Doing business in the Czech Republic: What investors need to consider when entering the market

Industrial production has a long tradition in the Czech Republic as well as significant position – it accounts for more than one third of the Czech economy. The most important industries include mechanical engineering and especially the automotive and transport industry. In addition to the production of cars and trucks, led by Škoda, buses, trams and airplanes are also produced in the Czech Republic. Furthermore, the chemical, food, metallurgical and consumer industries form substantial part of Czech manufacturing. The fast-growing industry is construction.

Of interest is the exceptional position of nanotechnologies. The field is developing incredibly fast and encourages the creation of new scientific workplaces. The Czech Republic has been one of the world’s leaders of nanotechnology in industry and consumer goods for many years. The production of various nanofibers and nano fabrics is common, but also the use of nanotechnologies in nanooptics.

In recent years, information and communication technologies (ICT) have come to the forefront, as in many other countries. However, they are hampered by a shortage of qualified IT professionals.

Tourism is also an important sector of the Czech economy. The capital city of Prague has long been one of the most visited cities in Europe, and other tourist regions are also attractive. As a result of the coronavirus pandemic and related measures, the number of tourists visiting Czech Republic has dropped dramatically – as it has everywhere else in the world. However, tourists are returning and reviving this economic sector.

Within the industry department, the automotive industry is the most prevalent, it generates circa 9% of country’s GDP, 26% of Czech construction and 24% of Czech export. Within the services department accommodation, food and hospitality industries have traditionally been the most dominant. However, information & communication services as well as transportation & storage are quickly catching up. Overall, the services industry enjoyed year-over-year growth of 12,5% in 2021-22 (even after adjusting for seasonal effects).

The Czech Republic offers a wide range of investment incentives for various economy sectors.

All investment-incentive applications are assessed and approved by the government, which takes into account especially the benefits for the given region and the state. In practice, this means that all investment-incentive applicants must quantify their anticipated contributions to public budgets and their impact on the labour market in their applications. In addition to that, they must also describe the means by which they intend to incorporate research and development into their activities and to cooperate with research institutes and schools, and how they will utilise the potential of local suppliers and contribute to the development of the local infrastructure.

Corporate income tax

Corporate income tax (CIT) applies to the profits generated by all companies, including branches of foreign companies. Corporate partners in general partnerships (i.e., unlimited) and corporate general partners (i.e., unlimited) in a limited partnership are subject to CIT on their share of the profits in the partnership.

Czech resident companies are required to pay CIT on income derived from worldwide sources. Non-resident companies are required to pay CIT on income sourced in the Czech Republic.

• 19% is the CIT rate and applies to all business profits, including capital gains from the sale of shares (if not exempt under the participation exemption regime)
• 15% is a special CIT rate levied on dividend income of Czech tax resident entities from non-resident entities (unless subject to participation exemption)
• 5% reduced CIT rate applies to income of certain investment funds
• 0% CIT rate applies to pension funds

Tax residence

A company is resident in the Czech Republic for CIT purposes if it:

Permanent establishment (PE)

Under domestic law, the creation of a PE of a foreign tax resident in the Czech Republic is triggered by a fixed place available for carrying out business activities, long-term provision of services (for more than six months in any 12 consecutive months), or presence of a dependent agent, unless an applicable double taxation treaty (DTT) stipulates otherwise. For interpretation purposes, the commentary OECD Model Tax Convention is followed. The Czech Republic tends to have a ‘service PE’ clause (i.e., clause stipulating that a PE is created by provision of services on the territory of the Czech Republic even without the existence of a fixed place of business) included in its DTTs.

It is possible to request the tax authority for a legally binding ruling confirming a chosen method of determination of the CIT base of the PE.

Corporate income tax base determination

The accounting result as per the Czech accounting standards represents the base for corporate income tax base determination. Companies keeping books of accounts under the International Financial Reporting Standards (IFRS) are liable to recalculate the accounting result to follow the rules of the Czech accounting standards.

The accounting result is subsequently modified by tax non-deductible expenses and non-taxable revenues as specified by the income tax legislation.

General tax deductibility rule

Expenses may generally be treated as tax deductible provided that the following conditions are met:

• the expenses must be incurred to generate, assure and maintain the taxable income,
• the incurred expenses relate in nature and timing to the period,
• the taxpayer must be able to prove that a supply for which he incurred expenses was really provided to him,
• the taxpayer must be able to prove that a link exists between expense and income.

