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TAX BREAKS HIGHLIGHT DIFFICULT POSITION FOR CABINET

Treading the EU's investment line

The incentives offered by the government to convince foreign investors to settle in Slovakia, including tax holidays and exemptions from environment laws, have drawn the ire of two groups - the European Union and domestic Slovak companies. The former worry that generous tax breaks could lure investors away from EU countries. The latter have complained they are being disadvantaged in a Pyrrhic war among central Europe's developing economies for foreign investment dollars.
The debate flared anew last month over a Slovak government promise to grant 10 year tax holidays to steel giant US Steel Košice.
If the Slovak government gives the green light to the American firm's request for a five year 100% tax break, followed by a five year 50% tax break, it may be found in violation of Slovak government-approved legislation on financial assistance provided by the state to private firms.


Keeping EC Commissioners, like these pictured above, happy by balancing local needs and EU legislation is a tricky job for Slovakia.
photo: TASR

The incentives offered by the government to convince foreign investors to settle in Slovakia, including tax holidays and exemptions from environment laws, have drawn the ire of two groups - the European Union and domestic Slovak companies. The former worry that generous tax breaks could lure investors away from EU countries. The latter have complained they are being disadvantaged in a Pyrrhic war among central Europe's developing economies for foreign investment dollars.

The debate flared anew last month over a Slovak government promise to grant 10 year tax holidays to steel giant US Steel Košice.

If the Slovak government gives the green light to the American firm's request for a five year 100% tax break, followed by a five year 50% tax break, it may be found in violation of Slovak government-approved legislation on financial assistance provided by the state to private firms. The state assistance rules, which EU candidate states like Slovakia must comply with before accession, should take effect August 1.

Passed last month by cabinet, the State Assistance Law says the state cannot provide tax relief for companies in the steel sector.

The problem is that the government appears to have made a tax holiday promise to US Steel Košice which is not in keeping with the State Assistance Law. Representatives of US Steel, one of the largest employers in Slovakia, say that after their $400 million acquisition of Slovak steel mill Východoslovenské železiarne (VSZ) last fall, they were assured by the Slovak government that there would be no problems with obtaining the tax holidays.

The new state assistance legislation, US Steel says, will not affect them as they intend to apply for tax holidays under separate existing tax laws.


The government says that it has given domestic investors the same opportunities on incentives as foreign giants like Volkswagen.
photo: TASR

"We intend to apply for the tax holidays under section 35 of the tax code, and we have committed to a number of things to comply with this," David Luptak, general counsel at US Steel Košice, told The Slovak Spectator June 6.

"As far as we're concerned, there is no question of us not getting the tax holidays."

EU concerns

The issue is a thorny one, as Slovakia is struggling to catch up with regional neighbours Poland, the Czech Republic and Hungary in a fight for foreign direct investment (FDI) that saw Slovakia left far behind in the 1990s amid concerns over its political stability and commitment to democracy.

The Mikuláš Dzurinda government, elected in 1998, has aggressively targeted FDI, introducing a variety of tax incentives to put the country on a par with regional neighbours. One of these packages, approved in 1999 and offering complete tax relief for five years and partial breaks for the next five, is at the centre of the European Union's potential beef with US Steel.

In US Steel's case, the tax breaks offered by the 1999 package are at loggerheads with a recent cabinet-approved amendment to the Law on State Assistance, which reads: "State assistance for the steel industry may [only] be provided for research and development, protection of the environment, payment of expenses related to partial or total and permanent stopping of steel production."

The law puts the same restraints on the automotive industry. Were tax holidays to be barred as a form of state assistance for both sectors, it could thus affect not only US Steel but also Slovakia's explosive automotive sector investor, German car maker Volkswagen. The latter is currently constructing a new plant as part of an automotive industrial park in Lozorno outside Bratislava.

It all depends on who interprets the law, and how. US Steel maintains that the tax breaks which it has applied for do not constitute state aid, but fall under the tax law. "We will apply for tax holidays under tax legislation that all foreign investors are entitled to, we just happen to be a steel company that is applying," explained Luptak.

The firm's stance is supported by many tax experts, who say that the legal definition of 'state assistance' is vague. One, who asked not to be named, said: "In some cases, the EU looks to protect its own industries, but in Slovakia, under existing legislation, any foreign investor that meets the criteria can qualify for these incentives. It's as simple as that."

The opinion of SARIO, the government's own investment agency, is unequivocal. SARIO head Alan Sitár gave primacy to the State Assistance Law: "All investment incentives must be in accordance with valid legislation on state assistance," he said when reached in Madrid June 6.

SARIO, however, is not dealing with US Steel's request for tax relief, a role it plays in the majority of investment cases.

