Note: This article was written in 2003. Since business changes fast in Slovakia, the information contained in it might be out of date. Please review newer articles or contact a professional consultant before making business decisions.

These articles were published in the Spectacular Slovakia travel guide, published annually by The Slovak Spectator since 1996. The latest editions can be obtained from our online shop.

The end of Slovak tax holidays?

By Ton Verbraeken

 Courtesy: KPMG

Slovakia was a relative latecomer in the CEE region in introducing comprehensive tax holiday legislation as a way of attracting foreign investors to the country. From 1999, in various forms, tax holidays and tax incentives have been available and since then foreign direct investment (FDI) has increased significantly. Of course it is difficult to say to what extent tax incentives played a role in the increase. Other issues such as low labour costs, a good infrastructure and political stability have been of very great significance for the inflow of FDI.

There are several different types of Slovak tax incentives available but the ones used by most companies in our experience (under Sections 35 and 35A of the Income Tax Act) have a number of key advantages; particularly that they were granted automatically if qualifying conditions were met and were based on key qualifying criteria (including the type of business) rather than ongoing investment. The take up of these tax incentives has been steadily increasing although numbers are difficult to quantify. However in some respects this tax relief legislation has proved very restrictive. The conditions were often hard to meet for existing companies, especially if they had generated profits in the past. In addition there were many anti-avoidance provisions which could trap unwary investors. Small and medium sized enterprises complained as the application of tax relief required high cash injections to the registered capital.

As part of its EU Accession negotiations Slovakia had to implement EU State Aid rules as a result of which legislation was introduced "capping" incentives at limits set at an EU level based on the amount and type of investment, type of industry and gross domestic product of the area in which the investment is made. Foreign investors therefore had to take account of the amount of investments made in calculating their entitlement to tax relief. Slovak companies, both those already applying for incentives and those who intended to do so in future had to discuss their entitlement with the State Aid Office.

Although EU Accession places limits on tax holidays it does not abolish them. It may therefore seem somewhat surprising that the current draft of the new Income Tax Act under the tax reform plan envisages that these tax incentives will cease to be available for companies established after 31 December 2003. Existing qualifying companies will continue to be entitled to claim tax holidays after that date.

If this cancellation does occur, will it have a negative impact on the inflow of FDI in Slovakia? Presumably the expectation is that the effect will be limited due to the fact that a lower tax rate and simplified tax system together with other non tax factors will compensate for the abolition and so foreign investors will continue to come to Slovakia. From a competitive perspective other EU entrant countries have or will have to amend their tax incentive legislation to comply with EU law and even the later wave of entrants (potentially Romania, Bulgaria and Croatia) will only have a limited period to offer high tax incentives before they too must comply with EU limits.

Overall it does appear likely that tax incentives in the form we have known them in the past few years will be phased out and that future investors will need to base their investment decisions on other factors.

The author is a Senior Tax Manager at KPMG Slovakia specializing in tax incentives and state aid.

These articles and related information were published in Spectacular Slovakia 2003.

Make your comment to the article...