Czech Republic - Taxation of cross-border mergers and acquisitions
Taxation of cross-border mergers and acquisitions for Czech Republic.
Taxation of cross-border mergers and acquisitions for Czech Republic.
Czech law contains a number of specific provisions applying to mergers and acquisitions (M&A) in areas such as company law, competition, environmental protection, accounting and tax.
Broadly, a deal can be structured as a sale of a shareholding in a legal entity or a sale of assets (possibly the entire business). Depending on certain factors, it may be appropriate for the buyer to form a new Czech legal entity to make the acquisition. Further reorganizations may be necessary after the acquisition to help maximize tax deductions.
As a member state of the European Union (EU), the country has implemented various measures contained in the EU Anti-Tax Avoidance Directives (ATAD and ATAD 2). Mandatory Disclosure Rules contained in the DAC 6 amendment to the Directive on Administrative Co-operation in the Field of Taxation have been transposed into Czech legislation, pursuant to which certain tax planning arrangements undertaken in periods after 25 June 2018 may need to be reported to the Czech tax authorities.
The Czech Republic is a party to the Multilateral Convention to Implement (MLI) Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS). The MLI takes effect for relevant tax treaties from 1 September 2020 (but new measures concerning withholding tax shall not apply before 1 January 2021). The Czech Republic has opted to apply only the minimal standards, for example, principal purpose test (whereby treaty benefits may be denied if the purpose of an arrangement were to obtain undue benefit of the treaty) and mutual agreement procedure.
Since 1 April 2019, taxpayers are required to make special notifications of payments, including dividends, interest and royalties as well fees for services physically rendered in the Czech Republic, to foreign entities which would be subject to withholding tax, except for the fact that exemptions claimed under tax treaties or EU Directives.
Asset purchase or share purchase
There are two broad acquisition structures — asset deal and share deal.
Purchase of assets
The main tax effect of an asset deal is that the buyer assumes full tax basis in the assets acquired and the seller is subject to tax on any gain. As a general rule, tax liabilities of the seller are not carried over to the buyer upon a sale.
An asset deal may take one of two forms:
- purchase of an enterprise or part of an enterprise (an activity capable of being operated as a separate business)
- purchase of individual assets.
In both cases, the gain is taxable at 19 percent or 15 percent (personal income tax). However, where the assets are sold individually, losses on the sale of some assets (e.g. receivables) are not tax-deductible.
The buyer and the seller can apportion the price between individual assets, and the tax authorities are unlikely to question a reasonable apportionment as long as the buyer and seller are not related.
In the case of a purchase of an enterprise, it is possible to carry out a valuation of the assets acquired, and such valuation is usually accepted for the tax purposes of the buyer. Any part of the purchase price not attributed to the individual assets in the valuation is treated as goodwill, which can be depreciated for tax purposes over 15 years (5 years for accounting purposes). When no valuation is carried out, any difference between the price and the pre-sale accounting book value of the assets is classified as a valuation difference, which is depreciated for both tax and accounting purposes over 15 years (the period can be shorter for accounting purposes). The purchaser then records the pre-sale accounting book values of the assets as the tax entry value of the assets.
No goodwill or valuation differences can arise on a purchase of individual assets. In this case, the whole purchase price is allocated between the individual assets.
The accounting and tax rules on goodwill also apply to negative goodwill, which arises where the price is lower than the value of the assets. Negative goodwill is treated as taxable income recognized over 15 years.
Generally, the buyer recommences tax depreciation (i.e. does not continue the depreciation policies of the seller) of the assets acquired pursuant to a purchase of assets or purchase of an enterprise. The buyer commences depreciation by reference to the new depreciation base, which is generally the purchase price plus any related transaction costs.
Tax losses cannot be transferred to the buyer in the case of an asset acquisition; they remain with the seller. As already noted, tax liabilities also remain with the seller.
