National Council of the Slovak Republic is currently discussing a draft act to amend Act 595/2003 on Income Tax, as amended (the Income Tax Act) and which amends Act 563/2009 on Tax Administration (Tax Code) and amendment of certain acts, as amended. The current status of the draft act may be monitored at: https://www.slov-lex.sk/legislativne-procesy/SK/LP/2022/408.
This act is set to enter into force on two dates: 1 January 2023 and 1 January 2024. Given that some of the changes are set to take effect less than six months from now, we have prepared an overview of the changes that the new act will introduce into the Income Tax Act and the dates on which they take effect.
Multiple changes take effect on 1 January 2023 concerning the definition of dependent parties, the application of transfer pricing rules, and the assessment of permanent establishments.
An overview of the main changes in these areas and their potential application into practice is provided below.
- 2 (o), first subsection was amended to include an addendum according to which the ownership interests of close persons are combined and if their total is at least 25%, the relevant parties or entities are then considered economically linked.
The goal of the act is to define a situation where, for example, one spouse holds a 100% ownership interest in company A, and a 15% ownership interest in company B and the other spouse holds a 15% ownership interest in company B. Under existing provisions, company A and company B were not linked, but under the new provisions they are considered linked companies.
- 2 (r) was reformulated with respect to the definition of dependent foreign entities, but this term is not used further in the Income Tax Act. The draft provisions define economic links in the case of permanent establishments, which has been missing in the current version of the Income Tax Act.;
Relations between permanent establishments and their founders, relations between permanent establishments of the same “founder” and the fall under the term of economically linked and they must be handled as dependent entities and their transfer pricing policies must be reviewed.
- 2 (ab) contains the definition of a controlled transaction and is amended per the change to §2 (r), whereby a relationship between a taxpayer with unlimited tax liability and its permanent establishment abroad is still considered a controlled transaction, and the same is applied to the relationship between a taxpayer with limited tax liability and its permanent establishments in Slovakia and the relationship between the permanent establishments of linked taxpayers under letter n) and the mutual relationship between these permanent establishments and taxpayers. A negative definition of a controlled transaction is also added to the provisions. In general, dependent activity, the income from which falls under §5 of the Income Tax Act is not considered a controlled transaction, regardless of if performed by an employee of the dependent entity, a partner, or a managing director.;
If for example a managing director or partner receives income from dependent activity, this relationship is not considered a controlled transaction and is therefore not subject to transfer pricing.
- Letters d) and e) in §17 (1) are amended and allow a foreign taxpayer doing business in Slovakia through a permanent establishment to define the tax base of this permanent establishment as the difference between the income and expenses attributable to the permanent establishment. Such income and expenses would be determined from the accounting or other similar records of the foreign taxpayer. This change helps to improve the standing of taxpayers that maintain a permanent establishment in Slovakia, but who are not obliged to maintain accounting in accordance with Slovak accounting regulations.;
If a foreign taxpayer has a permanent establishment without any organisational unit, they would have had to determine their tax base from the income and expenses under current legislation if they did not voluntarily decide to maintain their accounting under Slovak legislation. Now they will be able to use the income and expenses maintained in this foreign taxpayer’s own records.
- The amendment of §17 (5) adds a definition of a significant controlled transaction which does not include any legal relationship or similar relationship under which no dependent entity generates taxable income or taxable expenditure in the given tax period in excess of €10,000 (which does not apply in the case of credit or a loan with principle exceeding €10,000). The purpose of this stipulation is to reduce the administrative burden on entrepreneurs for low-value transactions.;
Example 1: A taxpayer has conclude an agreement to provide consulting services with a dependent entity within which the dependent entity provides them with consulting services. Within the relevant tax period, the taxpayer recorded expenses totalling €20,000 but only actually paid €5,000. Under §17 (19) of the act, expenses for consulting services only constitute part of the tax base after payment. A legal relationship or similar relationship under which no dependent entity generates taxable income or taxable expenses in the given tax period in excess of €10,000 is not considered a significant controlled transaction. This agreement to provide consulting services is considered a significant controlled transaction as the consulting service provider generated taxable income of €20,000 in the given tax period.
