Another tool used by the Czech tax administration to combat tax evasion is the ongoing implementation of the ATA Directive (Council Directive (EU) 2016/1164 laying down rules against tax avoidance practices) that is to be completed by 31 December 2018. Primarily, the Directive lays down new rules for the tax-deductibility of interest expenses. The rules are so complicated that they will significantly increase the administrative burden on corporate income tax payers. Moreover, the rules will be very hard to administer for the tax authorities themselves.
Ministry of Finance’s view of the implementation of the Directive
As part of public consultations, the Ministry of Finance has expressed its opinion as to how the Directive is going to be implemented. The Directive gives the Member States a certain freedom for implementing the large volume of general and variable rules.
The Directive only applies to legal entities subject to income tax in the EU and to permanent establishments of third-country residents situated in the EU. The Member States may exclude financial undertakings and standalone entities from the scope of the rules.
As stated above, the Directive primarily limits the tax-deductibility of interest by, in fact, modifying / tightening up and extending thin capitalisation rules (currently regulated in Section 25(1)(w) of the Czech Income Taxes Act). Under the new basic rule, borrowing costs exceeding 30% of the taxpayer’s operating profit (EBITDA) will be considered non-deductible. The Directive allows the implementation of a lower percentage, i.e. a stricter limit. However, in view of the competitiveness of Czech companies, the Ministry of Finance assumes that the less burdening limit of 30% of EBITDA will be implemented.
Nevertheless, compared to current thin capitalisation rules, a major tightening will result from the fact that the basic rule will also apply to credits and loans from unrelated parties.
Another novelty introduced by the Directive is the definition of exceeding borrowing costs. Compared to currently used ‘financial costs’, the definition will also cover items such as interest on financial leases and capitalised interest and costs of foreign exchange transactions related to financing. Quantifying and defending the costs before the tax authority will, of course, bring a significant increase of the already considerable administrative burden on taxpayers.
However, in this context, a positive fact is that the Ministry of Finance supports the minimum threshold for the application of the rules, specifically the option of not applying the rules to exceeding borrowing costs of up to € 1 million (approx. CZK 26 million). The Directive offers a limit of up to € 3 million but the Ministry of Finance sees this as a rather large amount. Nevertheless, if you do avoid the new rules, you are to be subject to standard (‘original’) thin capitalisation rules.
Another positive fact for taxpayers is that non-deductible interest costs could be carried forward to other tax periods, which de facto means that currently incurred costs could be set off against future EBIDTA. In all of its alternatives, the Directive provides opportunities for carrying exceeding borrowing costs forward to other tax periods without any time limitation. Hopefully the Ministry of Finance will not come with an extra limitation instead.
Finally, here is some bad news, as is common in taxes. The Ministry of Finance is not going to implement the possibility of excluding from the scope of the new rules loans and credits concluded before 17 June 2016. As a result, the new rules would have to be applied to ‘old’ financing.
If you need advice on tax optimisation or if you wish to discuss these issues, please do not hesitate to contact us. We will be happy to help.