Value Added Tax
The Czech Republic levies Value Added Tax (VAT) at rates of 10, 15 and 21 percent. Most goods and services are subject to the standard rate of 21 percent. A sale of assets is usually a taxable supply for VAT purposes, although some items are VAT-exempt or outside its scope. The sale of an enterprise is under a special rule not considered a supply for VAT purposes.
Where a transaction involves the transfer of the whole or part of an enterprise, the buyer may have to repay input VAT claimed by the original owner on the purchase of fixed assets if the assets are used for VAT-exempt supplies in the future. The look-back period for checking which VAT may be clawed back is 10 years for real estate (including improvements, and also including repairs over 200,000 Czech crowns (CZK) made after 1 April 2019) and 5 years for other assets.
There are no transfer taxes, stamp or capital duties in the Czech Republic.
A 4 percent real estate transfer tax was applicable until 2019 but was abolished in 2020. No real estate transfer tax is paid on acquisitions of real estate (buildings and land) where the ownership change was registered in the Real Estate Register after December 2019.
Purchase of shares
In a share deal, there is no step-up for the buyer or the target in relation to any premium over the accounting/tax value of the target’s assets. The only possible exception to this is where the shareholding is acquired as part of a wider transaction consisting in the ‘purchase of a business’, where the relevant shareholding represented a component of that business. In such case it is possible in principle for the purchaser to record a goodwill-type amount consisting of a ‘valuation difference’, and such amount can in principle be amortized for tax purposes, subject to fulfilment of the general criterion for deductibility, namely being incurred in connection with generation of taxable revenue.
Under a share deal, the buyer effectively takes over undisclosed liabilities, including tax liabilities of the target company.
The tax treatment of the sale depends on the status of the seller. In the case of a corporation, any gain on the sale of share investments generally is subject to corporate income tax of 19 percent as normal income unless the participation exemption applies. The participation exemption applies to gains on the sale of shares in a Czech subsidiary (10 percent share capital holding for at least 12 months) realized by corporate sellers resident in the Czech Republic, the EU, Iceland, Norway or Liechtenstein.
The exemption cannot be applied if either the parent company or the subsidiary:
- is exempt from corporate income (or similar) tax,
- may claim a corporate income tax exemption or corporate income tax relief, or
- is subject to corporate income tax at a rate of 0 percent.
The exemption also applies to gains earned from sale by a Czech company of non-Czech subsidiaries. For the exemption to apply, a minimum of 10 percent of the share capital of the company whose shares are sold should be held for at least 12 months, and this company must be tax-resident in a country with which the Czech Republic has concluded a tax treaty and which has a corporate tax rate of at least 12 percent. Losses on disposal are generally not deductible, except in the case of certain shares held for trading purposes.
Note, however, that the above-mentioned participation exemptions do not apply in cases where and to the extent that:
- the shareholding is sold as part of a wider transaction consisting in the sale of a business, where the shares owned represent a component of that business
- the shareholding being sold was originally acquired by the seller as part of a wider transaction consisting in the ‘purchase of a business’, where the relevant shareholding represented a component of that business.
In the case of an individual who has not treated the shares as a business asset, a gain on the sale of securities (including shares in joint stock companies) is tax exempt if held for 3 years. No tax is in any case payable where the taxable sales (i.e. gross proceeds) of securities do not exceed CZK100,000 in a tax year.
A gain on the sale of an interest in a limited liability company (s.r.o.) is similarly exempt from tax but only if it has been held for more than 5 years.
Where the buyer is a Czech tax-resident and the seller is not based in the EU or European Economic Area (EEA), the buyer is required to withhold a ‘security tax’ as an advance against tax payable unless treaty protection is available. The rates are 1 percent for income from the sale of ‘investment instruments’ as defined by the Czech law and 10 percent for income from the sale of an interest in an s.r.o.
The sale of shares in a legal entity, including a joint stock company (a.s.) or an s.r.o. is exempt from VAT with no right to deduct input VAT.
