CORPORATE INCOME TAXATION

• 1. INCOME TAX ACT

Tax Rate

The corporate income tax rate is reducing from the current 24% to 21%, and the rate is intended to begradually decreased further: in 2009 a corporate income tax rate of 20% should apply, and from 2010 the rate should be 19%.The tax rate valid at the beginning of the taxable period is going to be applied instead of the tax ratevalid on the last day of the taxable period. This change has a negative impact on companies using thefiscal tax year as their tax period.

Tax exemption

An amendment in this area has broadened the scope of tax exemptions on income from dividends andother profit shares, through extending their application to dividends paid by entities not established inthe EU.Such incomes will be tax exempt under the following conditions:

• The taxpayer paying the dividends is the resident of a third country with which the CzechRepublic has concluded a double tax treaty;
• • The entity paying the dividends has a similar legal form to a limited liability company, publiclimited company or co-operative;
• The entity paying the dividends is related to the recipient of dividends similar to a subsidiary tothe parent company;
• The taxpayer paying the dividends is subject to a tax similar to the Czech income tax rate, andthe tax rate is at least 12%.

An even more significant change introduced in this field is the tax exemption of the transfer of theshares that a Czech parent company holds in a subsidiary. An exemption can be claimed uponfulfillment of the same conditions that apply to income from dividends. The exemption applies to thetransfer of shares held in Czech subsidiaries as well as the transfer of shares held in a subsidiaryestabli-Public finance reformOctober 20071established abroad. The exemption is not applicable when company shares are acquired through thepurchase either of a whole company or parts of it. This change, which has already been implementedin a number of more developed foreign jurisdictions, should support the creation of new holdingstructures in the Czech Republic. Tax exemption of income from the interest from the mortgage bondsis abolished.

Taxation of unpaid payables

The unpaid payables that are more than 36 months overdue or are statute-barred will be subject totaxation. This rule is not applied to payables resulting from credit or loans, a payment in favour of ownequity, or contractual penalties.

Thin capitalization

Many changes in the tax deductibility of interest on credit and loans have been ratified, i.e. in the areaof thin capitalization and the arms’ length rules applicable to interest on loans/credit.New rules are applied also to related costs, including the costs for securing and processing credit andfees for guarantees. These costs and interests on loans/credit are jointly termed ‘financial costs’.The main change is the fact that the thin capitalization rules are applied to the financial costs relatingto credit or a loan from unrelated parties, and thus to e.g. the bank loans and credit. The taxdeductibilityof the financial costs arising from the credit/loan provided by a related party will be morerestrictive - the current limit is reduced by half.In particular, the financial costs are tax-non-deductible if:

•  The financial costs exceed the value of average size of the credit and loans in the taxable periodmultiplied by the flat interest rate increased by 4%. The flat interest rate is determined as theaverage of the reference value of interest rates in the interbank deposit market for the 12-monthmaturity period, as the last day of each month in the taxable period for which the tax return isto be filled; or
•  The financial costs from credit and loans are subordinated to other payables of the taxpayer; or• The amount of the financial costs depends on the economic results of the debtor; or
•  The amount of credit and loans (from unrelated and related persons) exceeds the debt/equityratio of 6:1 for the year 2008; 4:1 in the subsequent years; or
•  The amount of credit and loan provided by related parties exceeds the debt/equity ratio 2:1; forfinancial institutions is the debt/equity ratio is 3:1.

These regulations do not apply to the financial costs which are part of the input price of the assets,credits/loans not bearing any interest, and to credits or loans with a maximum financial cost of CZK1 million (not applied to the financial costs from credit/loan from related parties).The new thin capitalization rules are applied to credit and loan agreements concluded after 1 January 2008 and to amendments to existing agreements that come into force after 1 January 2008.These restrictions shall be applied to the financial costs from all credit and loan agreements (includingthe agreements concluded before 1 January 2008) from 2010.As part of the new rules concerning tax deductibility of financial costs, the rule for the commoninterest rate from the loan between related parties, amounting to 140% of the discount rate of theCzech National Bank, is abolished. This change applies also to loans concluded before 1 January 2008.

Financial leasing

Since financial leasing with the subsequent purchase of the leased asset includes financial costs, thetax-deductibility of such financial costs is reduced by the amendment to the Income Tax Act.The tax evaluation of these financial costs is ensured by excluding the percentage, determined by theamendment, from the tax-deductible leasing payments. This amount would correspond approximatelyto the amount of these financial costs and is stipulated as 1% of the lease payments. Otherwise, thecosts related to financial leasing with the subsequent purchase of the leased asset are tax-deductibleonly up to 99% of the total leasing amount.This provision does not apply to the financial costs related to the financial leasing with the subsequentpurchase of leased assets which do not exceed CZK 1 million in the taxable period or the period inwhich the tax return was submitted.In addition, the amendment to the Act proposes lengthening the minimum period of financial leasingin the following way:

•  For tangible assets the minimum length corresponds to the length of tax depreciation(according the classification of assets in the depreciation category);
•  For buildings the minimum length is 30 years instead of the current eight.