Tax losses

Tax losses determined for the tax period may be carried forward to offset tax profits for five immediately following taxable periods. The amount of the tax losses that may be carried forward is not limited. Starting from 2020 tax losses may be carried back for two immediately preceding tax periods. The maximum amount of the tax losses to be carried back is CZK 30 million.

Capital gains

No separate capital gain tax is applied in the Czech Republic. Revenues from sale of shares form part of regular corporate income tax base of the tax period in which the gain is realised (provided that the capital gain is not exempt from taxation under the participation exemption).

Dividend income

Dividends received by Czech tax resident corporations from non-resident entities are subject to a special tax rate of 15% (unless exempt from taxation under the participation exemption).

Dividends paid by Czech tax resident corporations to Czech resident entities are subject to 15% final withholding tax (or WHT, in short), unless exempt from taxation under the participation exemption.

Dividends paid by Czech tax resident corporations to Czech non-resident entities are subject to 15% final WHT, unless exempt under the participation exemption or unless the applicable WHT rate is reduced by the relevant DTT. An increased WHT rate of 35% applies to dividends paid to entities that are not tax residents in any EU or European Economic Area member state or in a country with which the Czech Republic concluded a DTT or agreement on exchange of information in tax area.

Participation exemption

Income generated from sale of shares or dividend income may be exempt from taxation in the Czech Republic provided that the following criteria are met:

• The parent entity (Czech or EU tax resident) holds at least 10% shares of the subsidiary for a minimum period of 12 months (this time test may also be fulfilled in the future period).
• The subsidiary is tax resident of the Czech Republic or other EU member state.
• The parent entity and the subsidiary are both of a specific legal from listed in the Annex to the Parent/Subsidiary Directive.
• Neither the parent or the subsidiary entity is exempt from corporate income tax or may vote for corporate income tax exemption.

Provided that the above conditions are fulfilled, withholding tax exemption on dividend income applies also to a situation when Czech subsidiary pays dividends to parent entity being tax resident in Switzerland, Norway, Liechtenstein or Iceland.

In case of dividends or capital gains received by a Czech parent company, the participation exemption may be applied in a situation when the subsidiary is a tax resident of a country which concluded a DTT with the Czech Republic, the subsidiary has a legal from similar to a limited liability/joint stock company, it is subject to a corporate income tax at the minimum nominal rate of 12% in the year in which the dividends are paid and in the preceding year, and the time test of holding at least 10% share for at least 12 consecutive calendar months in that subsidiary is met.

Interest and royalty income

Interest and royalties received by Czech tax residents are included in the standard tax base subject to the 19% CIT rate.

Czech-source interest and royalty income received by Czech tax non-residents is subject to 15% WHT, unless subject to tax exemption or reduced withholding tax rate applicable under the relevant DTT. An increased WHT rate of 35% applies to interest and royalties paid by Czech tax residents to entities that are not tax residents in any EU or EEA member state or in a country with which the Czech Republic concluded a DTT or agreement on exchange of information in tax area.

Arising based on the EU Interest and Royalty Directive which was incorporated into the domestic legislation interest and/or royalty income is exempt if it is paid by a Czech resident to an EU resident recipient who is a beneficial owner of the interest and/or royalty income, provided that for at least 24 months before the payment:

• the payer is in at least a 25% parent – subsidiary relationship or at least 25% direct sister relationship to the recipient of the income,
• the interest or the royalty is not attributable to a Czech permanent establishment of the recipient and
• the application of the withholding tax exemption was confirmed by a decision issued by Czech tax authorities.

VAT

VAT is generally charged at 21% on supplies of goods and services within the Czech Republic. Certain supplies (e.g., groceries, construction works related to social housing) are taxed at a rate of 15%, and a second reduced rate of 10% is applicable for specified categories of goods (e.g., books, newspapers, medicines, supply of heat and cold, catering services, soft drinks, clothing and shoe repairs, hotel accommodation, cultural and sport facilities).

VAT registration

Companies seated in the Czech Republic whose turnover exceeds 1 million CZK in any consecutive 12-month period are liable to register as a VAT payer.

For non-resident companies no registration threshold applies. These are, however, liable to VAT registration provided that they:

• carry out a supply that is subject to Czech VAT (unless the liability to declare and pay VAT is transferred to the recipient of the supply), or
• supply goods from the Czech Republic to another EU member state.

A company can register as a VAT payer voluntarily even if its turnover does not reach the threshold if it renders or is going to render taxable supplies or VAT exempt supplies with an entitlement for VAT refund in the Czech Republic.