Tax indemnities and warranties
In a share acquisition, the buyer takes over the target company and, indirectly, all of its related liabilities, including tax liabilities. Therefore, the buyer normally needs more extensive indemnities and warranties than in the case of an asset acquisition, where tax liabilities do not transfer.
Tax losses may be carried forward for 5 years. Furthermore, tax losses up to CZK30 million incurred in any year ending on or after 30 June 2020 may be carried back to be utilized in the prior 2 years. The tax law prevents the use of tax losses where there is a substantial change in the persons directly participating in the company’s equity or management and less than 80 percent of the company’s income in the year in which the loss is to be used is derived from those activities which were carried on in the year when the loss arose. A change in the ownership of more than 25 percent of the registered capital or voting rights is always a substantial change. A taxpayer can apply to the authorities to confirm the availability of the carried forward losses after the end of the taxable period in which the losses are to be used.
Crystallization of tax charges
The Czech Republic does not have CIT groups, and there are no special rules crystallizing a CIT charge when a company leaves a group.
Pre-sale dividends are rare in practice. If there is a qualifying corporate shareholding, both dividends and capital gains are exempt (i.e. the tax treatment does not differ). If the dividends are paid to an individual, there is no exemption from taxation; the dividends are always taxable while the gain can be exempt. Therefore, pre-sale dividends are not especially tax-efficient.
There are no stamp or capital duties in the Czech Republic. Administration fees are payable on certain services rendered by various government bodies.
Most transactions and reliefs are not subject to tax clearances, and tax rulings are possible only in certain limited areas. For instance, a taxpayer can ask the tax authorities for a tax ruling relating to certain issues in advance (e.g. use of tax losses, transfer pricing). There is no general ruling system.
In a share deal, the seller is typically asked prior to Share Purchase Agreement signing to provide confirmation from the tax authorities that there are no tax arrears. Such confirmation provides only limited comfort since it does not preclude additional tax from being assessed in the future.
Choice of acquisition vehicle
Several potential acquisition vehicles are available to a foreign buyer, and tax factors often influence the choice. There is no capital duty on the introduction of new capital to a Czech company, including a Czech-registered SE or branch.
Local holding company
A Czech holding company is often used as an acquisition vehicle where the buyer wishes to ensure that the future taxable earnings of the Czech target company can be offset against tax-deductible interest expenses from borrowings used to finance the acquisition loan. Under a typical structure, the company that makes the acquisition subsequently merges with the target so that the taxable income of the target and the expenses related to the acquisition are within the same entity. Absent the merger interest on acquisition loans would be treated as non-deductible. Care must be taken in implementing such structures, since in recent years they have attracted attention of the tax authorities. In certain circumstances, courts have rejected tax deductions for acquisition-related borrowings.
The legal forms most commonly used are limited liability companies and joint stock companies. These two legal forms allow the exemption from taxation of profit distributions to qualifying EU parent companies under the EU Parent-Subsidiary Directive. They also give limited liability to the shareholders. Companies can have the SE form which would be subject to a similar tax regime as is applicable to joint stock companies.
Foreign parent company
A foreign buyer might choose to acquire the Czech target company directly, which may be efficient if it was possible under its law to offset the interest on acquisition borrowings against its own profits. As noted earlier, cross-border mergers of Czech companies are possible although they are more administratively demanding than mergers of two Czech companies.
Non-resident intermediate holding company
Non-resident intermediate holding and finance companies have historically been used as a tax-efficient means of making inward investment where a relevant tax treaty provided more favorable tax treatment for capital gains or dividends. International developments, such as the OECD MLI (see earlier), mean that closer attention will be paid to the substance of such holding and finance company structures.
Under some circumstances, a foreign parent company may structure its investments through a Czech branch. Czech commercial law requires a branch to be registered where the foreign parent company systematically carries on business in the Czech Republic and has no local subsidiary.
