September 2010 – The general elections in June 2010 resulted in a change of government and the ruling coalition in Slovakia. Several new ministers (including the Minister of Finance responsible for tax policy) were members of the government during the period 1998–2006 and were responsible for reforms which earned Slovakia the label “economic tiger of the CEE”. One might expect a similar development in the tax system, in particular, in the context of the ongoing economic crisis, the rising state budget deficit, and the need to consolidate public finance.
At the time of this article, no concrete tax legislation had yet been introduced by the government. There are, however, lively discussions among the members of government, parliament, political parties, professionals and the general public on the extent and form of the changes to the tax system. It seems that no one really doubts the need for changes, but only a few know exactly what changes should be adopted.
We provide below an initial overview of the current discussions and our assessment of the upcoming changes in order to help our clients adjust their investment decisions.
Corporate Tax: Will Companies Pay More?
Current discussions seem to overlook the level of corporate tax (currently 19%). The Ministry of Finance stressed on several occasions that, instead of simply increasing the tax rate, they intend to focus on:
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closing the gaps to prevent tax avoidance – abolishing exemptions and irregularities and an overall simplification of the Income Tax Act; and
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reducing the opportunities for tax evasion – making the administration and collection system more efficient, unifying the collection of taxes and social security contributions, and structural changes to tax administration.
Overall, this is good news for investors in Slovakia. On the other hand, there are voices claiming that the government’s intentions not to raise tax rates may soon be faced with a different reality, i.e. a rising state deficit and the inevitability of additional tax increases. This is difficult to predict – we assume that no changes to corporate tax rates will occur in 2011, but a slight rise is likely in 2012.
Dividends: Back to Double Taxation?
No taxation of received and paid dividends is a feature that distinguishes the Slovak tax system from most of the other EU jurisdictions and has historically played an important role in attracting foreign investment. This cornerstone of the 2004 tax reform is now subject to intense disputes. The government hopes to collect additional revenue by re-introducing withholding tax on dividends, and even imposing social security obligations on the dividend income of individuals (individual entrepreneurs often avoid social security contributions by carrying out business through limited liability companies, while receiving only dividends and not income from employment).
On the other hand, the government cannot overrule the existing network of double tax treaties signed by Slovakia and the EU directives, such as the Parent-Subsidiary Directive. Both the directives and the treaties enable businesses to transfer dividends tax free (or almost tax free) to and from Slovakia, regardless of the Slovak legislation. This is a strong argument in favour of the current beneficial regime.
We would recommend that international groups active in Slovakia review their structures to prepare for the future re-introduction of the dividend withholding tax. In most cases, this should not have significant adverse effects on the overall level of taxation. The anticipated change may, however, significantly affect individual Slovak residents using various tax optimisation structures.
Personal Tax: End of the Flat Rate?
The idea to return to progressive taxation for relatively high-income individuals has been considered several times by the previous government, but was never implemented. The current plans of the government do not seem to encompass this idea, but funds still need to be raised somewhere. Instead of modifications to the tax rates, the government will try to make the flat tax even more flat by abolishing a number of existing exemptions and allowances. For example, personal allowance for private life and pension insurance will very likely be cancelled from 2011.
Even if the flat tax rate remains at 19%, employers should prepare for an increase in overall wage costs. It is very likely that the government will cut existing exemptions in the tax system and in the social security system. Therefore, several forms of payment to employees could be subject to social security (e.g. severance, bonuses for anniversaries, or wages paid under agreements for part-time work). It is also expected that contributions to the Social Insurance Authority will be reconciled on an annual basis, similarly to health insurance contributions. This should eliminate leaks in social insurance for one-off bonuses paid to employees instead of regular monthly wages.
VAT: The Right Way to Collect Revenue?
Value added tax contributes the largest share to state budget revenues and its administration is fairly simple for the state. Therefore, increasing the VAT rate would appear to be easy (as has recently occurred in Romania or the UK). VAT increases are, however, sensitive from a political point of view, and the government seems to be concerned about the reaction of the general public. There are currently three VAT rates in Slovakia:
(i) a 19% general rate;
(ii) a 10% rate on pharmaceuticals, medical products and books;
(iii) a 6% rate on food products sold by small farmers.
Despite the past declarations made by ruling party officials, many believe that it is inevitable and, in fact, economically correct to unify the VAT rate and to increase it by two to three percentage points. We believe this increase is likely, and we would, therefore, recommend that companies factor such an increase into their 2011 budgets.
At the time of writing, the Government adopted a fresh decision on the increase of the general VAT rate by 1 percentage point to a new VAT rate of 20%. It has also decided on cancellation of the 6% rate on food products sold by small farmers and these will be subject to the general VAT rate; the 10% rate on pharmaceuticals, medical products and books will remain unchanged. The relevant amendment of the VAT legislation will be submitted to the Parliament for its approval soon – if approved (which is very likely), the new VAT rates may be expected from 1 January 2011. The VAT increase is, in the view of the Government, introduced only as a temporary measure for next two or three years.
We are continually monitoring the current developments in tax and other legislation and will provide you with more information in the upcoming issues of our newsletter.
For further information please contact Adam Hodoň, Partner, at .