Czech law contains a variety of special provisions applying to mergers and acquisitions (M&A) in areas such as company law, competition, environmental protection, accounting and tax.
Czech law contains a variety of special provisions applying to mergers and acquisitions (M&A) in areas such as company law, competition, environmental protection, accounting and tax.
In general, an acquisition can be structured as a purchase of either a legal entity or assets
(possibly the entire business). Depending on the requirements of the buyer, it may be appropriate to form a Czech legal entity to make the acquisition. Further reorganizations may be necessary after the acquisition to help maximize tax deductions.
The form chosen for an acquisition generally determines its tax consequences, although the tax authorities have the power to question the form where they believe the substance is different or there is an abuse of law.
The Czech Republic is a signatory to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting. As a member state of the European Union (EU), the country is also committed to implementing various measures contained in the EU Anti-Tax Avoidance Directives (ATAD). These developments need to be understood and taken into account when making decision about the tax and legal structuring of M&A transactions in the Czech Republic
There are two basic acquisition methods — asset deal and share deal.
Purchase of assets
The main tax effect of an asset deal is that the buyer has full tax basis in the assets acquired and the seller is subject to tax on any gain.
An asset deal may take one of two forms:
The main difference is that, in a purchase of an enterprise, the buyer takes over all the assets and liabilities of the seller, both disclosed and undisclosed. It is generally considered that tax liabilities do not transfer on a sale.
For the seller who realizes a gain, it is of little significance whether the sale is of assets or of an enterprise. In both cases, the gain is taxable at 19 percent and 15 percent (personal income tax). However, where the assets are sold individually, losses on the sale of some assets (e.g. receivables) are not
The buyer and the seller can apportion the price between individual assets, and the tax authorities are unlikely to question this apportionment as long as the buyer and seller are not related.
In the case of a purchase of an enterprise, it is possible to carry out a valuation of the assets acquired that usually is accepted for the tax purposes of the buyer. Any part of the purchase price not attributed to the individual assets in the valuation is treated as goodwill, which can be depreciated for tax purposes over 15 years (5–10 years for accounting purposes). When no valuation is carried out, any difference between the price and the book value of the assets is classified as a valuation difference, which is depreciated for both tax and accounting purposes over 15 years.
No goodwill or valuation differences can arise on a purchase of individual assets. In this case, the whole purchase price is allocated between the individual assets.
The accounting and tax rules on goodwill also apply to negative goodwill, which arises where the price is lower than the value of the assets. Negative goodwill is treated as taxable income recognized over 15 years.
Generally, the buyer re-starts tax depreciation of the acquired assets (i.e. does not continue the depreciation policies of the seller) often it acquires assets pursuant to a sale of assets or a sale of an enterprise.The buyer starts depreciating the new depreciation base, which is generally the purchase price plus related acquisition costs.
Tax losses carried forward cannot be transferred in the case of an asset acquisition; they remain with the seller.Tax liabilities also remain with the seller.
Value added tax
The Czech Republic levies valued added tax (VAT) at rates of 10, 15 and 21 percent. Most goods and services are subject to the standard rate of 21 percent. A sale of assets is usually a taxable supply for VAT purposes, although some item are exempt from VAT or outside its scope (in which case a VAT clawback from input VAT previously claimed on the sold assets might arise).
The sale of an enterprise is not a supply for VAT purposes; the seller remains entitled to a credit for any related input VAT.
Where a transaction involves the transfer of the whole or part of an enterprise, the buyer may have to repay input VAT claimed by the original owner on the purchase of fixed assets if the assets are used for VAT-exempt supplies in the future.The period during which such VAT may be clawed back is 10 years for real estate (including improvements) and 5 years for other assets.
The tax authorities do not recognize goodwill for VAT purposes. Where there is goodwill on a sale of assets subject to VAT (i.e. not an exempt sale of an enterprise), the goodwill element must be attributed to the other assets transferred and VAT is imposed according to the classification of the individual assets.
There are no stamp or capital duties in the Czech Republic.
The only transfer tax that may apply on an acquisition is the tax on the acquisition of immovable property (formerly real estate transfer tax), currently levied at 4 percent of the tax base.