Generally, the tax status of a Czech branch does not differ from the tax status of a local company (i.e. same rules for the tax base calculation, same corporate income tax rate). However, there are some differences. For example, the distribution of profit by a Czech branch is not regarded as a dividend, and there are no associated withholding taxes.
A joint venture can be either corporate (with the joint venture partners holding shares in a Czech company) or unincorporated (usually a partnership), which is (at least partially) tax-transparent.
Choice of acquisition funding
A buyer using a Czech entity to carry out an acquisition can finance the acquisition vehicle with debt, equity or a combination of both.
The principal advantage of financing an acquisition with debt is the potential interest deductibility, as opposed to the payment of dividends that are not tax-deductible. Any related expenses (e.g. loan arrangement fees) are usually deductible. Moreover, debt financing has the advantage of avoiding a dilution of equity.
Therefore, the costs of debt financing are typically lower than the costs of equity. It is important to choose an acquisition vehicle that allows the offsetting of interest expenses against taxable income.
Deductibility of interest
Expenses paid or payable for the purpose of earning taxable income are generally tax-deductible. Therefore, interest on acquisition financing should be deductible subject to transfer pricing and thin capitalization considerations.
This general rule is subject to some exceptions:
- Interest paid by a Czech company is generally deductible on an accrual basis. However, where it is payable to an individual who does not keep double-entry books, it can generally be deducted only when paid.
- When the interest or other revenue is derived from the borrower’s profit (e.g. profit participating loan), the interest and other financial expenses are not tax-deductible.
- Interest should be incurred to earn taxable income. Income received in the form of dividends and other income subject to withholding tax (WHT) as a final tax do not qualify as taxable income for this purpose.
- Expenses paid in connection with a holding in a subsidiary company are generally non-deductible. The law includes a rebuttable presumption that interest on loans taken out less than 6 months before the acquisition is paid in connection with the holding in the subsidiary. There is also a rebuttable presumption that 5 percent of distributions received from a subsidiary is a disallowable indirect cost of holding the investment. Such costs can be added to the base cost of the shares when calculating gains on future disposals (although in most cases such gains would benefit from exemption under the participation exemption). The definition of ‘subsidiary’ for this purpose is drawn from the legislation enacting the EU Parent-Subsidiary Directive, which includes a requirement for the parent to hold 10 percent of share capital for at least 12 months.
A merger of the target with the holding company can mitigate the last two of these concerns. Alternatively, it is possible to convert the target into a tax-transparent entity, so that the buyer’s interest expense becomes deductible against its share of the profits of the target’s business. Care must be taken in implementing such structures, since the tax-deductibility of acquisition loan interest may be vulnerable to challenge in some circumstances.
The Czech thin capitalization provisions restrict the deductibility of interest where the borrower has insufficient equity. Financial expenses arising from loans and credits received from related parties in excess of four times (six times for banks and insurance companies) the borrower’s equity are not tax-deductible. Interest on loans and credits received from unrelated parties, or those secured by a related party, is fully deductible on general principles, except for interest on back-to-back loans (i.e. where a related party provides a loan, credit or a deposit to an unrelated party, which then provides the funds to the borrower), which is treated as interest on related-party debt.
Notwithstanding these provisions, financial expenses that directly relate to taxable income (e.g. interest income) can be deducted up to the amount of that income.
In addition, following implementation of ATAD, the deductibility of excess borrowing costs (which includes interest, finance lease payments, capitalized interest or its amortization, hedging arrangements relating to borrowings, and certain foreign exchange losses), is subject to an overall cap, such cap being the higher of 30 percent of the taxpayer’s earnings before interest, taxes, depreciation and amortization or CZK80 million. The rules allow for carry forward of amounts for which deductions were restricted, so that they can be offset in future periods, subject to the same limitation.
