New interest deductibility rules in the Czech Republic
- Daniela Riegel
We would like to inform you that an amendment of the Czech Income Tax Act came into force in March 2019. The amendment implements some of the “ATAD” rules in the Czech Republic. Among others there are new rules for tax deductibility of loan interests that may impact on your business. Especially if there are intercompany loans granted within your company group involving the Czech Republic. Below you will find a brief overview of the current rules for tax deductibility of loan interests (and related financial costs) and the new implemented “ATAD” rules.
Current interest deductibility rules
- Financial costs related to a shareholding in a subsidiary are considered as tax non-deductible fully (e.g. interest related to loan financing acquisition).
- Financial costs not satisfying the thin capitalization rules are tax non-deductible. Thin capitalization rules apply only to all financial costs (interest, other related fees) paid on loans agreed between related parties. Financial costs on loans exceeding the debt-to-equity ratio of 1:4 for other entities than banks are treated as tax non-deductible expense. This includes also back-to-back loans. The rules however do not apply to interest which forms a part of acquisition costs of assets (i.e. this interest becomes tax deductible through the depreciation of assets).
- Financial costs related to tax exempt income are tax non-deductible fully.
- Financial costs related to a loan where the amount of such costs (or the due date of these costs) depends on the amount of the profit of the debtor, are not tax deductible fully.
- Unpaid interest from a loan granted by a physical person (individual) are fully tax non-deductible (becomes deductible when paid).
New interest deductibility rules
Basically, the taxpayer will firstly apply the existing rules above and then the new rules to interests, which pass these tests, will be applied.
New rules restrict the tax deductibility of exceeding financial costs (i.e. costs exceeding related income) these will be tax deductible up to the higher of CZK 80 million or 30% of earnings before interest, tax and depreciation (EBITDA) in a tax period (income tax act has special rules concerning calculating EBITDA; so it does not equal to accounting EBITDA). Financial costs above these limits will be considered tax non-deductible.
The above-mentioned thin capitalization rule is the closest one to the new rules. The new rules considerably expand the range of financial costs, which the taxpayer needs to assess - interests paid to unrelated parties (e.g. a bank), exchange-rate differences from revaluation of loans, “implicit interest” paid as part of financial lease, etc.
The new rules also adjust the list of taxpayers, to whom the rule will or will not apply, e.g. the new rules will not affect taxpayers, who do not control foreign companies, have no permanent establishment abroad and are not either obliged to compile a consolidated financial statement or being part of consolidation.
Capitalized interests, i.e. interests which form a part of acquisition costs of assets, are not subject to the current thin capitalization test. In case of the new rules it will be necessary to calculate a part corresponding to the capitalized interest from the tax depreciations or residual value in every tax period.
From the above it is clear that the new rules will be one of the most demanding rules for evaluation of tax-deductible costs, which we have ever had in the tax law.
Should you be interested in this topic, we will be pleased to provide you with more detailed information or evaluate the impact on tax deductibility of financial costs in your company.
Daniela Riegel & Štěpán Osička