The tax base is the higher of the agreed price and the reference value.The tax authorities calculate the reference value based on prices for similar transactions. If the tax authorities cannot determine a reference value, the tax base is the higher of the
agreed price and 75 percent of the value assessed by an expert. If real estate is transferred as part of an enterprise, the tax base is based on an expert valuation.
The tax is payable by the buyer.
Purchase of shares
In a share deal, there is no step-up for the buyer or the target in relation to any premium over the accounting/tax value of the target’s assets.The buyer inherits undisclosed liabilities, including the tax liabilities of the target company.
The tax treatment of the sale depends on the status of the seller. In the case of a corporation, any gain on the sale of share investments generally is subject to corporate income tax of 19 percent as normal income unless the participation exemption applies. However, gains on the sale of shares
in a Czech subsidiary (10 percent holding for at least 12 months) are tax-exempt for corporate sellers resident in the Czech Republic, the EU, Iceland, Norway and, as of 2016, Liechtenstein.
The exemption cannot be applied if the parent company or the subsidiary:
The exemption also applies to sales of some non-Czech subsidiaries. For the exemption to apply, a minimum of 10 percent of the share capital of the company whose
shares are sold should be held for at least 12 months, and this company must be tax-resident in either the EU or a country with which the Czech Republic has concluded a tax
treaty and that has a corporate tax rate of at least 12 percent. Losses on disposal are not deductible, except in the case of shares in a joint stock company (a.s.) or European company (SE) held for trading purposes.
In the case of an individual who has not treated the shares as a business asset, a gain on the sale of shares in a
joint stock company or SE acquired before 31 December 2013 is tax-exempt where the securities have been held for more than 6 months and do not represent more than 5 percent of registered capital and voting rights for 24
months preceding the sale. Gains on the sale of securities acquired before 31 December 2013 representing more than 5 percent of registered capital and voting rights and any securities acquired from 1 January 2014 are exempt if held for 3 years. If the required holding period is not fulfilled, the gain is taxable at a rate of 15 percent.
No tax is payable where the taxable sales of securities do not exceed 100,000 Czech crowns (CZK) in a tax year.
A gain on the sale of an interest in a limited liability company (s.r.o.) is exempt from tax if it has been held for more than 5 years.
Where the buyer is a Czech tax-resident and the seller is not based in the EU or European Economic Area (EEA), the buyer is required to withhold a so-called ‘security tax’ as an advance against tax payable unless treaty protection is available. The rates are 1 percent for income from the sale of ‘investment instruments’ as defined by the Czech law
and 10 percent for income from the sale of an interest in an
s.r.o. The sale of shares in an a.s. and s.r.o. is exempt from VAT with no right to deduct input VAT.
Tax indemnities and warranties
In a share acquisition, the buyer takes over the target company and, indirectly, all of its related liabilities, including tax
liabilities.Therefore, the buyer normally needs more extensive indemnities and warranties than in the case of an asset acquisition, where tax liabilities do not transfer.
Tax losses may be carried forward for 5 years.The tax law prevents the use of tax losses where there is a substantial change in the persons directly participating in the company’s equity or management and less than 80 percent of the company’s income in the year in which the loss is to be used is derived from the same activities as in the year when the loss arose. A change in the ownership of more than 25 percent of the registered capital or voting rights is always a substantial change. A taxpayer can apply to the authorities to confirm the availability of the carried forward losses after the end of the taxable period in which the losses are to be used.
Crystallization of tax charges
There are usually no exit charges on leaving the group.The main exceptions are:
Pre-sale dividends are rare in practice. If there is a qualifying corporate shareholding, both dividends and capital gains are exempt (i.e. the tax treatment does not differ). If the dividends are paid to an individual, there is no exemption from taxation; the dividends are always taxable while the gain can be exempt. Therefore, dividends are not usually tax-efficient.
There are no stamp or capital duties in the Czech Republic. Administration fees are payable on certain services rendered by various government bodies.
Most transactions and reliefs are not subject to tax clearances. Some formalities need to be fulfilled for corporate reorganizations.
In a share deal, the seller is usually required to provide confirmation from the tax authorities that there are no tax arrears, although this does not preclude additional tax being assessed in the future.
