exemption from taxation for profits generated on certain transactions with bonds and similar instruments, as well as tax exemption for individuals on long term capital gains on securities generally. Also, there is no general distinction between capital and revenue transactions, which can lead to significant taxation planning opportunities.
Careful structuring of operation financing is also essential. Thin capitalisation rules may limit the amount of interest an entity may deduct for tax purposes dependent upon the amount and nature of debt taken on by the entity when compared to its equity. Tax losses of an entity may be carried forward for a period of 7 years.
Tax depreciation asset lives ranging from four to forty-five years are based on classifications defined in the tax legislation. Entities may also choose between straight line or accelerated forms of tax depreciation on an asset by asset basis. Hence, scope exists for maximization of tax depreciation by appropriate classification. Furthermore, this choice can also affect claiming of 10 % tax investment allowances, which are effectively the only tax investment incentives available in CR.
The development of the VAT system is also causing difficulties and opportunities. Rates of 5% and 22% (1995) increase costs to entities such as financial institutions and individuals, and the combination of numerous VAT procedural rules and high penalties for noncompliance provides many chances for planning and monitoring.
The Czech taxation system is certain to continue evolving, and ensuring full understanding of developments is crucial to maximising returns from Czech operations.
The content of this article is intended to provide general information on the subject matter. It is therefore not a substitute for specialist advice.
For further information contact Richard Fletcher, Arthur Andersen Prague, tel: +42 2 2440 1300, or enter text search "Arthur Andersen' and 'Business Monitor'.
