Taxation in Slovakia and foreign investment

a view from a foreign advisor

Paying taxes is no fun anywhere. This applies to foreign investors in Slovakia as well. However investors have to accept that there is taxation every where. Often even this does not hurt them too much because the tax system in their home countries might allow them to deduct foreign taxes from their home country income tax.

However there are some expectations regarding taxation which investors have. Legality, clarity, fairness, orientation to business, reasonably fast assessment and so on. Further the investor always compares different countries in similar situations, like countries neighbouring Slovakia or countries with a similar wage level.

Before I try to assess whether Slovakia meets the expectations of investors I would like to give a very brief overview on Slovak taxation. This overview should not be the basis for any decision as I cannot go into any detail. For investors the advice of a professional experienced in dealing with foreigners is absolutely necessary. Special tax rules for special industries like banks or insurance companies are not dealt with here.

After the "velvet revolution" the Czechoslovak legislation was adapted to the end of the planned economy. This included a new tax system which was developed within a comparatively short time. Efforts were made to make this system comparable to Western standards and suitable for the new economical and legal environment which included incentives for foreign investments. This difficult task had been concluded by the end of 1992.

After the creation of Slovakia most of the investment benefits were abolished and little was done to reduce doubts inherent in the old tax legislation. The tax authorities - at least compared to those of the home countries of potential investors - only reluctantly gave hints regarding the interpretation on unclear legal provisions. High court decisions in tax matters, elsewhere published, still seem to be kept as secrets.

Starting point is the profit worked out in accordance with Slovak accounting principles. These are stated in laws and ordinances and need to be strictly followed. The accounting year always ends on December, 31. Unrealised currency exchange losses have to be recorded but are not deductible.

The following items have to be added back to the accounting profit:

Few items are "tax free": e.g. income where taxes were withheld (dividends, interest on certain papers etc)

As tax benefits for investors there are basically only two opportunities: a provision for repairs and an accelerated depreciation of fixed assets. Both result in earlier deductibility of expenses compared to statutory statements.

As mentioned above transactions between related companies need to be made at "market conditions" otherwise the difference to market has to be added to income or cannot be deducted. There is no group taxation. Dividends from subsidiaries are tax free but they are subject to a 15% withholding tax.

Payments are deductible in case the lease agreement exceeds 40% of the stipulated period of depreciation (minimum of 8 years for immovable and three years for movable assets) and the final purchase price is less than the residual value. In case it exceeded the residual value then presumably the previous payments become non-deductible. This might increase the income for prior periods which results in penalties of up to 40%.

The tax loss of one year can be offset from income in the following years in equal portions of 20%. Tax losses within that period cannot be brought forward.

Branches - whether registered at the commercial court or not - are taxed as permanent establishments. A permanent establishment arises through execution of certain activities like e. g. construction sites, offices, excavation of raw materials and consulting services. The permanent establishment has to be registered with the tax authorities. Until then a 10% collateral tax has to be withheld. The permanent establishment is taxed on its profits according to its records unless margins of sales figures or other figures are established as tax basis.

Double tax treaties might specify the taxation of permanent establishments.

A speciality to my knowledge only to be found in Slovakia and the Czech Republic is the "deemed" permanent establishment arising through the secondment of staff. The speciality is that double tax treaties are overruled.

The corporate tax rate is 40%

The tax returns have to be filed until the 31 March of the subsequent year. Any tax duty for the last year has to be paid by then. Prepayments from then on are due monthly or quarterly, depending on total amount. Any amounts not paid in time are subject to a penalty interest of 0,3 % a day which is more than 100 % a year. This applies also for amounts requested after tax audits.

Such treaties exist with a number of countries like Austria, Belgium, Czech Republic, France, Germany, Hungary, Italy, Japan, Netherlands, UK and US, however, not with Switzerland. Apart from the deemed permanent establishment Slovakia respects these agreements.

My comments are limited to foreigners working in Slovakia. Residents, that means those having residence, usual abode in Slovakia, are taxed on their world income unless double tax treaties provide otherwise. Foreign experts resident in Slovakia with permanent residency abroad who are seconded by a foreign company to provide expert assistance to Slovak companies and who stay in Slovakia only for that purpose shall be considered as non-residents. They thus can claim a flat 30% deduction on their gross income related to Slovakia in addition to the social security charges withheld abroad. The top rate is 42 %, thus the experts' rate after the flat deduction cannot exceed 29%.

Questions like what is an expert and what means "stay in Slovakia only for providing expert assistance" can endanger the benefit for example when the expert takes a meal or sleeps in Slovakia. Then the expert ceases to be an expert and the purpose of his stay becomes the search for recovering rather than providing the assistance. If I had not had such discussions I would not mention them.

Though similar in principle there are some important differences compared with VAT in EU countries. One of them is formality which needs to be watched carefully otherwise heavy penalties arise or input tax is lost.

Difficulties start with the registration continue with the determination of the place of delivery and end with high penalties. One should avoid any action before having studied the law and the practice of tax authorities.

Normal tax rate is 23% the reduced rate 6%.

Basis is the purchase price agreed. In case one party was a foreigner than the price is determined by the "methodology" of the home country of the foreigner which might result in comparatively high prices . The tax rate depends on the price and the relationship of the parties, it can be up to 20 %.

For a business to start in Slovakia life is hard. The tax loss rules are only beneficial in the case of only one loss year. Limited deduction of advertising, bad debt losses and of losses on inventories and fixed assets do not encourage new business.

The withholding tax on dividends appears to be a problem for restructuring companies as profitable divisions cannot be easily spun off.

Compared to neighbouring countries there are nearly no tax benefits in Slovakia.

Here are some points which I observed. There might be more and not all of them hurt investors to the same extent.

In other countries unclear laws exist as well. But in Slovakia it seems that the burden of the lack of clarity is always with the tax payer.

Tax offices do not give any advice, the opinions of different tax offices vary a lot and decisions of the highest courts are not published. Oral explanations of officials are always unofficial and tend to change a lot. Often even tax advisors, usually very knowledgeable about their subject, seem to be unable to include all aspects of a question in their answers.

By the end of a calendar year often laws related to taxation are amended with retroactive effect. This makes tax planning difficult and might even result in penalties.

In our view the taxation of "deemed permanent establishments" is not in line with the double tax treaties.

The tax payer's duty is in most cases to file returns, work out the tax and pay it within a comparatively short time which cannot be extended. Any error is a burden to him. In case he paid too little there is a high penalty in case he paid too much he has to fight for recovering the excess payment.

Often one gets the impression that the administration so far is not able or willing to understand the process of certain industries. Thus often Slovakia was excluded from investments because the tax treatment of certain improvements to goods could not be clarified. The statement "go ahead and then you will see how much taxes you pay" in many cases was too risky.

We can hope that the new government will try to abolish some if not all of the problems foreign and Slovak investors face because of the tax legislation. These changes will not necessary result in less receipts but rather in more because investors will employ more people.

Dr. Felix Mayrhofer Grüenbühl

Slovak Trade FORUM