A taxpayer can ask the tax authorities for a tax ruling relating to certain issues in advance (e.g. use of tax losses, transfer pricing).There is no general ruling system.
Several potential acquisition vehicles are available to a foreign buyer, and tax factors often influence the choice.There is
no capital duty on the introduction of new capital to a Czech company, including a Czech-registered SE or branch.
Local holding company
A Czech holding company is usually used as an acquisition vehicle where the buyer wishes to ensure that the taxable profits of the Czech target company can be offset against tax-deductible interest expenses from an acquisition loan. Under a typical structure, the company that makes the acquisition subsequently merges with the target so that the taxable income of the target and the expenses related to the acquisition are within one entity. Interest on acquisition loans is generally non-deductible. However, where the target company merges with the buyer within 1 year, there may be a case to treat the interest expenses as tax-deductible. Care must be taken in implementing such structures, since they recently have attracted attention of the tax authorities. In certain circumstances, courts have rejected tax deductions for acquisition-related borrowings.
The legal forms most commonly used are limited liability companies and joint stock companies because only these two legal forms allow the exemption from taxation of profit distributions under the EU Parent-Subsidiary Directive.They also give limited liability to the shareholders. An SE could also function as an acquisition vehicle but is more administratively burdensome.
Foreign parent company
The foreign buyer might choose to acquire the Czech target company itself because it wishes to offset the interest on an acquisition loan against its own profits, which is possible in certain tax jurisdictions. As noted earlier, cross-border mergers of Czech companies are allowed but are more administratively demanding than mergers of two Czech companies.
Non-resident intermediate holding company
Non-resident intermediate holding companies have historically been used as a tax-efficient means of making inward investment where a relevant tax treaty provided more favorable tax treatment for capital gains or dividends. International developments, such as the Organisation for Economic Co-operation and Development’s (OECD) base erosion and profit shifting (BEPS) project, mean that closer attention will be paid to the substance of such holding company structures.
Under some circumstances, a foreign parent company may structure its investments through a Czech branch. Czech commercial law requires a branch to be registered where the foreign parent company systematically carries on business in the Czech Republic and has no local subsidiary.
Generally, the tax status of a Czech branch does not differ from the tax status of a local company (i.e. same rules for the tax base calculation, same tax rate). However, there are some differences. For example, the distribution of profit by a Czech branch is not regarded as a dividend.There is no branch profits tax.
A joint venture can be either corporate (with the joint venture partners holding shares in a Czech company) or unincorporated (usually a partnership), which is (at least partially) tax- transparent.
A buyer using a Czech entity to carry out an acquisition can finance the acquisition vehicle with debt, equity or a combination of both.
The principal advantage of financing an acquisition with debt is the potential interest deductibility, as opposed to the payment of dividends that are not tax-deductible. Any related expenses (e.g. loan arrangement fees) are usually deductible. Moreover, debt financing has the advantage of avoiding a dilution of equity.
Therefore, the costs of debt financing are lower than the costs of equity. It is important to choose an acquisition vehicle that allows the offsetting of interest expenses against taxable income.
According to the Czech tax law, interest on loans taken out less than 6 months before the acquisition of a subsidiary is generally non-deductible (see later in the report).The tax-deductibility of interest on loans provided by a related party can also be limited by the Czech thin capitalization and transfer pricing rules.
Deductibility of interest
Expenses paid or payable for the purpose of earning taxable income are generally tax-deductible.Therefore, interest on acquisition financing should be deductible subject to transfer pricing and thin capitalization considerations.
This general rule is subject to some exceptions:
A merger of the target with the holding company can mitigate the last two of these concerns. Alternatively, it is possible to convert the target into a tax-transparent entity, so that the buyer’s interest expense becomes deductible against its share of the profits of the target’s business. Care must be taken in implementing such structures, since the tax-deductibility of acquisition loan interest may be vulnerable to challenge in some circumstances.
The Czech thin capitalization provisions restrict the deductibility of interest where the borrower has insufficient equity. Financial expenses arising from loans and credits received from related parties in excess of four times (six times for banks and insurance companies) the borrower’s equity
are not tax-deductible. Interest on loans and credits received from unrelated parties, or those secured by a related party, is fully deductible on general principles, except for interest on back-to-back loans (i.e. where a related party provides a loan, credit or a deposit to an unrelated party, which then provides the funds to the borrower), which is treated as interest on related-party debt.
