Equalisation tax, Czech implementation of the EU Directive
Further to our last article of May 2023, we would like to inform you about further developments in the area of Pillar 2, i.e. the implementation of Council Directive (EU) 2022/2523 of 14 December 2022 on ensuring a global minimum level of taxation of large multinational enterprise groups and large domestic groups in the Union.
Act on equalisation taxes
In May 2023, the draft Czech implementation of the aforementioned directive, namely the “Draft bill on equalisation taxes for the purpose of ensuring a minimum level of taxation of large multinational and large domestic groups” (hereinafter referred to as the “ITA”), was omitted from the external comment procedure. At present, the bill was already read at the 1st reading in the Chamber of Deputies on 29 August 2023. The Chamber of Deputies did not approve the accelerated procedure for passing the bill in the first reading and it is currently referred to government committees for discussion.
Unfortunately (as we expected), the Czech legislators put the implementation of the Directive into the ITA without significant interventions, and therefore the ITA is relatively “illegible”, same as the Directive itself.
Below, we summarise at least the rough outlines of the forthcoming legislation.
The equalisation taxes will include:
- assigned equalisation tax (either at the level of the state or at the level of the member entity) and
- national equalisation tax (i.e. taxation of group member entities located in one state, in this case the Czech Republic).
While the assigned equalisation tax is in principle compulsory, national equalisation taxes could be opted for by individual countries. The Czech Republic has decided to apply a national equalisation tax.
The mechanism for calculating the equalisation taxes is quite complex and will certainly impose a high administrative burden on the taxpayers affected.
Simply put, if a national equalisation tax is applied and it is considered qualified (i.e. it meets the requirements of both the EU and the OECD), there will be no need to calculate and apply the relevant assigned equalisation tax.
It will therefore always be necessary to examine how the EU Directive, or the OECD model rules, have been implemented in the specific countries concerned and whether these countries apply a “qualified” national equalisation tax, which de facto has priority.
According to the Czech ITA, equalisation taxes:
- are not considered income taxes, i.e. they are generally not subject to double taxation treaties;
- represent a non-tax deductible expense for income tax purposes;
- but a qualifying domestic equalisation tax (under the law of a third country or an EU Member State) may partially reduce the Czech corporate income tax imposed on a controlled foreign company.
Exceptions to the application of equalisation taxes
In view of the administrative complexity of introducing a full-fledged implementation of equalisation taxes, we strongly recommend examining whether exemptions from the obligation to apply equalisation taxes (the so-called safe harbours) can be applied. These are both permanent exemptions as well as temporary exemptions.
While permanent exemptions are likely to be explained further in OECD commentaries or guidance, the OECD has already issued a document on temporary exemptions, “Safe Harbours and Penalty Relief: Global Anti-Base Erosion Rules (Pillar Two)“.
Temporary exemptions essentially replicate permanent exemptions, but have their own specifics and simplified procedures, simplified data, etc. are used to meet them, e.g. they can be based on Country by Country Reporting (CbCR).
The temporary exceptions are:
- de minimis test (small-scale test) – revenues in the country are lower than EUR 10 million according to the CbCR and profit before tax in the country is lower than EUR 1 million according to the CbCR,
- simplified ETR (effective tax rate) test – the included tax in the country to the pre-tax profit reported for the country in the CbCR is at least 15% (for 2023 and 2024), 16% (for 2025), 17% (for 2026) or
- routine profits test – exclusion of profits on the basis of economic substance (essentially covers the simplified profit in the country under the CbCR).
The above is only a basic and simplified insight into the possible exceptions. The ITA also contains other exemptions, e.g. for the start-up phase of a group of companies.
Also, the ITA contains specific conditions for certain selected entities, e.g. transparent ultimate parent entities, investment entities, ultimate parent entities subject to the deductible dividend regime, groups with multiple parent entities, etc.
Penalties for non-compliance
The ITA contains penalties for its violation, where according to Section 110 of the ITA, a fine of up to CZK 1,500,000 may be imposed for failure to comply with an obligation of a non-monetary nature in the administration of the equalisation tax.
At the same time, the provisions of the Tax Code relating to tax accessories (i.e. penalty for tax assessment, interest on late payment) should apply to the Czech compensatory tax.
Effectiveness of the ITA
The draft ITA generally provides for the effective date of 31 December 2023, which is in line with the EU Directive, i.e. the first tax period to which the equalisation taxes will apply will be the tax period beginning on 31 December 2023 at the earliest, i.e. in the case of tax periods corresponding to the calendar year it is the year 2024.
If the issue concerns you, please do not hesitate to contact us. We will be happy to discuss the details and possible impacts on your group with you. We particularly recommend checking the possibility of applying safe harbours.
Author: Martin Hahn, Petr Němec