Under certain circumstances, companies that are not VAT registered may become so called VAT identified persons provided that they acquire goods or services from EU or third countries. VAT identified person is liable to pay VAT from received supplies but is not entitled to VAT deduction.

VAT returns

VAT returns must be filed and VAT liability paid within 25 days from the end of the taxable period. The taxable period is a calendar month or a calendar quarter under specific circumstances. An essential and inseparable part of the VAT return is so called control statement through which the VAT payer provides that tax authority with specific information about all transactions carried out with business partners. Both the VAT return and the control statement must be filed with the tax authority electronically.

Other taxes

Entitlement to work

In the Czech Republic, the following natural persons are entitled to work:

• Czech nationals – they do not need any employment permission
• Foreigners – when fulfilling specific conditions to perform work in the Czech Republic

Foreigners from the EU, Switzerland and EEA and their family members do not need an employment permit

Foreigners from third countries (except some special categories of employees, such as holders of long-term residency permits, students etc.) need one of the following:

Taxes on personal income

Czech tax residents are generally subject to taxation of their worldwide income while Czech tax non-residents are taxed on their Czech-source income only.

According to the Czech tax legislation, an individual is considered a Czech tax resident, if he or she has a permanent place of residence in the Czech Republic in which he or she intends to stay permanently, and/or stays for 183 days or more in the Czech Republic continuously or intermittently in the calendar year. If the individual is considered a tax resident abroad as well, tie breakers stipulated in the respective avoiding double tax treaty apply.

For personal income tax purposes, the taxable period is set as the calendar year.

The basic tax return filing and tax liability payment deadline is 1 April of the year following the tax period. As of 2021, an automatic extension to 1 May is possible for taxpayers filing their tax returns electronically. The deadline of 1 July applies if a Czech registered tax advisor is empowered to file taxpayer’s personal income tax return.

Starting from 2021 the Czech Republic returned to progressive taxation. Gross income up to the social security cap (2022 threshold CZK 1,867,728) is subject to a 15% rate. Gross income (with the exception of foreign capital income) exceeding this threshold is subject to 23% rate.

The progressive tax rate is applicable to all types of income.

From 2013 to 2020 personal income tax rate of 15% applied on so-called super gross income.

Moreover, individuals with high income were subject to solidarity tax of 7% of the gross employment income and self-employment income (decreased by tax deductible expenses) exceeding the social security payment cap. The solidarity tax applied only to employment income and income from entrepreneurial activity. The abolishment of solidarity tax led to decrease of personal income tax burden for majority of individuals with employment income only.

Taxable income of an individual

All forms of compensation, whether in cash or in kind, are generally considered as taxable income (except for some tax-exempt benefits/income). According to the Czech tax legislation the following types of income are taxable here:

Remuneration of members of statutory bodies

Remuneration of managing directors and members of other statutories, who are not Czech tax residents, is subject to a withholding tax of:

• 15% for residents of the European Union, European Economic Area (EEA), or a DTT country (or a country with which the Czech Republic has an agreement on exchange of tax information in place).
• 35% for others.

Remuneration paid to managing directors and members of other statutory bodies who are Czech tax resident is taxed through payroll withholding.

Both tax resident and non-resident directors from EU member states and other countries from the European Economic Area may, however, file the personal income tax return through which they utilise their personal tax deduction(s).

Separate tax base

As of 2021 investment income (e.g., dividends and interest from abroad) of non-Czech source fall within a special tax base on which 15% tax rate applies.

Tax allowances or tax-deductible items are not applicable to reduce this tax base.

Social security and health insurance contributions

Social security contributions provide funding for three separate funds: pensions, unemployment benefits, and sickness (together with other benefits). Entrepreneurs can choose whether to contribute to the sickness fund.

Health insurance covers medical care. An individual can choose the health insurance company to which he will pay the health insurance contributions.

Social security and health insurance contributions are calculated from the individual’s gross remuneration (including most allowances and benefits).

The contribution rates for the employer are 24.8% for social security and 9% for health insurance. The contribution rates for the employee are 6.5% for social security and 4.5% for health insurance. The payments are done by the employer (for both employee and employer parts of contributions).

For self-employed personnel the social security contribution rate amounts to 29.2% from the assessment base (half of revenues decreased by expenses). The contributions to health insurance amount to 13.5% from the assessment base.

The maximum annual cap for the assessment base for calculation of contributions into the social security system is 48 times the average monthly wage per year (i.e., CZK 1,867,728 for 2022). This cap applies to both employees and entrepreneurs.