Notwithstanding these provisions, financial expenses that directly relate to taxable income (e.g. interest income) can be deducted up to the amount of that income.
In addition, the forthcoming change in the taxation of interest expense caused by the application of ATAD should be noted.
The directive provides, among others, for limitation of deductibility of borrowing costs (which includes interest, finance lease payments, capitalized interest or its amortization, hedging arrangements relating to borrowings, and certain foreign exchange losses).The limitation applies for both internal and external borrowing costs.
Based on the ATAD, the deduction of borrowing costs (less borrowing income) is generally limited to 30 percent of earnings before interest, taxes, depreciation and amortization or EUR 3 million.The rules allow flexibility and exemptions on transposition, and they include de minimis thresholds, escape clauses and a grandfathering provision. EU member states must implement the main provisions of the directive in their national legislation (by 31 December 2018), with effect as of 1 January 2019. It is not yet clear how the Czech Republic will implement the rules.
Withholding tax on debt and methods to reduce or eliminate this tax
The Czech Republic levies WHT of 15 or 35 percent on interest payable to non-resident lenders, which is often reduced by a tax treaty to zero. Interest paid to certain associated EU resident companies is free of WHT under the EU Interest and Royalties Directive, provided the recipient is the beneficial owner of the interest and the tax authorities confirm the entitlement to the exemption.
The 35 percent rate applies where the interest is paid to residents of countries that have no tax treaty with the Czech Republic or arrangement with the country for the exchange of information on tax matters.
The Czech tax law allows interest to be re-classified as a dividend where it is non-deductible due to a breach of the transfer pricing or thin capitalization rules.This can have adverse WHT consequences.This reclassification does not apply to EU or EEA lenders.
Interest paid by a Czech-resident company to a Czech-resident lender is not subject to WHT.
Checklist for debt funding
The following factors should be taken into account when debt funding is being considered:
A buyer can use equity to fund the acquisition rather than debt. The main way to increase equity is by issuing new shares.
The main disadvantage of equity financing is dilution of the shareholders’ ownership (in the case of an increase of equity made disproportionately to the voting rights of each
shareholder) and the non-tax-deductibility of dividends. Equity financing generally is considered less preferable than debt financing.
However, in certain situations, equity financing might be preferable, such as where:
Tax-free corporate reorganizations
There are no comprehensive tax rules on corporate reorganizations.The rules enacted under the EU Merger Directive and Directive on Cross-border Mergers is intended to allow reorganizations to take place on a tax-neutral basis.The tax authorities have the power to challenge the intended tax effects of a transaction on the basis that the substance of the transaction is other than the form but this is rare in practice.
Typical transactions are described below.
Contribution in kind
The IncomeTax Act (ITA), section 30(10) requires the recipient of a contribution in kind to the capital of a company to continue the tax depreciation policies of the person making the contribution. On a cross-border contribution to a Czech company, the recipient must continue the tax depreciation of the contributed assets based on the original purchase price
of the contributed asset calculated in CZK on the date of contribution and using the Czech tax rules.Tax depreciation on the contributed assets can only be claimed up to the difference between the original purchase price and the tax depreciation already claimed by the contributor. Except where the EU Merger Directive applies (Section 23a, ITA), the tax law is
silent on the treatment of the person making the contribution; however, according to the accounting rules, the contributor does not realize a gain in such a case but records the shares received at the net book value of the asset contributed.
Section 23a of the ITA does not refer to contributions of assets.
The section refers only to a contribution of an enterprise or part of an enterprise as defined for the purposes of the Civil Code (i.e. an activity that can be operated as a separate business, as required by the Merger Directive, and including all liabilities, both disclosed and undisclosed) involving Czech and/ or EU-resident companies (but excluding both types of Czech partnership).
The law states explicitly that the person making the contribution does not realize a taxable gain and permits the transfer of reserves and tax losses. Further, the law provides that the person receiving shares in exchange for a qualifying contribution should record these shares at market value for tax purposes.This does not apply where the contributor transfers the shares within 1 year. Moreover, tax attributes cannot be transferred where the main or one of the reasons for the contribution is to reduce or avoid the tax liability.
