Will major Croatian tax reform boost investments and reduce outflow of workers?
May 2017 | EXPERT BRIEFING | CORPORATE TAX
On 1 January 2017, Croatia introduced a comprehensive tax reform affecting a number of tax and social contribution related laws. Most of the laws have entered into force but there have been exceptions, such as real estate tax, which will follow in 2018. As announced by lawmakers, the main goal of such a large and comprehensive tax reform is to achieve economic growth, increase employment, strengthen the competitiveness of the Croatian economy, encourage demographic renewal and keep highly educated people in Croatia.
Yet, the question remains: what is the decisive motive behind such a dramatic change of tax rules? The answer may be sought in the expensive, overstaffed and ineffective state administration, unstable tax regime and demographic decline. For years, Croatia has faced an unfavourable tax regime, with frequent and endless changes of the rules making the country an unattractive and uncertain destination for foreign investment in comparison with its neighbours. In addition, high tax rates discouraged public consumption and a further absence of economic growth in the private sector caused a great number of young and educated people to flee Croatia in search of a better future.
According to statistical assessments, in 2016, more than 80,000 people left Croatia to seek new business opportunities. With such a negative population trend, and without any incentive measures aiming at improving quality of life, rough assessments indicate a decreasing Croatian population. As such, the long-expected tax reform is a necessity.
The package of adopted tax reform-related laws – comprising the Personal Income Tax Act, Corporate Profit Tax Act, Value Added Tax Act, Real Estate Transfer Tax Act, Contributions Act, Local Taxes Act, Motor Vehicles Special Tax Act, Tax Advising Act, General Tax Act, Fiscalisation Act, Administrative Fees Act, Excises Act, Customs Office Act, Tax Administration Act and Administrative Cooperation in the Area of Taxes Act – is expected to result in higher salaries for most workers and a reduction of the tax burden on businesses.
The general impression is that although the reform is aimed at decreasing the tax burden for all taxpayers, it focuses on supporting start-ups and encouraging entrepreneurship. Thus, in the area of corporate profit tax, the general tax rate has been decreased from 20 to 18 percent, and with regard to agricultural producers, craftsmen and small businesses with annual revenues less than HRK3m (€400,000), it is further discounted to 12 percent.
So-called ‘small taxpayers’ with an annual income lower than HRK3m may elect to pay the corporate profit tax based on cash flow. Reduced corporate profit tax rates apply to the calculation of corporate profit tax prepayments for 2017, on the basis of 2016 corporate profit tax returns.
In addition, new provisions have been introduced regarding advance pricing arrangements with the tax authorities in respect of planned related party transactions, based on which transfer prices will be agreed for a predetermined period of time. One of the novelties within the field of corporate profit tax concerns the tax deductibility of interest on loans between related parties, where the interest rate can be determined either by applying one of the transfer pricing methods or the interest rate published by the minister of finance.
Aimed at helping the over-indebted and, at the same time, enabling banks to limit their tax exposure, the tax reform redefines certain conditions for writing off receivables by credit institutions. As a one-off measure for credit institutions during 2017, write-offs of partly recoverable and fully irrecoverable receivables (as of 31 December 2015) will be tax deductible.
In the area of personal income tax, the goal was to remove the high tax burden on salaries which was negatively impacting the competitiveness of highly educated employees. One of the most significant reforms is the substitution of the previous progressive tax rates of 12, 25 and 40 percent with 24 and 36 percent rates, where the 24 percent applies to a monthly tax base up to HRK17,500 (€2300) and the 36 percent applies to the base above this amount.
Furthermore, the 24 percent tax rate instead of 25 percent applies to other income, income from property rights, income from alienation of real estate and property rights and capital income from the allocation of own shares or purchased call options of own shares. The tax rate of 36 percent instead of 40 percent applies to capital income from withdrawals of assets and the use of services by shareholders and other income from refunded contributions.
The 36 percent tax rate instead of 40 percent also applies to other income, determined as the difference between the value of an asset and the proven amount of funds spent to acquire it. The tax rate of 12 percent applying to insurance income, rental income and capital income from interest, capital gains, dividends and shares in profits has remained the same.
The basic personal allowance which decreases the tax base has been increased from HRK2600 to HRK3800.The Personal Income Tax Act also introduces new fiscal terms: annual income and final income. The annual income is the entire income from employment, independent activity and other income, except income that is considered final and is determined through the annual tax return. The tax rate for annual income is 24 percent for the annual tax base up to HRK210,000 and 36 percent for the base exceeding that threshold. The final income is considered to be income derived from property and property related rights, capital and insurance and shall be, depending on the source, taxable at the rates of 12, 24 and 36 percent.
In the area of value added tax, paying regard to social stability the government decided to retain a 5 percent VAT rate for bread, milk, medicine and orthopedic equipment. Yet, the proposed VAT reform has caused a great deal of public debate and upset the owners of cafes, bars and restaurants, as the VAT for their services has been raised from 13 percent to a standard VAT rate of 25 percent.
Other changes worth noting are the reduction of the real estate transfer tax rate from 5 to 4 percent (applied since 1 January 2017) and the introduction of a real estate tax which is to come into force on 1 January 2018 (the details of which remain unknown). A significant change has also been made in respect of tax administrative procedures, in which a relative statute of limitation period of three years has been abolished and a unique statute of limitation period of six years has been introduced.
Hrvoje Vidan is a partner and founder of the Vidan Law Office. He can be contacted on +385 1 48 54 070 or by email: firstname.lastname@example.org.
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