International Tax Planning opportunities within the Czech Republic
Článek o podnikatelském prostředí v ČR v nejprestižnějším časopise zabývajícím se offshore problematikou.
7.9. 1998, Offshore Investment Issue 89, Ing. Pavel Petrovič a Ing. David Vavruška
Článek o podnikatelském prostředí v ČR v nejprestižnějším časopise zabývajícím se offshore problematikou.
BY DAVID VAVRUSKA AND TOMAS CHROBAK, AKONT SRO., PRAGUE, THE CZECH REPUBLIC
Earlier this year, the Czech Republic received an invitation to begin negotiations to join NATO and the European Union. Eight and a half years after the "velvet revolution" which abolished the communist regime, this central European country now sees the real chance to complete its re-integration with Europe - in political and economic terms - over the next couple of years. This article intends to show that even in the sphere of international tax planning and new investment opportunities, the Czech Republic has much to offer and is well worth considering.
Already a full member of the OECD, the Czech Republic has always ranked among the most successful ex-communist countries. The high level of skills seen in the Czech labour force, along with the low level of wages (only 10 - 20 percent of those in Germany), together with the full convertibility of the Czech currency for most business purposes (introduced by the new Foreign Exchange Act enacted in October 1995) and solid investment grade ratings make this country an ideal platform for exporting eastwards.
MOST COMMONLY USED BUSINESS ENTITIES
The most commonly used Czech business entities are limited liability companies (SRO) and corporations (a.s.), both governed by the 1991 Commercial Code as amended.
a) The limited liability company (s.r.o.)
The Czech SRO offers limited liability to its partners and is, in many respects, similar to the Dutch B.V. or German GmbH. The number of partners of an SRO may not exceed 50, irrespective of whether these partners are natural or legal persons. The minimum amount of issued capital is 100,000 koruna (approximately US$ 2,900). An essential feature of an SRO is that it must appoint at least one natural person as director who has to be a resident of the Czech Republic.
b) The Corporation (AS)
The corporation is suited for cases where the number of shareholders is high or when its shares are to be traded in public. The minimum amount of the issued share capital is 1 million koruna (US$ 29,000) of which at least 30 % must be paid in cash prior to the incorporation by each shareholder. At the time of incorporation, an AS must appoint the board of directors - the statutory body of the corporation, and the supervisory board. The board of directors is formed by three members at least, all of whom must be natural persons and residents of the Czech Republic.
Since January 1993, a new taxation system has been introduced, corresponding to EU standards, which particularly concentrate on two types of taxes :
a) Corporate income tax, implemented by the Income Tax Law 586/1992 as amended, is levied on all income of Czech-based legal entities under the following rules:
- resident companies (limited liability companies, corporations and others), are subject to a corporate income tax on their world-wide income,
- the current standard rate of the corporate income tax is 35 % of the tax base and applies irrespective of the residency or citizenship of owners of a Czech legal entity,
- no tax is levied on the capital and reserves of a Czech company.
Profits which are earned on Czech investments can be freely repatriated after a withholding tax of 25 % is deducted. Reductions of this rate are widely available thanks to the network of double taxation agreements extending to practically all OECD and many other countries (among which especially the Netherlands and Cyprus are particularly popular) . Where any of these agreements are in effect, a rate of 0 % - 15 % applies. Besides the withholding tax, there are no restrictions or laws in the Czech Republic which would restrict the outflow of capital abroad.
b) Value added tax (VAT) is a consumption tax levied with respect to all goods, both domestic and foreign, sold within the Czech Republic. The Czech VAT system is similar to that of EU countries, the tax rate is generally 22 %, although a lower VAT of 5 % is charged for selected goods as food, pharmaceutical products and many kinds of services.
Apart from the two types of taxes mentioned above, the new system now also includes excise taxes, inheritance tax and taxes levied on immovable property and its transfers.
FINANCIAL REPORTING AND AUDITING REQUIREMENTS
All companies registered in the Czech Commercial Register are required by law to keep proper books of accounts and to prepare annual accounts. Accounting rules are based on western accounting principles and follow the EU directives in all relevant aspects. In case of corporations and large limited liability companies (with a turnover exceeding approximately US$ 1,1 million.) they must be audited by independent auditors. Financial statements should be filed with the Czech tax authorities within three months following the year to which the statements relate (or six months if the financial statements are prepared by a certified tax advisor). The tax should be paid with the filing of the financial statements.
BASIC INVESTMENT INCENTIVES:
Czech Republic law permits foreign investors to take advantage of thirteen commercial or industrial customs-free zones which do not form part of the Czech Republic`s territory for tax purposes (four in Prague, two in Zlin, one in Cheb, Ostrava, Pardubice, Trinec, Bor u Tachova, Uherske Hradiste and Hradec Kralove). A company from any country can easily hire a warehouse into which goods may be imported and later exported without incurring customs duty or VAT burden. This duty must be paid only in the event that the goods brought into the Czech Republic are circulated in the local economy. Applications to establish operations within a customs-free zone are made to the Customs Office in Prague.
Special investments incentives:
In the past, the Czech government authorities have generally been opposed to special tax incentives because of their effect on public revenues (although there are examples of considerable tax relief being offered in relation to large foreign investments, for example, Volkswagen was granted a series of tax incentives and a temporary protective tariff against imported cars in return for an investment commitment of about US$ 3 billion to upgrade the Skoda car factory). Recently, the faltering influx of foreign capital has forced the government to issue a declaration which guarantees grants and various incentives (including tax holidays) to any foreign investment exceeding US$ 25 million.