Also following implementation of ATAD and ATAD 2, from 1 January 2020 Czech law counteracts cases of hybrid mismatches, which may arise in connection with loan financing, in certain cases where they would otherwise result in double deduction without dual inclusion of related expenses or in deduction without inclusion. The rules apply also to cases of imported mismatches, for example, where a hybrid mismatch may exist between two entities that are not Czech taxpayers but where the benefit of the mismatch is ‘imported’ into the Czech Republic. The Czech rules would disallow the imported benefit in cases where neither of the relevant non-Czech jurisdictions counteracted it.
Withholding tax on debt and methods to reduce or eliminate this tax
The Czech Republic levies WHT of 15 percent on interest payable to non-resident lenders (35 percent for payments to entities resident in jurisdictions not permitting exchange of tax information). No WHT applies to interest incomes deemed to be earned via a Czech permanent establishment of the non-resident. An exemption applies to interest on qualifying Eurobonds issued by Czech companies outside the Czech Republic, but this will no longer apply for bonds issued after 2021.
WHT on interest is often reduced or eliminated for qualifying recipients under tax treaties, and via the EU Interest and Royalties Directive.
The Czech tax law allows interest to be reclassified as a dividend where it is non-deductible due to a breach of the transfer pricing or thin capitalization rules. This can have adverse WHT consequences. This reclassification does not apply to EU or EEA lenders.
Interest paid by a Czech-resident company to a Czech-resident lender is not subject to WHT.
Checklist for debt funding
The following factors should be taken into account when debt funding is being considered:
- deductibility of interest connected with an acquisition of a company
- thin capitalization rules, where a loan is granted by a related party
- earnings stripping cap
- anti-hybrid rules, including imported mismatches
- transfer pricing rules, which require interest on a related-party loan to be set at arm’s length
- effective tax rate of the lender
- reduction of or exemption from WHT.
A buyer can use equity to fund the acquisition rather than debt. The main way to increase equity is by issuing new shares.
The main disadvantage of equity financing is dilution of the shareholders’ ownership (in the case of an increase of equity made disproportionately to the voting rights of each shareholder) and the non-tax-deductibility of dividends. Equity financing generally is considered less preferable than debt financing.
However, in certain situations, equity financing might be preferable, such as where:
- the target company is a loss-making company
- the debt-to-equity ratio is too high and exceeds the thin capitalization limits
- a higher effective tax rate applies in the home country of the lender
- non-tax-related business reasons exist, such as credibility of a company or regulatory restrictions.
Tax-free corporate reorganizations
There are no comprehensive tax rules on corporate reorganizations. The rules enacted under the EU Merger Directive and Directive on Cross-Border Mergers are intended to allow reorganizations to take place on a tax-neutral basis. The tax authorities have the power to challenge the intended tax effects of a transaction on the basis that the substance of the transaction is other than the form but this is rare in practice.
Typical transactions are described below.
Contribution in kind
The Income Tax Act (ITA), section 30(10) requires the recipient of a contribution in kind to the capital of a company to continue the tax depreciation policies of the person making the contribution. On a cross-border contribution to a Czech company, the recipient must continue the tax depreciation of the contributed assets based on the original purchase price of the contributed asset converted into using the exchange rate on the date of contribution and using the Czech tax rules. Tax depreciation on the contributed assets can be claimed up to the difference between the original purchase price and the tax depreciation already claimed by the contributor. Except where the EU Merger Directive applies (Section 23a, ITA), the tax law is silent on the treatment of the person making the contribution; however, according to the accounting rules, the contributor does not realize a gain in such a case but records the shares received at the net book value of the asset contributed.
Section 23a of the ITA does not refer to contributions of assets.
The section refers only to a contribution of an enterprise or part of an enterprise as defined for the purposes of the Civil Code (i.e. an activity that can be operated as a separate business, as required by the Merger Directive, and including all liabilities, both disclosed and undisclosed) involving Czech and/or EU-resident companies (but excluding both types of Czech partnership).
