This report addresses the three fundamental decisions facing a prospective buyer in..
This report addresses the three fundamental decisions facing a prospective buyer in Croatia:
Tax is, of course, only one piece of the transaction structuring puzzle. Company law governs the legal form of a transaction. Accounting issues are also highly relevant when selecting the optimal structure. These areas are outside the scope of this report, but some key points that arise when planning the steps in a transaction are summarized later in this report.
Three recent developments impacting M&A are discussed in detail later in this chapter:
The usual form of an acquisition in Croatia is the purchase of shares of a Croatian company rather than its assets. The purchase of assets is a less attractive option for a foreign seller of shares because capital gains on sales of assets of a Croatian company are taxable and there is a risk of double taxation on remittance of the sales proceeds.
Where the seller of the shares of a company is a Croatian tax non-resident or a Croatian tax resident individual, any capital gains may be exempt from taxation in Croatia. However, the acquisition of assets has certain advantages for the buyer. Both forms of acquisition are discussed below.
Purchase of assets
In the case of a purchase of assets, the agreed value is usually above book value and the buyer may use this increased cost base for capital gains tax and depreciation purposes. Historical tax liabilities generally remain with the seller and are not transferred with the purchased assets.
It is necessary to apportion the total consideration among the assets acquired. A purchase agreement should be concluded to specify the allocation, which is usually accepted for tax purposes provided it is commercially justifiable.
Generally, goodwill that arises in acquisitions is subject to annual impairment testing for accounting purposes. Any impairment of goodwill cannot be deducted for tax purposes under Croatian legislation.
For tax purposes, fixed assets are depreciated using the straight-line method of depreciation, using annual depreciation rates as follows:
A taxpayer may elect to double these depreciation rates, in which case, the depreciation period is halved. Generally, no justification is required to apply double depreciation rates. However, if a taxpayer applies ‘normal’ depreciation rates and then decides to change its depreciation policy and apply double depreciation rates, the tax authorities might request an explanation for the change. The depreciation charge prescribed by the Corporate Profit Tax (CPT) Law can be claimed for tax purposes only where the same amounts were booked in the taxpayer’s income statement.
Tax losses are not transferred to the buyer on an asset acquisition. They remain with the seller or are eliminated. Where the buyer wishes to acquire the seller company’s trade along with its tax losses, a business activity may be transferred to a new company (typically through simultaneous demerger and merger) and the new company can then be sold to the buyer. However, transferred tax losses are only available to the buyer (i.e. merged company) where the activity test is satisfied as detailed in this report’s section on tax losses.
Value added tax
Value added tax (VAT) is charged on most goods and services at the standard 25 percent rate.The transfer of shares is not subject to VAT. The transfer of assets is generally subject to VAT at the rate of 25 percent. Reduced rates of 13 percent and 5 percent apply to certain goods and services.The transfer of shares is not subject to VAT.The transfer of assets is generally subject to VAT at the rate of 25 percent. The transfer of a business as a going concern is not subject to VAT, provided certain conditions are met.To benefit from this exemption, the aim of the transfer must be to put the new owner in possession of a business unit. Therefore, the sale of a portion of assets cannot be classified as a transfer of a business unit: all assets and liabilities related to the business unit need to be transferred.
The transfer of land (except for construction sites), buildings and the land on which buildings stand are exempt from VAT. The exemption does not apply to a sale by a VAT-registered taxpayer before first occupation or if less than 2 years elapsed between the date of first occupation and the date of sale.
There are no stamp duty or stamp duty land tax requirements in Croatia.
Croatia levies transfer tax at the rate of 4 percent on transfers of real estate that is not considered to be ‘new’ which includes real estate in use for longer than 2 years.
In certain cases the parties may opt to have the transfer of such real estate taxed with VAT rather than transfer tax in cases where (if the buyer is VAT-registered and intends to use the real estate for making VAT able supplies), with the view to eliminating the tax cost of supplies of real estate for business purposes.
In certain cases, the transfer of real estate as a contribution in kind to the share capital of a company eliminates transfer taxes and VAT.
As of 1 January 2018, the special 5 percent tax on the transfer of used personal motor vehicles and motorcycles was replaced by an administrative duty, payable based on the age of the vehicle and engine power (ranging from 1 to 50 Croatian Kuna (HRK) per kilowatt for personal motor vehicles and from HRK0.1 to 3 per cubic centimeter for motorcycles).
