The Government of the Slovak Republic approved the Amendment to the Income Tax Act at the end of August. One of the planned changes valid from 2021 is the introduction of the so-called CFC (Controlled foreign corporation) rules for individuals to prevent the outflow of tax revenue abroad. This is another step to prevent tax fraud. Read all important information related to CFC rules for individuals in our latest eBook.
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CFC rules for owners of foreign letter-box companies
CFC rules mean an extension of the rules for controlled foreign companies even to natural persons, respectively the owners of companies who are trying to reduce or eliminate their tax obligations in Slovakia by shifting their income to tax havens. However, this situation will not be possible from January 1, 2021. The application of the CFC rules in Slovakia contributes to the taxation of the profits (dividends) from controlled foreign companies at the moment of their potential claim by natural persons and not when they are paid, as has been the case so far.
The controlled foreign companies will pay such forced dividends so the taxpayer (natural person) may subsequently set off the tax already collected from these assigned profit shares. However, the tax deduction will occur even when the controlled foreign company decides to reinvest the profit. The company´s previous losses are not considered.
Therefore, the tax rates applied to the allocated and not yet paid income will be the same as in the case of actually paid profit shares (dividends) – 7%, respectively 35%. The higher tax rate will apply to controlled foreign companies from non-cooperating countries. In the case of natural persons (tax residents of the Slovak republic), these incomes will be taxed through a special tax base. For the first time, the amount allocated to the allocable taxpayer will be taken from the economic result (profit or loss) of the controlled foreign company for the tax period ending during 2021.
How to calculate taxable income = special tax base?
The attributable amount is calculated from the positive economic result reported by the controlled foreign company, decreased by corporate income tax and demonstrably paid in the proportion that in the case of direct participation, the profit share would apply, if it would have been due. Or in a case of another income (revenue) due to actually exercised control over the company, unless there is no right to a share of the profit (dividend) and when paying the real share of the profit (dividend), the exemption method would not apply to this income in the case of double taxation treaties.
The same applies in the case of indirect participation or in the proportion of actual control, if the controlled foreign company does not have capital. The difference is in the so-called offset of the tax paid by the company abroad.
The income is allocated from the economic result of the controlled foreign company as reported abroad. It is not necessary to transform the income into an economic result according to the Slovak regulations. The economic result may similarly to §17 par. 1 of the Income Tax Act be based on double-entry bookkeeping, IFRS (International Financial Reporting Standards) or in the case of non-bookkeeping, e.g. from the difference between revenues and expenses.
It will be possible to extend the deadline for tax return filling by 6 months even if the natural person will tax her/his incomes according to the special tax base. The real control means the right to decide on the management of the company´s or entity´s assets and the income from these assets, as well.
What does „controlled foreign company“ mean?
By this term we mean a legal entity or another entity with a corporate seat abroad, if the following conditions are met:
- natural person alone or together with the dependent persons has a direct, indirect or indirect derived share in the capital, voting rights or has the right to share in the profit of at least 10%, or has real control over this company
- the controlled foreign company is a taxpayer of a non-cooperating state or is a non-taxpayer of a non-cooperating country, but the effective taxation of income is less than 10%
The effective taxation is calculated by the taxpayer as a share of demonstrably paid tax of the controlled foreign company and its economic result (profit or loss) is expressed as a percentage.
The CFC rules have three exemptions:
- a minimum threshold of EUR 100,000, at which the taxpayer does not have to apply the rule. However, if the attributable income exceeds this minimum threshold the full amount of income shall be included in the special tax base.
- they are primarily applied by a legal entity according to the 17h of the Income Tax Act. If the legal entity does not include the income of a controlled foreign company in the tax base in the relevant tax period, a natural person will apply the CFC rules by including the income attributable to the special tax base.
- The CFC rules exclude situation in which a controlled foreign company from an EU Member State or from a country, that is a contracting party to the EEA (European Economic Area) Agreement and the taxpayer can prove that this company actually carries on business activities in that country, while he/she can support the statement by the real existence of company premises, the employee´s activities, material equipment and so on.
If a natural person cannot obtain information on the economic result of the controlled foreign company, nor the amount of the tax paid within the extended deadline for filing a tax return of natural persons, then it will be based on the amount of the expected economic result and expected tax paid by this company
If a natural person subsequently finds out the data necessary for the correct taxation of income and he/she submits an additional tax return, the tax office will not apply the procedure under the Tax Code applied when filing the additional tax return.
The tax administrator shall proceed in the same way, even if the taxpayer submits additional tax return due to the fact the demonstrably paid tax has been adjusted in the controlled foreign company. If the tax administrator finds out that the taxpayer has not taxed the income under CFC rules, he will impose a fine in the amount of the tax difference levied on the taxpayer = 100% fine.
Pay attention to the credit of such taxes
It is important to consider whether it is direct, indirect or indirectly derived share.
- Direct participation – if a natural person has a direct participation in a controlled foreign company and the dividends from the relevant tax period are actually received from this company subsequently or if a share on business (participation) in the company is sold, then in these cases the taxpayer will be able to reduce the calculated tax by the tax paid under the CFC rules by individual companies. In the case when an entire direct share in the company is about to be sold and the income from the sale of this share would not be taxable in Slovakia, the amount of tax collected will be returned to the taxpayer.
- Indirect participation – a taxpayer who has an indirect participation in a controlled foreign company cannot receive dividends, respectively to sell a share in participation, to which he/she could apply a reduction of the already collected tax. In order to avoid double taxation, it is possible to reduce the calculated tax by the provably paid tax by the company abroad in the proportion attributable to the taxpayer when assigning the amount of the company´s income. However, this does not apply to non-cooperating countries.