The law states explicitly that the person making the contribution does not realize a taxable gain and permits the transfer of reserves and tax losses. Further, the law provides that the person receiving shares in exchange for a qualifying contribution should record these shares at market value for tax purposes. This does not apply where the contributor subsequently transfers the shares within 1 year. Moreover, tax attributes cannot be transferred where the main or one of the reasons for the contribution is to reduce or avoid the tax liability.
A contribution of assets that does not qualify as an enterprise is regarded as taxable supply for VAT purposes, where the contributor claimed an input VAT deduction when the assets were purchased. The contributor and buyer are jointly liable for the VAT. The contribution of some asset classes can be exempt from VAT (e.g. real estate) where certain conditions are met.
A contribution of an enterprise or part of an enterprise is not a taxable supply for VAT purposes. Nevertheless, a company that receives an enterprise or part of an enterprise may be obliged to repay input VAT claimed originally by the contributor, where the fixed assets are later used for VAT-exempt supplies. The general clawback period is 5 years, extended to 10 years for buildings.
There are no stamp or capital duties.
In a merger, the predecessor company ceases to exist without going into liquidation and all its assets and liabilities pass to the successor. There are no detailed tax rules on mergers except for cases dealt with by Section 23c of the ITA (which implements the EU Merger Directive). In general, a merger is tax-neutral. The transfer of fixed assets is at the tax residual value, and any goodwill arising cannot be depreciated for tax purposes.
For qualifying mergers:
- No gain or loss is realized by the shareholders of the dissolving company on their disposal of its shares, except to the extent that they receive cash.
- The value of the shares received is equal to the value of the shares in the company that ceases to exist (i.e. no step-up in the value of the shares).
- Tax depreciation policies of the company that ceases to exist are continued by the successor(s).
- Tax losses arising after EU accession are transferred, provided that tax avoidance is not a main purpose of the transaction.
- Reserves and provisions are automatically transferred, subject to the same tax avoidance restriction that applies on the transfer of losses.
The companies concerned have to be resident in the Czech Republic or another EU member state. Based on the EU Directive on Cross-Border Mergers, it is possible to merge a Czech company with any company registered in an EU member state.
For accounting and income tax purposes (but not legally or for VAT purposes), it is possible for the effective date of a merger to be up to 12 months earlier than the date on which the application for registration of the merger is filed with the commercial court.
There is no real estate transfer tax, VAT or stamp/capital duty on a merger. Nevertheless, the successor may be obliged to repay input VAT claimed originally by the predecessor, where the fixed assets acquired are later used for VAT-exempt supplies. The general clawback period is 5 years, extended to 10 years for buildings.
In a demerger, the predecessor company ceases to exist and its assets are transferred to two or more newly incorporated successor companies, which issue shares to the shareholders of the predecessor. Again, the ITA is generally silent on the effects except for the provisions implementing the EU Merger Directive legislation (Section 23c ITA). The same rules apply as in the case of a merger (with the necessary changes), namely, tax-neutrality with regard to transfers of assets, no tax deduction for the depreciation of goodwill, transfer of tax losses and possible transfer of reserves and provisions by agreement.
No liabilities to Czech real estate transfer tax, VAT or stamp/capital duty apply upon a demerger. Where the fixed assets are later used for VAT-exempt supplies, the successors may be obliged to repay input VAT originally claimed by the predecessor. The general clawback period is 5 years, extended to 10 years for buildings.
A spin-off is an alternative to a demerger. The demerged company does not cease to exist, but the spin-off part is transferred to an existing or newly incorporated company. The spin-off is tax-neutral. The transfer of tax provisions, tax reserves and tax losses to the successor is possible to the extent that the transaction can be commercially justified.
There is no real estate transfer tax, VAT or stamp/capital duty. Again, the successor may be obliged to repay input VAT claimed originally by the demerged company, where the fixed assets are later used for VAT-exempt supplies.