Purchase of shares
The purchase of shares as a form of acquisition does not result in an increased cost base of the underlying assets.
Tax indemnities and warranties
On a purchase of shares, the buyer takes over not only the company’s assets but also its liabilities, including contingent liabilities. Thus, the buyer usually requires more extensive indemnities and warranties than in the case of an asset purchase. Where significant amounts are involved, the buyer customarily conducts a due diligence exercise, including a review of the target company’s tax affairs.
Tax losses may be carried forward for a maximum of 5 years. Earlier losses are set off before later ones. Croatia has no loss carryback or tax grouping provisions.
The utilization of tax losses is restricted in the case of a corporate restructuring (activity test). A legal successor does not assume the right to carry forward the tax losses of a legal predecessor where either:
Where the legal successor utilizes the tax losses and subsequently loses the rights for reasons mentioned above, the legal successor is obliged to increase its taxable base in the period in which the right to carry forward tax losses expired.
These provisions on the utilization of tax losses and increase of taxable base of a taxpayer also apply where there is a change in the taxpayer’s ownership structure of more than 50 percent compared to the ownership structure at the beginning of a tax period.
It is possible for the seller to realize part of the consideration through a pre-sale dividend payment.The proceeds from the sale of shares are decreased as a result of the payment of the pre-sale dividend. Since dividend payments are currently not subject to taxation for Croatian corporate shareholders, a pre- sale dividend payment reduces tax liabilities on the gain on the sale of the shares that may arise for a Croatian corporate seller.
It is possible to apply for binding tax opinions.
An advisory body for binding tax opinions (appointed by the director of the tax authorities) has the authority to issue binding tax opinions on the tax treatment of future and planned transactions, business events and activities. Such opinions are binding on the tax authorities. Generally, the deadline for the issuance of a binding tax opinion is 60 days (90 days for more complicated opinions and longer periods in exceptional cases). The cost of obtaining a binding tax opinion for companies ranges from HRK5,000 to 30,000, depending on company income (income from HRK3 to 150 million). The cost of obtaining a binding opinion for individuals amounts to HRK5,000.
Areas of application for binding tax opinions are as follows:
The tax authorities’ previous practice was to issue opinions on a taxpayer’s request. Such opinions were not binding for the tax authorities or the taxpayer. Although it is still possible to apply for such non-binding opinions, with the introduction of the binding opinion concept, an additional level of certainty is available to taxpayers.
Further, in the course of tax inspections, prior to issuance of minutes of inspection, the tax authorities and the taxpayer can conclude a settlement for tax liabilities identified during the course of a tax inspection. One of the conditions required for entering into a settlement is that the taxpayer accepts the tax liabilities identified and waives the right to use legal remedies. If a settlement is concluded, penalty interest can be reduced by up to 100 percent (although it is not possible to reduce potential fines).
There are several acquisition vehicles the buyer may choose, depending on the specifics of the acquisition.There is no capital duty on the introduction of new capital to a Croatian company.
Local holding company
Buyers do not prefer local holding companies as it may be difficult to offset the target’s taxable profits with interest payments on funds borrowed by the Croatian holding company to purchase the target company. The reason is that, in the absence of tax-grouping provisions, the deduction for interest payments on borrowed funds generally can be achieved only through a subsequent merger of the Croatian holding company and the target company. Further analysis of the accounting and taxation implications of the merger is required to determine whether this is feasible.
Where the funds to purchase the target company are obtained cross-border, interest payments may be subject to certain limitations discussed in the sections on deductibility of interest and withholding tax (WHT) on debt below.
Foreign parent company
Where a foreign parent company wishes to offset the cost of financing the purchase of the target company against its own taxable profits, the target company may be purchased through the foreign parent company. WHT of 12 percent applies to dividends paid by a Croatian company to foreign companies. The WHT rate may be decreased or eliminated under one of Croatia’s tax treaties.
In addition, dividends paid to European Union (EU) resident companies or qualifying Swiss companies are exempt from Croatian WHT, provided certain conditions are met (see ‘Equity’ later in this chapter).
Non-resident intermediate holding company
The buyer may opt for a non-resident intermediary holding company as an acquisition vehicle where the foreign parent’s country of residence taxes capital gains and/or dividends received from foreign companies. This structure potentially allows the buyer to take advantage of a more favorable tax treaty than the treaty its country of residence has concluded with Croatia.