At the same time, the special leasing depreciation of leased assets, currently applied by lessors(currently assets can be depreciated up to 90% of the input price, in equal amounts over three years)will be abolished. This provision applies to financial leasing contracts concluded after 1 January 2008.The withholding tax applied to financial leasing payments paid abroad is raised from the current 1% to5%.

Changes in the depreciation of cars

Under the amendment to the Act, the maximum input price of cars is abolished. The cancellation ofthe limit applies only to cars purchased after 1 January 2008. Vehicles purchased by 31 December2007 will be depreciated at a maximum amount of CZK 1.5 million.The amendment abolishes the depreciation category 1a. Under the new system a passenger car isclassified under depreciation category 2, and is depreciated over five years instead of the current four.

Changes in tax-deductible costs

Tax-deductible costs such as transfer of employees, and employer contributions to employee pensioninsurance schemes, life insurance schemes and employee accommodation, are abolished. From1 January 2008 these expenses can be regarded as tax-deductible only if the right of an employee tosuch a payment is determined in a collective agreement, employment or other contract, or in theemployer’s internal guidelines.Social insurance, health insurance and national employment policy dues paid by a general partnershipfor the partners of such a company and by a limited partnership for the general partners will beregarded as tax-non-deductible items.On the contrary, the liquidation of materials, goods, unfinished products, half-finished products andfinished products is going to be tax-deductible. The liquidation must be proved by a liquidationprotocol under the applicable acts.

Binding rulings

Some new sections are included in Income Tax Act giving taxpayers the opportunity to request thefinancial authority for a binding ruling on:

• The allocation of costs relating to both the taxable and non taxable revenues;
•  The adjustments of long-term assets (repair and maintenance versus technical improvement);• Eligibility of costs for research and development for tax deductions;
•  The allocation of costs relating to using immovable assets, if such assets are used for bothbusiness and private purposes.

ACT ON RESERVES

Starting on 1 January 2008 the equalization reserves of non-life insurance and other technical reservesof both life and non-life insurance will not be considered tax-deductible. Reserves recorded before theamendment to the Act comes into force will be dissolved in the tax period starting in 2008.In addition, the amendment tightens the rules regarding the creation of provisions to receivables. Thecreation of provisions for receivables (amounting to 20% of the unsettled balance-sheet value of suchreceivables) where more than six months have elapsed since the maturity date is possible only forreceivables amounting to less than CZK 200,000 if court, administrative or arbitration proceedingshave not been initiated. This restriction will apply for the first time to provisions created after theamendment comes into force; provisions created before the amendment will not be taken intoconsideration

.PERSONAL INCOME TAX.

INCOME TAX ACT

Tax rate

The Income Tax Act amendment brings several changes in the area of personal taxation, the mostimportant of which is naturally the implementation of a flat tax rate of 15% for the year 2008. A yearlater, tax rate should be further decreased to 12.5%.

Tax base

The tax base will be equal to the ‘supergross wage’, i.e. the sum of the gross salary of an employee andthe amount of social security and health insurance payments paid by the employer on behalf of theemployee (generally 35% of gross salary) in case of earnings from dependent activities.Shareholders of companies with unlimited liability as well as the self-employed individuals will not beentitled to consider the mandatory social security and health insurance paid by them or on their behalfas a tax-deductible expense.

Tax relief

Tax relief thresholds were increased for the year 2008 to compensate for the raised tax rate applying tolow-income individuals. However, it is assumed that these thresholds will be decreased again for theyear 2009.

Joint taxation of married couples

Due to the flat tax rate applicable to all categories and levels of an individual’s income there is noreason for a joint taxation system. As of 1 January 2008 each individual should file his or her taxreturn separately.

Minimum tax base

The Income Tax Act amendment abolishes the minimum tax base for self-employed individuals.

Tax-free income from the sale of securities

The current exemption of income from sale shares (six-month holding test) from tax will only apply tothe sale of investment securities, collective investment securities and income from shares, when ashares fund is cancelled. This exemption is applicable under the condition that an individual’s totalshare in the equity and voting rights in the company whose shares were sold did not exceed 5% duringthe period of 24 months before the sale.Income from sale of all other kinds of securities will be tax exempt if the period between theacquisition of shares and their sale exceeds 5 years.The above restrictions do not apply to securities acquired before the effective date of the newlegislation. Therefore, the income form the sale of the securities acquired before 1 January 2008 willbe tax-exempt, provided that the period between the acquisition and the sale of security exceeds sixmonths.