Tax losses and reorganizations
When losses are transferred on a merger, demerger or spin-off, they can only be used against the profits derived from the activity that generated them. Similarly, any losses of the surviving company can be used only against the profits generated by the same activity. Where an activity is transferred through a contribution of an enterprise, the losses transferred can only be used against the profits of the activity transferred. There is no restriction on the use of the losses by the transferee.
The tax treatment of securities issued at a discount to third parties generally follows the accounting treatment. The discounted amount should be written off over the period until maturity. Under domestic legislation, interest paid to non-residents and settlement of the accrued discount are subject to 15 percent WHT, subject to potential tax treaty mitigation.
An acquisition often involves an element of deferred consideration, the amount of which can only be determined at a later date on the basis of the post-acquisition performance of the business. The right to receive an unknown/conditional future amount should not be recognized for either tax or accounting purposes, applying the prudence principle.
The characterization of payments, whether as purchase price adjustments or as other types of income, needs to be made on a case-by-case basis looking at both the legal and contractual characterization but also the substance of the arrangement.
Where receipt of an agreed upon amount is simply deferred without conditions, then where the seller is a corporation, the deferred amount is recognized as income at the time of the sale and typically subject to the same tax treatment as would be applicable if the payment had not been deferred. This does not however apply where the seller is an individual, since individuals generally are subject to tax only on a ‘receipts’ basis.
Both the substance-over-form rule and the abuse of law concept (following implementation of ATAD, the Czech Republic now has a codified General Anti Abuse Rule (GAAR)) need to be taken into account when structuring transactions. The tax authorities have the power to ignore the strict legal form and adjust the tax effects of any transaction based on these concepts.
Under the DAC 6 Mandatory Disclosure Rules, arrangements which possess certain ‘hallmarks’ generally perceived to be indicative of tax avoidance, will need to be disclosed to the Czech tax authorities. Any structuring arrangements need to be assessed from the point of view of whether they give rise to mandatory disclosure under this rule.
Concerns of the seller
As the Czech tax law provides for an exemption from the taxation of capital gains for many sellers, this is often a main area of concern.
Company law and accounting
The Czech company law provides for the following legal entities:
- general partnership (v.o.s.)
- limited partnership (k.s.)
- European company (SE)
- limited liability company (s.r.o.)
- joint stock company (a.s.).
The shareholders of an s.r.o. are liable for the unpaid liabilities of the company, up to the total amount of unpaid contributions to the registered capital. The shareholders of an a.s. or an SE (governed by Czech law) are not liable for the unpaid obligations of the company. The SE is administratively demanding to establish, so it is not often used.
A general partnership is a tax-transparent entity. A limited partnership is partly tax-transparent (for the income apportioned to the general partner). The main disadvantage of these two legal forms is the unlimited liability of the general partners.
The partners in a v.o.s. are liable for all unpaid liabilities of the partnership. In the case of a k.s., a general partner is fully liable for unpaid liabilities, while a limited partner is only liable up to the amount of unpaid contributions to capital.
Generally, the Czech accounting rules are governed by the Act on Accounting. Further detailed guidance is provided in the Decrees on Double-Entry Accounting and Czech National Accounting Standards. All businesses registered in the Czech Commercial Register are obliged to use double-entry bookkeeping.
The accounting period generally is defined as a period of 12 consecutive months. The accounting unit can either use a calendar year or specify a business year-end other than 31 December. Statutory financial statements consist of a balance sheet, a profit and loss account, and notes. Cash flow statements and statements of equity changes must also be prepared in certain cases (depending on the entity’s turnover, value of fixed assets and number of employees). The Act on Accounting states that certain business units are subject to mandatory statutory audits and must prepare separate annual reports. Additional filings may need to be made in the event of a reorganization.
There is no tax consolidation for Czech corporate tax purposes. Thus, the use of a highly leveraged Czech holding company to acquire a target is ineffective for tax purposes unless followed by a merger or a transformation of the target to a partnership.