Example 2: A taxpayer purchases a pre-built structure from a dependent entity for €108,000. The building itself falls into the 4th depreciation group with a 12-year tax depreciation period. The taxpayer’s annual tax depreciation is €9,000. This transaction will be a significant controlled transaction in the year of the purchase / sale of the building as the seller generated taxable income of €108,000 from this transaction in the given tax period. The transaction will not be considered a significant controlled transaction in the following tax periods when the taxpayer applies the annual tax depreciation in the amount of €9,000.
- Entitlement to a corresponding tax base adjustment is added to §17 (6) in cases where the primary adjustment is performed by a Slovak legal entity and the counterparty to the transaction is the Slovak permanent establishment of a non-resident.;
A foreign taxpayer has established a permanent establishment in Slovakia and also has a subsidiary company in Slovakia in which it holds a 100% ownership interest. The subsidiary performs an adjustment under §17 (5)(a) of the Income Tax Adjustment with respect to the permanent establishment, and therefore increase its tax base by €10,000 in its tax return. The permanent establishment may then reduce its tax base by €10,000.
- The provisions of §17 (7) of the Income Tax Act are amended given the need to align them with current OECD methodology for defining the tax base of permanent establishments. The purpose of the proposed changes is to specify the wording of the act, to harmonise it with OECD methodology, including the assessment of expenses (costs) demonstrably incurred by the founder of the permanent establishment for the purposes of this permanent establishment, including expenses (costs) for management and general administrative expenses (costs). Moreover, these provisions resolve the issue of including costs into the tax base if the taxpayer incurs costs before the establishment of a permanent establishment / after its dissolution.
Income (revenues) and expenses (costs) attributable to a permanent establishment in Slovakia and incurred by its founder prior to its establishment are reported in the first tax return filed for this permanent establishment.
- To improve legal certainty, the proposed change in §18 (1) adds a reference to the OECD Guidelines on transfer pricing (“Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations”), which is generally used as an interpretive guide for the area of transfer pricing. The tax administrator’s procedure has also been added to the provisions to provide additional legal certainly with respect to situations when prices used by a taxpayer in a transaction with a dependent entity do not correspond to the principle of an arms-length relationship.;
The taxpayer uses the net trading margin method. Based on data from the database of independent companies, the tax administrator determines the range of profit mark-up values from 1.5 – 8.3% with a mean value of 5.3% (median). Despite the fact that the quartile range (0.25% – 0.75% quartile) is from 3.5 to 7.5% in the given case, the tax administrator determines an independent profit surcharge at the level of 5.3% during the tax audit. However, the taxpayer is of the opinion that the lower limit of the quartile range is more appropriate in his case, i.e. 3.5%. If the taxpayer is able to demonstrate this fact, the tax administrator will adjust the tax base according to this value.
- Multiple changes in terminology appear in §18 (2) and (3) but these are primarily changes intended to harmonise with the latest OECD methodology, to better differentiate methods or as a result of changes to other definitions in the Income Tax Act.
- 18 (5) is expanded and for the purpose of eliminating problems when issuing decisions on bilateral and multilateral approval of the use of a valuation method, in the event that the competent authorities have agreed on the use of a valuation method also for taxation periods prior to the submission of the application (so-called “rollback”), and the possibility to issue a decision for more than five tax periods.;
- 18 (11) has been amended to eliminate enduring issues that have been caused in practice by the current version of §18 (11) of the Income Tax Act with regards to the procedure for submitting documentation, and to facilitate the submission of documentation in a foreign language and then, should the tax administrator request such documentation in the official state language, it may call on the taxpayer to do so, who then has 15 days from receipt of this notification to provide the documentation in the official state language.;
An overview of additional changes is provided below.