Other changes in personal income tax

The value of temporary accommodation will be tax-exempt only up to the amount of CZK 3,500 permonth. Income received in the form sickness benefit paid by the employer to the employees whenthey are on sick leave will be tax exempt only up to the amount of the minimum entitlement stipulatedby the Labour Code.5The amendment introduces a joint maximum limit of employer’s contributions to an employee’s lifeinsurance or pension scheme which are tax exempt for the employee in the amount of CZK 24,000.The limit for applying withholding tax to an authors’ income from newspaper or magazine articles willbe increased to a maximum of CZK 7,000 (the current maximum is CZK 3,000) per month. If theincome does not exceed this limit it is subject to a special withholding tax at source.Tax exemption of interest on mortgage bonds issued after 1 January 2008 is abolished.

SOCIAL SECURITY AND HEALTH INSURANCE

Sickness insurance

According to the amendment sickness benefit should be paid out from the fourth day of illness, and thecalculation method has been changed.The date from which the new Act on Sickness Insurance will come into force is postponed by oneyear, i.e. to 1 January 2009. In this connection, the implementation of the contractual and foreignemployee(employees of employers with their registered office outside the EU and apart fromcountries that concluded the Totalization Agreement with the Czech Republic) concept, i.e. themandatory participation of these individuals in the Czech social security system, is also postponed.The sickness insurance contributions rate will decrease to 2.3% in 2009 and 1.4% as of the year 2010.

Social security contributions

The amendment introduces a maximum general assessment base for calculating employee socialsecurity contributions. The maximum annual assessment base amounts to the average Czech monthlysalary multiplied by 48.The amendment introduces a new definition of the term ‘income accounted to an employee by anemployer’ i.e. the income included in the assessment base for calculating social security contributions.In the future, it will not be necessary for the employer to realise the cost in connection with theprovision of the income to the employee.According to the amendment the maximum assessment base for self-employed individuals is the sameas for employees.

Public health insurance

There is also a new definition of an employee obliged to participate in the mandatory health insurancesystem. Employees are defined as all persons having earnings from dependent activity under theIncome Taxes Act. This means that for example members of the boards of directors and of otherboards of companies must pay health insurance contributions.The amendment also determines the maximum assessment base for calculating employee healthinsurance contributions. The maximum annual assessment base amounts to the average Czech monthlysalary multiplied by 48 (the same method used for social security purposes).6The definition of the term ‘income accounted to an employee by an employer’ (i.e. the incomeincluded in the assessment base for calculating the health insurance contributions) is amended in thedefinition used for social security purposes.For self-employed individuals the maximum annual assessment base is amount as for the employees,i.e. the average monthly salary multiplied by 48.

VALUE ADDED TAX

VAT rate

The reduced VAT rate will be increased from 5% to 9% on 1 January 2008.

Tax base

Tax on electricity, natural gas and certain other gases, and tax on solid fuels, will be included in theVAT base for the first time.

Social housing

The VAT Act further introduces the term ‘construction for social housing’, which among others meansa flat with floor space of no more than 120m2, or a family house with a floor space of no more than350m2. A reduced VAT rate of 9% is applied to construction and assembly work related to suchbuildings and their transfer.

VAT rates for other housing types

The reduced VAT rate should apply temporarily to construction and assembly work concerning thechanges to already finished apartment buildings, family houses and flats. The legal effect of thisexception is limited to 31 December 2010.

Group registration

The amendment makes it possible for all members of commercial groups with a registered office in theCzech Republic to register jointly. In this connection, the amendment introduces the term ‘group ofrelated persons’, meaning a group of persons with a registered office in the Czech Republic, relatedthrough capital or closely linked through other relations. All group members will be registered in theCzech Republic for VAT. The persons forming a group will be treated as one person liable to VAT,and one member will act on behalf of the whole group. In practice, companies forming a group willsubmit a joint VAT return for the whole group.Persons are considered related through capital if one party directly or indirectly holds another person’scapital or voting rights, whereby this party holds at least 40% of the other’s registered capital or votingrights. Otherwise, related persons are regarded as persons who participate in the management orcontrol of another person.Companies forming a group will not pay output VAT on mutual supplies, which is the most importantadvantage of group registration. A monthly taxation period will apply to the group.7The group can be registered only as of the beginning of a calendar year. An application for groupregistration must be submitted by 31 October of the preceding year. In view of the fact that anapplication can be made in 2008 at the earliest, group registration will be possible from 1 January 2009at the earliest.

Binding rulings for the correct submission of the taxable supply in terms of tax rate

The amendment enables taxpayers to request the Ministry of Finance for a binding ruling regarding thecorrect submission of the taxable supply at the right tax rate. The fee for such a request is CZK 10,000.One request will apply to one tax supply. Unfortunately, the Act does not determine any deadlines bywhich the Ministry must issue a decision.

Source: mazars.cz