Changes to Income Tax Act in 2019
Taxpayers are up for major changes starting from 2019. At least according to the first draft of the amendment to the Income Tax Act, released by the Ministry of Finance for external comments. The concept of taxation of individuals is to change fundamentally. Corporate entities will be subject to the EU Anti-Tax Avoidance Directive, and a general anti-abuse rule will be introduced in tax procedure.
Personal income tax
In the tax on income of individuals, the concept of a super-gross wage and a solidarity tax increase will be abandoned. Instead, the draft amendment introduces a progressive tax rate of 19% for income of up to CZK 1.5 million and 24% for income above this amount. Entrepreneurs, including those claiming expenses as a percentage of income, will be allowed to deduct 75% of social security and health insurance contributions paid.
Deductibility of borrowing costs
Corporate entities will face a number of changes due to the implementation of the EU Anti-Tax Avoidance Directive (ATAD). It introduces, inter alia, new rules restricting the deductibility of exceeding borrowing costs (i.e. costs exceeding related revenues): these will be tax deductible up to the higher of CZK 80 billion or 30% of earnings before interest, tax, depreciation and amortisation (EBITDA) in a taxation period; borrowing costs above these limits will be considered tax non-deductible. However, the proposed amendment assumes that the taxpayer could deduct such expenses from the tax base in future periods (carry-forward), if their exceeding borrowing costs do not reach the stipulated limit in these periods. This possibility will not apply to legal successors. The existing rules limiting the deductibility of interest expense (e.g. thin capitalisation rules) will remain in force.
Unlike the thin capitalisation test, the new rules will also cover borrowings from unrelated parties (such as bank loans). Also, the definition of borrowing costs will be wider than the definition of financing costs for the purposes of thin capitalisation rules. Borrowing costs will also include interest contained in the acquisition cost of assets, finance costs embedded in financial lease payments or exchange rate differences related to financing. The new rules will not apply to financial institutions and stand-alone companies that are not members of any group. The new rules should apply irrespective of the date when the relevant financial instrument was entered into. The draft amendment contains a transitory provision only as regards capitalised interest, which will not be considered excess borrowing costs if the asset was put into use before 17 June 2016. The same approach will be applied to interest contained in a consideration under an obligation to let an asset for use for consideration with subsequent transfer to the user for consideration, if the obligation originated before 17 June 2016.
The draft amendment also contains rules for the taxation of controlled foreign companies (CFC), in response to the obligatory implementation of the ATAD. Under these rules, a Czech entity will have to include in its tax base selected income of its controlled foreign company, i.e. a company in whose capital the Czech company participates directly or indirectly with more than 50%.
Another condition for the inclusion in the Czech tax base is that the foreign company does not carry out any substantial economic activity and its tax liability abroad is lower than one half of the tax liability that such company would have if it were taxed under Czech tax laws. If the foreign subsidiary qualifies as a controlled company under these conditions, its Czech parent will have to include its selected income, such as income from dividends, interest and royalties in its own tax base. The Czech parent may then offset any tax paid by the subsidiary on this income in abroad against its tax liability.
From 2020, the relocation of assets without a change of ownership should become subject to taxation. This rule will apply when Czech companies transfer assets to their foreign permanent establishments or vice versa, or when Czech companies change their tax residence. The transfer of the assets will then be taxed in the Czech Republic similarly as if it were a sale of assets. This means that the tax base would be the difference between the market value of the assets and their tax value. In some cases, the tax may be spread over the subsequent five years.
From 2020, the additional taxation of hybrid mismatches has been proposed for associated entities. Hybrid mismatches may take the form of a ‘double deduction’, when one amount (for instance a deductible expense) reduces the tax base in more than one jurisdiction, or the form of a ‘deduction without inclusion’ of the related income in the tax base, when the tax base is reduced in one jurisdiction without the same amount (income) being included in the tax base in another jurisdiction.
Abuse of right
The implementation of the ATAD will also affect the tax procedure rules: the Tax Procedure Code will contain a general anti-abuse rule, under which the tax administrator will not take into consideration “juridical acts and other facts whose main purpose or one of the main purposes is to obtain a tax or other advantage contrary to the meaning and purpose of the legal regulation“. The abuse of right concept is already being applied in the tax area, and has been formulated by Supreme Administrative Court case law. The draft amendment to the Income Tax Act and the Tax Procedure Code is currently going through the external commenting procedure and it is thus possible that the proposed provisions will still change in the legislative process.