Ministry of Finance Discussion Paper on the Implementation of the Anti-Tax Avoidance Directive
Council Directive (EU) 2016/1164 laying down rules against tax avoidance practices that directly affect the functioning of the internal market (Anti-Tax Avoidance Directive, ATAD) was adopted in July 2016.
The Directive should be implemented by 31 December 2018, with the exception of the exit tax, for which the deadline is one year longer.
To this end, the Czech Ministry of Finance has recently published papers for public consultation.
The reason for the consultation is that certain provisions of the Directive offer several implementation options.
It is the aim of the Ministry to choose an option which will “ensure protection of the financial interests of the Czech Republic, will be administrable and will not unreasonably burden taxpayers”.
A significant amendment to the Income Tax Act will be adopted as part of the implementation of the Directive. Thus it is worthwhile becoming acquainted, in general terms, with its expected wording.
Deductibility of interest and similar costs
The interest limitation rule is the most important provision of the Anti-Tax Avoidance Directive whilst also involving the most options.
Interest and similar costs, whether from related or unrelated parties, will be tax deductible only up to a limit of 30 % of gross operating earnings (earnings before interest, taxes, depreciation and amortization, EBITDA).
According to the Directive, the above rule need not be applied to interest up to EUR 3 million. The Ministry suggests reducing this limit to EUR 1 million.
Furthermore, the Ministry suggests that interest expense unrecognized in one tax period can be carried forward to following periods.
On the other hand, the Ministry does not plan to adopt the retrospective transfer of interest expense and unused EBITDA capacity proposed by the Directive, arguing that the retrospective transfer of tax losses is impossible.
Furthermore, the Ministry plans that limitations to the deductibility of interest shall not apply to financial institutions and entities outside a group. As a result of the implementation of the new rule limiting the deductibility of interest, the existing thin capitalisation rule contained in the Income Tax Act should be abolished.
As regards transitional provisions, the Ministry does not plan to introduce the Directive’s permitted exception for loan agreements concluded before 17 June 2016.
Apart from the limitation on the deductibility of interest, ATAD focuses on four additional areas.
First, the exit tax should be introduced. The difference between the market and tax value of transferred assets shall serve as the exit tax base.
Another measure is the taxation of controlled foreign companies, or “CFC rules”. The taxpayer will be obliged to include in its tax base passive income or income from the artificial transactions of a con trolled foreign company if its tax burden is lower than half of the tax the company would pay if it were resident in the Member State of the taxpayer.
The Directive also introduces hybrid mismatch arrangements. Individual tax systems contain different rules applying to the legal qualification of entities and financial instruments. Various hybrid structures use such mismatches between tax systems in order to obtain tax advantages. Examples include a different view of whether an entity is not fiscally transparent and is thus the taxpayer or whether it is fiscally transparent and the shareholders are the taxpayers.
Last but not least, the Directive contains the general anti-abuse rule (GAAR).
The Ministry of Finance expects the general anti-abuse rule not to be expressly incorporated into the Income Tax Act or any other legislation since the Czech legal order already implicitly contains this rule, for example as part of the case-law on the abuse of rights.
The other rules, i.e. the exit tax, CFC rules and hybrid mismatch arrangements, should be implemented to the extent proposed by the Directive.