ATAD directive: The rules for taxation of controlled foreign companies according to the ITA – part 2
- Jaroslav Foltýn
- David Mikolášek
The rules for taxation of controlled foreign companies (the so-called CFC rules) have been incorporated into the Czech income tax act (hereinafter the “ITA”) into the stipulation of article 38fa with effect from 1 April 2019 by act no. 80/2019 Coll. (hereinafter also as “ITA Amendment”). In the first part, we looked at whether or not a respective foreign company is considered a controlled foreign company and thus if its income is subject to the CFC rules. In today’s part, we will take a look at when the Czech taxpayer (legal entity) is in the position of a controlling Czech company to the controlled foreign entity and when the controlled foreign company achieves the so-called included income. We will also discuss, how to report the potential adjustment in the tax return.
The controlling company (with regard to a controlled company) is a corporate income tax payer – Czech tax resident who, alone or with associated enterprises has more than 50 %:
- direct or indirect participation in the registered capital of a controlled foreign company; or
- its voting rights; or
- has a right to more than one half of the profit of the controlled foreign entity.
Associated enterprises for the purposes of the ITA are understood to mean entities, where one entity holds directly or indirectly a participation in terms of voting rights or capital ownership of 25 percent or more or is entitled to receive 25 percent or more of the profits of that entity.
Example: For better understanding of the issue, let us illustrate it using the following situations:
- A Czech company A having an at least 50 % stake in the controlled foreign company is the controlling Czech company.
- Czech company A has itself an at least 10% stake in the capital of the controlled foreign company, its affiliated Czech company B has 45% stake in the capital of the controlled foreign company, together the Czech company A and B have a 55% stake in the capital of the controlled foreign company. Both Czech companies A and B are the controlling Czech company with respect to the controlled foreign company.
- Czech company A has itself an at least 15% stake in the capital of the controlled foreign company, its sole partner – an individual (a Czech tax resident) has an 85% stake in the capital of the controlled foreign company, together this Czech company A and the associated individual have a 100% stake in the capital of the controlled foreign company in total. Czech company A is the controlling Czech company. An individual (Czech tax resident) is not in the position of a Czech controlling entity, because he is not a corporate income tax payer.
The above-mentioned exclusion of individuals – Czech taxpayers from the application of the CFC rules is an important guideline for setting up future foreign structures. If the controlled foreign company is owned only by an individual – a Czech tax resident, Czech CFC rules will not apply to such a foreign entity. Individuals may, though, as the above-mentioned associated entities, influence the application of CFC rules for corporate income tax payers.
If based on the above-mentioned CFC rules, a corporate income tax payer (Czech tax resident) will be the controlling Czech company with regard to the controlled foreign company, then this taxpayer will be obliged to also include the so-called included income achieved by the controlled foreign entity in his tax base, in a proportionate amount calculated according to the percentage of the stake of the taxpayer in the registered capital of the controlled foreign company, as of the time of the end of the taxable period of the controlled foreign company abroad.
Included income, which needs to be included in the tax base, is listed conclusively in the ITA – it is income of passive nature:
- in the form of borrowing income, royalties, profit sharing, and from disposal of share in a corporate income tax payer,
- from the assignment of property for beneficial use with a right to subsequent acquisition of the property for consideration by the party to the obligation,
- from insurance, banking and other financial activities,
- from the sale of goods or provision of services bought from associated entities and sold to associated entities without any or with little added economic value,
- from the sale of goods or provision of service to an associated entity, whose activity consists predominantly in purchase of goods and services from associated entities and subsequent sale of these goods and provision of these services to associated entities without any or with little added economic value.
The activity of a controlled foreign company and the handling of its assets are viewed as if made by the controlling company on the territory of the Czech Republic only in a proportionate part calculated according to its stake in the registered capital of the controlled foreign company at the moment this activity or handling of assets took place. In human terms, this means that in the above-mentioned case B, the Czech controlling entity will be obliged to adjust its tax base for 10 % of included income (and related costs) of the controlled foreign company. In the above-mentioned case C, the Czech controlling entity A would adjust its tax base for 15 % of included income (and related costs).
The Information of the General Financial Directorate further specifies that the taxpayer, who will not be a controlling company for the entire taxable period, will then detect the amount of included income only for the part of the taxable period, in which the conditions of a controlling and controlled foreign company were fulfilled. The moment of performance of activities or handling of assets of the controlled foreign company will usually derive from the moment, which the controlling company specified as the moment of performance according to the rules of the Czech accounting act.
And finally, the stake of the Czech controlling company in the registered capital of the controlled foreign company is lowered by the part of the stake held via a different company, which is not a basic investment fund.
Treatment in the corporate income tax declaration
If, then, the situation occurs that a Czech corporate income tax payer is considered a controlling company, which is obliged to adjust its profit/loss based on the stipulation of article 38fa, the company will adjust its profit/loss in lines no. 63, 163, 319 and 319a, which have been added to the blank form of the corporate income tax declaration and which serve for a summary capturing of the increase or in case of a potential decrease of profit/loss, arising on grounds of the CFC rules.
Nevertheless, on grounds of applying the CFC rules, it is not possible to lower the tax base of the Czech controlling company by the tax loss of the controlled foreign company specified determined to the Czech ITA. The Czech controlling company can use such tax loss of the controlled foreign company in the 3 immediately following taxable periods always up to the amount, by which the tax based of the controlling company is raised in the given taxable period on grounds of the application of the CFC rules for the same controlled foreign company.
And finally, the tax of the controlling company can be lowered by a tax similar to the corporate income tax paid from income and handling of assets, which are subject to CFC rules, paid:
- by the controlled foreign company, which is a corporate income tax payer, in the country, of which it is a tax resident,
- the controlling company in the country, in which the permanent establishment, which is the controlled foreign company, is located
- by a corporate income tax payer, who is a tax non-resident and through which the controlling company owns a stake in the registered capital of the controlled foreign company, in the country, of which it is a tax resident.
Please note that the mentioned “tax” need not always mean the 19% corporate income tax, to which the general tax base of corporate taxpayers is subject. If the case of included income meant for example foreign dividends received, the above-mentioned term “tax” would mean the 15% tax, to which income taxed within a separate tax base is subject under article 20b of the ITA.
The newly implemented CFC rules generally mean a great intervention in the preparation of the tax return of corporate income tax payers who, on grounds of their foreign investments, may be considered controlling companies for the purposes of the CFC rules, and that is a major intervention both on grounds of the administrative demands of applying the CFC rules (de facto requiring a second calculation of the tax of the foreign company), and on grounds of the impact on the tax base of such a taxpayer. On grounds of this, it is necessary for corporate income tax payers to keep these new rules in mind in their international tax planning, especially in the case of the most frequently included income, i.e. interests, royalties and dividends.
 If the foreign entity were a tax resident in a country listed in the EU list of jurisdictions not cooperating in the tax area (e.g. the Seychelles, Panama, U.S. Virgin Islands etc.), a controlling Czech entity would, with effect as of 1 January 2021, include all income of the controlled foreign company, that is not only the included income, in its tax base.