Interposing a Croatian branch between the buyer and the target would not achieve additional tax advantages because a branch is treated as a regular taxpayer for Croatian tax purposes. However, the head office of any branch office may be able to claim any tax losses, especially financing costs. This would need to be considered case-by-case.
It is possible to establish a partnership or contractual joint venture in Croatia. In either case, a local company or branch office must be established.
A buyer that decides to pay for acquisition of a Croatian target via a Croatian company as the acquisition vehicle needs to decide whether to structure the acquisition as an asset purchase or share purchase and whether to obtain financing using debt or equity.
The principal advantage of debt is the potential tax- deductibility of interest (see this chapter’s section on deductibility of interest), as the payment of a dividend does not give rise to a tax deduction. Another potential advantage of debt is the deductibility of expenses, such as guarantee fees and bank fees, in computing profits for tax purposes.
To minimize the tax cost of debt, there must be sufficient taxable profits in the company borrowing the funds to offset interest expenses. Dividend income received by a Croatian company is not taxable, and there are no tax-grouping provisions. Therefore, the acquisition of a Croatian target company by a Croatian acquisition vehicle with financing costs but no taxable income is tax-inefficient.
Deductibility of interest
Croatian CPT law prescribes certain limitations on the tax- deductibility of expenses. Generally, in order to be deductible for CPT purposes, expenses need to be incurred with the purpose of generating income (i.e. profits). In addition, the deductibility of interest is subject to two specific limitations.
The first limitation arises from the thin capitalization rules that apply to non-resident shareholders that are not financial institutions. Interest on loans provided by direct non-resident shareholders with at least 25 percent of the shares or voting rights is not deductible for CPT purposes on the amount of the loan that exceeds four times the amount of the capital held by that shareholder. The thin capitalization rules also apply to loans guaranteed by a direct non-resident shareholder and to loans received from related parties.
The second limitation is that interest paid on loans provided by either resident related parties that are in a tax favorable or tax loss position or by non-resident related parties is CPT- deductible, up to the interest rate prescribed by the Minister of Finance. If no interest rate is prescribed, the Croatian National Bank’s discount rate is used.The interest rate prescribed by the Minister of Finance for Croatian CPT purposes on loans between related parties in 2018 is 4.55 percent per year.
In addition, as of 1 January 2017, instead of using the interest rate prescribed by the Minister of Finance, the interest rate in transactions with related parties can be determined by applying one of the transfer pricing methods. If one of these methods is applied, it must be consistently applied to all loans.
Parties are related where one of the parties directly or indirectly participates in the management, supervision or capital of the other, or where the same legal persons (one of which is a resident Croatian company and the other is a non-resident company) participate in the management, supervision or capital of another company.
Withholding tax on interest and methods to reduce or eliminate it
Interest payments made by Croatian-resident entities to any Croatian non-resident entities (whether or not related) are subject to Croatian WHT at the rate of 15 percent at the time of payment.
Exceptions are available for loans provided by foreign banks and financial institutions and interest paid on qualifying bonds issued by Croatian entities.
Further, where the foreign entity providing the loan is in a jurisdiction with which Croatia has a tax treaty and that foreign entity is the beneficial owner of the interest, the tax treaty may reduce or eliminate the WHT liability. To take advantage of a reduced rate, the prescribed form needs to be submitted to the tax authorities. To eliminate the WHT, the Croatian company needs to possess either a statement that the receiving entity is a tax resident of the treaty country or the prescribed form.
In addition, interest paid to EU-resident companies or qualifying Swiss companies is exempt from Croatian WHT where a minimum direct 25 percent shareholding exists between both companies or where a third company owns directly at least 25 percent of both companies, provided that the participation is held for an uninterrupted period of at least 2 years and certain other conditions are met.
Checklist for debt funding
Croatia does not have any capital duty, and neither stamp duty nor stamp duty reserve tax applies to new share issues. Dividends payable to Croatian resident companies are not treated as taxable income for Croatian resident companies for Croatian tax purposes.
Dividend payments made by Croatian-resident companies to Croatian non-resident entities (whether or not related) are subject to Croatian WHT at the rate of 12 percent at the time of payment. Where the foreign entity shareholder resides in a jurisdiction with which Croatia has a tax treaty and that foreign entity is the beneficial owner of the dividend, the tax treaty may reduce or eliminate the WHT. To take advantage of a reduced rate, a prescribed form needs to be submitted to the tax authorities. If WHT is eliminated, the Croatian company needs to possess either a statement that the receiving entity is a tax-resident of the treaty country or the prescribed form.