A contribution of assets that does not qualify as an enterprise is regarded as taxable supply for VAT purposes where the contributor claimed an input VAT deduction when the assets were purchased.The contributor and buyer are jointly liable for the VAT.The contribution of some asset classes can be exempt from VAT (e.g. real estate) where certain conditions are met.
A contribution of an enterprise or part of an enterprise is not a taxable supply for VAT purposes. Nevertheless, a company that receives an enterprise or part of an enterprise may be obliged to repay input VAT claimed originally by the contributor, where the fixed assets are later used for VAT-exempt supplies.The general clawback period is 5 years, extended to 10 years for buildings.
Until 31 December 2013, contributions of real estate to the registered capital of a company were exempt from real estate transfer tax where the contributor retained an interest in
the recipient for 5 years.The exemption was cancelled for contributions from 1 January 2014.
There are no stamp or capital duties.
In a merger, the predecessor company ceases to exist without going into liquidation and all its assets and liabilities pass to
the successor.There are no detailed tax rules on mergers except for cases dealt with by Section 23c of the ITA (which implements the EU Merger Directive). In general, a merger
is tax-neutral.The transfer of fixed assets is at the tax residual value, and any goodwill arising cannot be depreciated for tax purposes.
For qualifying mergers:
The companies concerned have to be resident in the Czech Republic or another EU Member State. Based on the EU Directive on Cross-Border Mergers, it is possible to merge a Czech company with any company registered in an EU member state.
For accounting and income tax purposes (but not legally or for VAT purposes), it is possible for the effective date of a merger to be up to 12 months earlier than the date on which the application for registration of the merger is filed with the commercial court.
There is no real estate transfer tax, VAT or stamp/capital duty on a merger. Nevertheless, the successor may be obliged to repay input VAT claimed originally by the predecessor, where the
fixed assets acquired are later used for VAT-exempt supplies. The general clawback period is 5 years, extended to 10 years for buildings.
In a demerger, the predecessor company ceases to exist and its assets are transferred to two or more newly incorporated successor companies, which issue shares to the shareholders of the predecessor. Again, the ITA is generally silent on the effects except for the provisions implementing the EU Merger Directive legislation (Section 23c ITA).The same rules apply
as in the case of a merger (with the necessary changes), namely, tax-neutrality with regard to transfers of assets, no tax deduction for the depreciation of goodwill, transfer of tax losses and possible transfer of reserves and provisions by agreement.
Where the fixed assets are later used for VAT-exempt supplies, the successors may be obliged to repay input VAT originally claimed by the predecessor. The general clawback period is 5 years, extended to 10 years for buildings.
A spin-off is an alternative to a demerger.The demerged company does not cease to exist, but the spin-off part is transferred to an existing or newly incorporated company. The spin-off is tax-neutral.The transfer of tax provisions, tax reserves and tax losses to the successor is possible to the extent that the transaction can be commercially justified.
There is no real estate transfer tax, VAT or stamp/capital duty. Again, the successor may be obliged to repay input VAT claimed originally by the demerged company, where the fixed assets are later used for VAT-exempt supplies.
Tax losses and reorganizations
When losses are transferred on a merger, demerger or spin- off, they can only be used against the profits derived from the activity that generated them. Similarly, any losses of
the surviving company can be used only against the profits generated by the same activity. Where an activity is transferred through a contribution of an enterprise, the losses transferred can only be used against the profits of the activity transferred. There is no restriction on the use of the losses by the transferee.
A buyer can combine both debt and equity to achieve the desired debt-to-equity ratio.
Generally, the Czech law does not deal with hybrid instruments, and the tax treatment tends to follow the legal form (subject
to the substance-over-form rule). Anti-hybrid rules must be introduced into the Czech tax law as of 1 January 2020 to implement the ATAD. How the rules will be implemented in the Czech Republic is not yet clear.
The tax treatment of securities issued at a discount to third parties generally follows the accounting treatment. The discounted amount should be written-off over the period until maturity. Under domestic legislation, interest paid to non-residents and the accrued discount are each subject to 15 percent WHT, subject to reductions under a tax treaty or the EU Interest and Royalties Directive.