Generally, prices between related parties should be set at arm’s length. The Czech ITA has a broad definition of ‘related parties.’ While it does not provide for mandatory transfer pricing documentation, guidelines have been issued that describe standards that the tax authorities expect to be followed. A taxpayer can ask the tax authorities for an advance tax ruling relating to the arm’s length price.
Taxpayers who fulfil specific conditions are required to make special disclosure of transactions with related parties, via an appendix to the annual corporate tax return. Separate disclosure of transactions by each separate related party is required. The tax authority is expected to use the information to determine the primary areas of focus for transfer pricing investigations.
The Czech Republic signed the Multilateral Agreement on Country-by-Country Reporting, which was initiated via the OECD BEPS project. The implementing legislation entered into force in 2017, and the country-by-country reporting obligation took effect in September 2017.
The Czech ITA defines a ‘resident company’ as one that has its seat in the Czech Republic or whose place of effective management is in the Czech Republic. The seat or effective management of a Czech company can be transferred outside the Czech Republic, which can result in a change of tax residency, depending on the relevant tax treaties. The tax implications of any such change of tax residency would need to be examined case-by-case. Following implementation of ATAD, the Czech Republic imposes an exit tax which applies in the event of transfers of assets from outside the net of the Czech taxing jurisdiction (for transfers to EU countries a tax deferral is possible).
Foreign investments of a local target company
Controlled Foreign Corporation rules have been introduced into Czech tax law with effect as of 1 April 2019 as a result of the implementation of ATAD. These rules result in certain incomes of low-taxed subsidiaries being attributed to the Czech parent.
Comparison of asset and share purchases
Advantages of asset purchases
- An asset deal can be structured as an acquisition of individual assets or an enterprise as a going concern.
- It is possible to acquire only part of a business.
- The purchase price, including goodwill, can be depreciated for tax purposes.
- Interest payable on borrowings is generally deductible.
- Except where an enterprise is purchased, liabilities are not inherited (even then, tax liabilities should be excluded), but in some cases, the buyer may be jointly liable for related debts where they knew or should have known about them.
- It is more straightforward to claim corporate tax and VAT deductions for deal-related costs.
Disadvantages of asset purchases
- Additional legal formalities apply in the areas of notification of suppliers, change of name and employment law (although on a purchase of an enterprise, employment contracts transfer automatically).
- Where only assets are purchased, the initial price is usually higher.
- Where the sellers are individuals, the existence of exemptions from tax for sales of companies makes this structure less attractive.
- Tax losses are not acquired.
- Complications may result from rules on the allocation of the purchase price on the purchase of an enterprise.
- Possible VAT clawbacks, if the transaction is VAT-exempt or if the business makes VAT-exempt supplies in the future.
Advantages of share purchases
- Attractive to sellers, especially if they are individuals or exempt from corporate tax on any gains.
- Possible to use historical tax losses, subject to restrictions.
- Contracts with suppliers, employees and others automatically transfer.
- No capital taxes.
Disadvantages of share purchases
- Typically no step-up in the cost base of assets is possible. However there may be exception to this in the case where the shareholding is acquired as part of a wider transaction consisting of the ‘purchase of a business’, where the relevant shareholding represented a component of that business. In such case it is possible in principle for the purchaser to record a goodwill-type amount consisting of a ‘valuation difference’, and such amount can in principle be amortized for tax purposes, but subject to fulfilment of the general criterion of being incurred in connection with generation of taxable revenue.]
- Interest deductibility may be restricted unless a merger follows the acquisition.
- Buyer inherits all undisclosed liabilities of the target company, including tax liabilities.
- It is typically not possible for the purchaser to claim full corporate tax and VAT deductions for deal-related costs (e.g. legal and advisory fees).
KPMG in Czech Republic
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This country document is updated as on
5 February 2021.