In addition, dividends paid to EU resident companies or qualifying Swiss companies are exempt from Croatian WHT where the shareholder owns at least 10 percent (for Swiss shareholders, at least 25 percent) of the payer’s shares, the shares have been held continuously for at least 2 years, and certain other conditions are met.
Although equity offers less flexibility should the parent subsequently wish to recover the funds it has injected, equity may be more appropriate than debt in certain circumstances. For example:
Mergers and demergers
Mergers and demergers should have no influence on taxation if continuity in taxation exists. Continuity in taxation is deemed to exist where, on merger or demerger, there is no change in the value of items of assets and liabilities that are being transferred. In addition, on a merger, the activity test must be satisfied in order to utilize tax losses (see ‘Tax losses’ above).
In addition, EU Merger Directive is implemented in Croatian CPT Law. The EU Merger Directive enables mergers and divisions covered by the provisions of the EU Merger Directive to be effected in a tax-neutral way, that is, gains realized upon mergers and divisions are not taxable and losses are not deductible, the increased value of the transferred assets cannot be depreciated for tax purposes and tax losses can be transferred and utilized. In order for the EU Merger Directive to apply, certain conditions need to be satisfied and the application of the EU Merger Directive needs to be reported to the tax authorities.
Hybrid instruments could be used to achieve an interest deduction for the borrower without any income tax for the lender. To date, however, there is little experience in this area in Croatia and potential benefits may be limited, especially in light of recent BEPS developments.
The issue of bonds and other securities may be an effective way for a Croatian company to raise finance.
The right of the seller to receive an unknown future amount is regarded as an asset that could be taxable in the same way as unrealized gains are taxable in Croatia.
Concerns of the seller
The tax position of the seller can be expected to significantly influence any transaction. In certain circumstances, the seller may prefer to realize part of the value of their investment, for example, where the seller has brought forward tax losses.
Croatia does not tax gains of non-residents that are not subject to CPT in Croatia, provided the non-resident does not have a permanent establishment in Croatia. A Croatian tax resident individual may also not be subject to personal income tax.
Companies law and accounting
Croatian companies law prescribes how Croatian companies may be formed, operated, reorganized and dissolved. The accounting law prescribes that International Financial Reporting Standards (IFRS) should be followed by large entities, listed companies or companies that are in the process of being listed. Croatian Financial Reporting Standards (CFRS) should be followed by micro, small and medium-sized entities. Nevertheless, a subsidiary company that would generally be obliged to use CFRS may use IFRS instead if its parent company uses IFRS.
The companies law and accounting standards determine the accounting treatment of a business combination. In general, most combinations are accounted for as acquisitions, with merger accounting only being applied in limited circumstances. Merger accounting is not allowed under IFRS; all business combinations must be accounted for as acquisitions. The relevant Croatian accounting standards and companies law restrict merger accounting to (and make it obligatory for) a very small number of genuine mergers and group reorganizations not involving minority interests.
One of the main practical distinctions between acquisition accounting and merger accounting is that acquisition accounting may give rise to goodwill. Under IFRS, goodwill is tested annually for impairment; under CFRS, goodwill is amortized over a period of 5 years. Impairment of goodwill arising from M&As is not tax-deductible, while amortization of goodwill is tax-deductible.
Another important feature of Croatian companies law concerns the ability to pay dividends. Distributions of profit may be made only out of a company’s distributable reserves. Regardless of whether acquisition or merger accounting is adopted in the group accounts, the ability to distribute the pre- acquisition profits of the acquired company may be restricted.
Group tax relief/tax consolidation
Current Croatian tax law does not provide for group tax relief/ tax consolidation.
Where intercompany transactions arise post-acquisition between the buyer and the target, failure to charge an arm’s length price for services or goods provided may cause the Croatian tax authorities to challenge the transactions.
Foreign investments of a local target company Current Croatian law does not include controlled foreign company provisions.
Advantages of asset purchases
Disadvantages of asset purchases
Advantages of share purchases
Disadvantages of share purchases
KPMG Croatia d.o.o. za reviziju
Ivana Lucˇ ic´ a 2a, Seventeenth Floor
T: + 385 1 5390 000