An acquisition often involves an element of deferred consideration, the amount of which can only be determined at a later date on the basis of the post-acquisition performance of
the business.The right to receive an unknown/conditional future amount should not be recognized for either tax or accounting purposes, applying the prudence principle. Where receipt of
an agreed amount is simply deferred without conditions, it is recognized as taxable income at the time of the sale.
Both the substance-over-form rule and the abuse of law concept need to be taken into account when structuring transactions.The tax authorities have the power to ignore the strict legal form and adjust the tax effects of any transaction based on these concepts.The abuse of law doctrine applies where a person exercises their rights to the detriment of others or society in general.The Czech courts cannot be expected to provide legal protection to such an exercise of rights that is, at the same time, an abuse of those concepts.
Concerns of the seller
As the Czech tax law provides for an exemption from the taxation of capital gains for many sellers, this is usually the main area of concern.
Company law and accounting
The Czech company law provides for the following legal entities:
The shareholders of an s.r.o. are liable for the unpaid liabilities of the company, up to the total amount of unpaid contributions to the registered capital.The shareholders of an a.s. or an SE (governed by Czech law) are not liable for the unpaid obligations of the company.The SE is administratively demanding to establish, so it is not often used.
A general partnership is a tax-transparent entity. A limited partnership is partly tax-transparent (for the income apportioned to the general partner).The main disadvantage of these two legal forms is the unlimited liability of the general partners.
The partners in a v.o.s. are liable for all unpaid liabilities of the partnership. In the case of a k.s., a general partner is fully liable for unpaid liabilities, while a limited partner is only liable up to the amount of unpaid contributions to capital.
Generally, the Czech accounting rules are governed by the Act on Accounting. Further detailed guidance is provided in the Decrees on Double-Entry Accounting and Czech National Accounting Standards. All businesses registered in the Czech Commercial Register are obliged to use double-entry bookkeeping.
The accounting period generally is defined as a period of 12 consecutive months.The accounting unit can either use a calendar year or specify a business year-end other than 31 December. Statutory financial statements consist of a
balance sheet, a profit and loss account and notes. Cash flow statements and statements of equity changes must also be prepared in certain cases (depending on the entity’s turnover, value of fixed assets and number of employees). The Act on Accounting states that certain business units are subject to mandatory statutory audits and must prepare separate annual reports. Additional filings may need to be made in the event of a reorganization.
There is no tax consolidation for Czech corporate tax purposes. Thus, the use of a highly leveraged Czech holding company to acquire a target is ineffective for tax purposes unless followed by a merger or a transformation of the target to a partnership.
Generally, prices between related parties should be set at arm’s length.The Czech ITA has a broad definition of ‘related parties’. While it does not provide for mandatory transfer pricing documentation, guidelines have been issued that describe standards that the tax authorities expect to be followed. A taxpayer can ask the tax authorities for an advance tax ruling relating to the arm’s length price.
Taxpayers who fulfill specific conditions are required to make special disclosure of transactions with related parties, via
an appendix to the annual corporate tax return. Separate disclosure of transactions by each separate related party is required.The tax authority is expected to use the information to determine the primary areas of focus for transfer pricing investigations.
The Czech Republic signed the Multilateral Agreement on Country-by-Country Reporting, which was initiated via the OECD BEPS project.The implementing legislation entered into force in 2017, and the country-by-country reporting obligation took effect in September 2017.
The Czech ITA defines a ‘resident company’ as one that has its seat in the Czech Republic or whose place of effective management is in the Czech Republic.The seat or effective management of a Czech company can be transferred outside the Czech Republic, which can result in a change of tax residency, depending on the relevant tax treaties.The tax
implications of any such change of tax residency would need to be examined case-by-case.
Foreign investments of a local target company
There is no controlled foreign company (CFC) legislation in the Czech Republic. As noted earlier, Czech tax law contains a substance-over-form rule and an abuse of law concept that may need to be considered when implementing international financial structures.
CFC rules should be introduced into the Czech tax law with effect as of 1 January 2019 as a result of the implementation of ATAD. How the rules will be implemented in the Czech Republic is not yet clear.
Advantages of asset purchases
Disadvantages of asset purchases
Advantages of share purchases
Disadvantages of share purchases
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