Double taxation treaties:
The extensive network of double taxation treaties which has been set up between the Czech Republic and 43 countries is probably the most important of all the investment incentives. Each of these treaties offers favourable rates of withholding taxes on dividends, interests and royalties, well under the standard rate of 25%. The following table shows the withholding tax rates contained in the most popular tax treaties:
|Germany||5* or 15||0||5|
|Ireland||5* or 15||0||10|
|Italy||15||0||0 or 5*****|
|Luxembourg||5* or 15||0||10|
|Netherlands||0* or 10||0||5|
|Poland||5** or 10||0**** or 10||5|
|United Kingdom||5* or 15||0||10|
|United States||5*** or 15||0||10|
* in cases where the recipient controls at least 25 % of the voting power in the company paying dividends,
** in cases where the recipient controls at least 20 % of the voting power in the company paying dividends,
*** in cases where the recipient controls at least 10 % of the voting power in the company paying dividends,
**** if the recipient of interests is a government authority, central bank or a government owned financial institution,
***** in case of royalties connected with the proprietorship of patents and trademarks.
N.B. Gains from the alienation of any movable property shall be taxable only in the treaty country of which the alienator is a resident. The profits of a treaty country`s enterprise are only taxable in that state unless the enterprise carries on business in the other treaty country through a permanent establishment situated therein.
SPECIAL CHARACTERISTICS OF THE CZECH INVESTMENT CLIMATE
One of very apparent, although temporary, features of the Czech economy is that it has an inadequate legal framework to cope with all aspects of local business activities. This is not surprising - the process of implementing modern laws has taken decades in well-established economies and could not have been successfully accomplished in the Czech Republic within a few short years. However, the result is that the legislative loopholes and the relevant authorities` lack of concern can often amuse and delight international tax planners.
In comparison with western countries, there is a considerable delay in implementing efficient legislation against tax avoidance schemes. This is exacerbated by the fact that what limited powers the local tax authorities have are exercised very ineffectively and indecisively. To date, the Czech administration has not made much of an effort to lay the foundations of a long-awaited modern anti-tax avoidance legislation, and this situation is unlikely to change in the near future. The consequences of this situation are often quite surprising.
The Czech authorities are clearly unfamiliar with basic aspects of international tax planning. For example, the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators which were released by OECD in July 1995 were translated into Czech and published by the Czech Ministry of Finance only last year and are now subject to long term studies. Due to this slow and cautious approach, a flexible adoption of relevant legal measures can hardly be expected in the near future.
The substance over form concept was implemented within Czech legislation by the 1992 Administration and Duties Act (as amended) but so far , there have been no cases recorded of its provisions being enforced against an international tax-avoidance structure. Besides that, only few anti-tax avoidance statutory provisions have followed and most of them had no significant effect. As a consequence, the current situation can be briefly summarised as follows:
- one of the basic taxation principles -the liability to pay the corporate income tax corresponding to the place where the effective management is located - does not exist in Czech legislation. Instead, only the Czech source of income of a foreign company is taxed. Up until now, there have not been any cases documented in which a foreign company, which does not trade with the Czech residents, was subject to tax even if it was controlled and managed from the Czech Republic,
- there is no CFC legislation to prevent any company from accumulating its profits in foreign subsidies,
- it is possible for every Czech resident company to divert its trade abroad to avoid local taxation as no restrictions on the migration of trade have been introduced,
- offshore trusts and companies for asset protection and tax purposes can be easily used, without even minor legal difficulties, provided the foreign entrepreneurs do not forget to use prudent business practices and common sense,
- the transfer pricing between associated entities is very poorly pursued or prosecuted,
- several tax havens, such as Bahamas, British Virgin Islands or Cyprus are well known by the Czech authorities but there exists no black list of low-tax countries in use by tax authorities,
- in contrast to the modern tax treaties (for example, the new treaty between the Netherlands and United States), the double taxation agreements to which the Czech Republic is a party do not contain any base erosion test or other tests restricting the entitlement to the treaty benefits. Owing to this fact, their provisions can be used by experienced tax planners from all over the world.
- the concept of a nominee company managed by an offshore company in order to facilitate foreign transactions, for example, merchandise being purchased abroad and sold abroad thereafter, can be realised through a Czech company (representative offices of offshore companies are widely used too) while the tax base liable to the Czech income tax may remain at a very low level,
- thanks to double taxation treaties protecting short-term business activities in treaty countries, the previous structure can be used for providing services in the territory of these countries,
- within the Czech Republic, creating a service or support organisation, in which can be used for many purposes (bookkeeping, promotional activities, general co-ordination, administration and so on ) can be beneficial for international companies. In fact, this type of organisation can be even more effective than the better known Dutch service company or Belgian co-ordination centre. The formation of a Czech service company does not rely upon obtaining an advance tax ruling from the Czech tax authorities, there are no formal requirements for employing Czech residents and no complications will arise if such company achieves only small or even zero profit.
It can be anticipated that after entering the EU, the Czech Republic will be forced to amend and refine its existing legislation. But for now, anyone wishing to carry out international business in affective way may find the right place to be is at the real heart of Europe.