Tax and Legal News - February 2025

The Pillar pathologies of incentives

We can argue about it, we can disagree, but the reality seems to be that without various forms of tax incentives and credits, the medium-sized Czech economy would not be competitive. In the Czech Republic, there is an ongoing professional and political debate about the form, scope and objectives of incentives and the extent to which externalities prevail. All this is taking place amid relatively low unemployment and low GDP growth, while, at the same time, there is a trend of shifting low-added-value activities elsewhere and factory closures in our country.

The new OECD/EU tax legislation known as Pillar 2 BEPS 2.0, which the Czech Republic has adopted with effect from 2024, has entered the decision matrix of whether or not to have incentives, and if so, in what form. It forces large multinational groups to make complex calculations about the effective taxation of their companies' profits on a jurisdictional basis. If the effective taxation is low, a top-up tax is applied, bringing taxation of the so-called excess profits (profits after taking into account substantive parameters – employees and tangible assets) to 15%. Complex rules, lots of exceptions, a gradual ramp-up, transitional provisions, safe harbours and dangerous waters full of complexities – all in one law.

One of the more complicated issues is tax credits, or if you prefer in the Czech Republic, investment incentives, subsidies and various tax deductions. Although one would expect that if a company receives an incentive, uses it and complies with its rules, no one can take it away. Wrong, they can. Pillar 2 divides the credits into 2 groups. The correct ones are called qualified refundable tax credits, which are paid to businesses within 4 years. These are then treated as income in the effective tax calculation and do not have as much impact on the effective tax.

Czech investment incentives and R&D deductions do not belong to this group. This means that even if the investment incentives reduce the corporate tax to zero, any excess profits are subject to 15% and the amount is paid to the state. And the incentive is over, at least in part. It may not even help anymore if the investment incentive was granted in the past and the company booked a deferred tax asset (which increases the effective tax rate when "used").

Last month, the OECD issued new administrative guidance on Pillar 2. One guidance focuses specifically on the treatment of deferred tax assets arising after 30 November 2021 from government agreements or elections relating to tax treatment with retroactive effects. The guidance says that the tax expense resulting from the "use" of such deferred tax assets should generally be excluded from the covered taxes for purposes of applying the Pillar 2 rules and from the simplified covered taxes for purposes of applying the CbCR safe harbour transition rules. The guidance at least introduces an exception to this general rule in the form of a two-year grace period during which a limited amount of this tax expense may be included for both purposes in certain circumstances. The question is whether this administrative guidance will also apply to Czech investment incentives.

However, neighbouring countries are already seizing the opportunity and adjusting the rules to get the Pillar 2 tax credits right. Hungary and Austria already have them, Poland is working on it. In our country, there seems to be silence. This will give these neighbouring countries a comparative advantage over us.

Isn't now a good time to look at the whole package of incentives and subsidies and consider its strategic, long-term set-up? A simple comparison with neighbouring countries shows our current range of investment incentives and subsidies to be unattractive and inadequate.