During 2023, a number of advisory firms informed their clients of Russia's inclusion on the list of non-cooperative tax jurisdictions, which occurred on 14 February 2023 following a decision of the EU Council.
What are the implications of Russia's inclusion on the list for the tax returns of Czech companies for the tax period of the calendar year 2023 or the financial year ending after 14 February 2023?
If your company had a permanent establishment in Russia after 14 February 2023 or owned directly or indirectly more than 50% of a company resident in the Russian Federation, it is obliged to apply the so-called CFC rules (Controlled Foreign Corporation) in the tax return filed in the Czech Republic.
The CFC rules were implemented into Czech legislation in an effort to prevent the shifting of profits of Czech companies through transactions with capital-linked companies established in jurisdictions with tax rates lower than half the Czech Republic's. Such a jurisdiction is, for example, Hungary. However, companies incorporated in jurisdictions that have not fulfilled their commitment to address the harmful aspects of the special tax regime for international holding companies are also targeted for taxation. And the Russian Federation is one of these jurisdictions.
Under the CFC rules, the Czech company is obliged to include in its basis the income of the directly or indirectly controlled Russian company (or permanent establishment) arising from activities and disposal of property in Russia as if it were income of the Czech company arising from activities and property in the Czech Republic, in the proportion in which the Czech company held the interest in the Russian company in the period when such income was realised.
Subsequently, adjustments to the tax base should be made in the tax return, which are linked to the income of the Russian company, in accordance with the provisions of the Czech Income Tax Act.
The tax return has separate lines for the purpose of adjusting the tax base according to the CFC rules.
According to the current provisions of the Income Tax Act, the tax of the Czech company calculated from the tax base increased according to the CFC rules by the income of the Russian company can be reduced by the tax paid by the Russian company in Russia, while the amount of tax paid in Russia that can be used for the purposes of this reduction should respect the principles of the simple credit method and should not exceed the amount of tax calculated according to the Czech law attributable to the income of the Russian company.
Given the fact that the Russian tax rate (24%) having the character of the Czech income tax was higher in 2023 than the Czech nominal tax rate in that period (19%). It would seem that the inclusion of Russia on the list will only bring administrative problems. However, it should not result in double taxation of the Russian company's income. Provided, of course, that the tax paid in Russia is documented to the Czech tax authorities with the legally required confirmation.
In this context, however, it should not be forgotten that the right to avoid double taxation primarily derives from international treaties that have been concluded in the field of income taxes. If no treaty has been concluded, the question is whether Czech law alone is sufficient to invoke the right to avoid double taxation in connection with the application of the CFC rules, without requiring the existence of an implemented international treaty. It is not irrelevant that the Double Taxation Treaty with the Russian Federation ceased to be implemented in the scope of Articles 5 to 22 and Article 24 on the basis of a diplomatic note from the Ministry of Foreign Affairs of the Russian Federation.
The Ministry of Finance, in an attempt to clarify the implications of the diplomatic note, issued a communication published in the Financial Bulletin 10/2023, in which it informed the public of its legal opinion that the non-implementation of Articles 5 to 22 and Article 24 of the Treaty with the Russian Federation cannot result in a situation where, as of the date of the suspension of the implementation of the Articles in question, one Party to the Treaty would be obliged to exclude double taxation under Article 23 of the Treaty.
If you are not sure how to apply the CFC rules correctly, we will be happy to provide you with the necessary consultation.
What are the implications of Russia's inclusion on the list for the tax returns of Czech companies for the tax period of the calendar year 2023 or the financial year ending after 14 February 2023?
If your company had a permanent establishment in Russia after 14 February 2023 or owned directly or indirectly more than 50% of a company resident in the Russian Federation, it is obliged to apply the so-called CFC rules (Controlled Foreign Corporation) in the tax return filed in the Czech Republic.
The CFC rules were implemented into Czech legislation in an effort to prevent the shifting of profits of Czech companies through transactions with capital-linked companies established in jurisdictions with tax rates lower than half the Czech Republic's. Such a jurisdiction is, for example, Hungary. However, companies incorporated in jurisdictions that have not fulfilled their commitment to address the harmful aspects of the special tax regime for international holding companies are also targeted for taxation. And the Russian Federation is one of these jurisdictions.
Under the CFC rules, the Czech company is obliged to include in its basis the income of the directly or indirectly controlled Russian company (or permanent establishment) arising from activities and disposal of property in Russia as if it were income of the Czech company arising from activities and property in the Czech Republic, in the proportion in which the Czech company held the interest in the Russian company in the period when such income was realised.
Subsequently, adjustments to the tax base should be made in the tax return, which are linked to the income of the Russian company, in accordance with the provisions of the Czech Income Tax Act.
The tax return has separate lines for the purpose of adjusting the tax base according to the CFC rules.
According to the current provisions of the Income Tax Act, the tax of the Czech company calculated from the tax base increased according to the CFC rules by the income of the Russian company can be reduced by the tax paid by the Russian company in Russia, while the amount of tax paid in Russia that can be used for the purposes of this reduction should respect the principles of the simple credit method and should not exceed the amount of tax calculated according to the Czech law attributable to the income of the Russian company.
Given the fact that the Russian tax rate (24%) having the character of the Czech income tax was higher in 2023 than the Czech nominal tax rate in that period (19%). It would seem that the inclusion of Russia on the list will only bring administrative problems. However, it should not result in double taxation of the Russian company's income. Provided, of course, that the tax paid in Russia is documented to the Czech tax authorities with the legally required confirmation.
In this context, however, it should not be forgotten that the right to avoid double taxation primarily derives from international treaties that have been concluded in the field of income taxes. If no treaty has been concluded, the question is whether Czech law alone is sufficient to invoke the right to avoid double taxation in connection with the application of the CFC rules, without requiring the existence of an implemented international treaty. It is not irrelevant that the Double Taxation Treaty with the Russian Federation ceased to be implemented in the scope of Articles 5 to 22 and Article 24 on the basis of a diplomatic note from the Ministry of Foreign Affairs of the Russian Federation.
The Ministry of Finance, in an attempt to clarify the implications of the diplomatic note, issued a communication published in the Financial Bulletin 10/2023, in which it informed the public of its legal opinion that the non-implementation of Articles 5 to 22 and Article 24 of the Treaty with the Russian Federation cannot result in a situation where, as of the date of the suspension of the implementation of the Articles in question, one Party to the Treaty would be obliged to exclude double taxation under Article 23 of the Treaty.
If you are not sure how to apply the CFC rules correctly, we will be happy to provide you with the necessary consultation.