The EU, for its part, views the steel and automotive sectors of its member states as particularly vulnerable, and fears that generous state assistance in the form of tax relief could attract potential investors away from its own markets.

As one senior diplomatic source in Bratislava said: "US Steel can't just expect the Slovak government to go around breaking EU regulations. The government knows what the rules are and what it should or shouldn't be doing."

The issue at stake, all agree, is extremely sensitive. Were the Slovak government to fulfil its tax incentive promises to US Steel without regard for EU concerns, it could damage what experts say are very solid relations between Brussels and Bratislava. Slovakia is hoping for EU membership in 2004, a target dependent on keeping the EU happy - including on issues such as tax holidays.

"This is certainly an issue that could become very politicised," said Vladimír Bilčík of the Slovak Foreign Policy Association.

The case for the defence

The possible conflict between Bratislava and Brussels has arisen after months of haggling over a recent package of even more investment-friendly incentives.

Cabinet last month approved a 100% tax break over 10 years for investors putting 400 million crowns ($8 million) into new or existing operations, or 200 million crowns into regions with an unemployment rate of 10% or more.

The 10 year holiday had been proposed by Deputy Prime Minister for the Economy Ivan Mikloš more than a year ago, but had been rejected by cabinet last fall over EU concerns that the breaks were too generous. Slovakia has since managed, through long negotiations, to persuade Brussels that the breaks would not lure vital investment away from the European Union.

But despite the agreement, the issue of tax incentives remains contentious, with local Slovak analysts arguing that regardless of the EU's stance on any individual investment, transition countries like Slovakia have no option but to use what tools they have to lure investors, both to bring fresh capital into the economy and to create jobs.

They say the key to making sure any clashes between EU and local legislation are smoothed out is preserving room for political manoeuvre on both sides.

"If the government has given its word on something like this [US Steel incentives] then it will have to keep it, and give US Steel these holidays. I don't know how they'll deal with it, but they'll reach some kind of compromise," said Marek Jakoby, an investment analyst with economic think tank MESA 10.

The government is understandably keen to accommodate US Steel. The firm employs more than 16,000 workers, and has attracted to eastern Slovakia, a region with 26% unemployment, Slovak-Luxembourg transport company Kralowetz, generating 250 new jobs over two years, and American high-pressure container producer Harsco, bringing another 180 new jobs. Both came on direct contracts with the American firm.

"We are committed to investing $700 million [in Slovakia]. The profit we'll get from the 10 year tax holiday is far less than this amount, according to our current calculations, and analyses of competitors around the world show that the employment we provide, on a regional basis, is fundamentally higher. For each $70 million of our investment, we have created almost 2,000 jobs indirectly," said US Steel Košice President John Goodish in an interview with the business paper Trend in late May.

While the government's investment representatives have been quiet on the American giant's request, sources in government believe a compromise solution for Brussels, Bratislava and US Steel can be found.

Indeed, the European Union has said itself on many occasions that there is room for negotiation whenever individual investments bring local laws into conflict with EU regulations. Moreover, the Union has not yet reacted to recently announced plans by both the Czech and Polish governments to support their steel industries in schemes involving billions of dollars as the sectors are privatised.

Overlooked

But possible conflicts wirh the EU aren't the the only opponents the Slovak government faces in its attempts to draw FDI. If one of Slovakia's largest investors and employers is seen to be granted special treatment in complying with EU legislation, it will only fuel complaints by domestic firms that not all investors, both domestic and foreign, face a level playing field.

"For whom are all these advantages fair? It's fine to give people exemptions on meeting environmental standards and giving them tax incentives, because Slovakia needs investment. But it's not wise to give a firm too many advantages in one go," said Karol Balog, head of the EU-funded Agency for Industrial Revitalisation and Development (AIDR).

Environmental exemptions for foreign investors are adding to the sense of grievance among domestic Slovak companies. As part of investment deals, three western companies - US Steel, Volkswagen and US electronics giant Motorola - reached an agreement with the government on who would finance clean-ups of pollution at their sites that had been caused prior to their investments.

An Environment Ministry working group looking at agreements signed in 1999 and 2000 on environmental contamination and foreign investors, said that the state was taking a different approach to foreign and domestic investors on this matter.

The conclusions of the group's research, as quoted from the minutes of a final meeting, state: "During the entry of foreign investors, the government took upon itself the responsibility for cleaning up past ecological damage, without regard for who had caused it (for example sites formerly owned by the Soviet Army, as well as Volkswagen Bratislava, Motorola Piešťany, VSŽ Košice). This is an unsystematic approach which, while just and beneficial for foreign investors, on the other hand creates unequal conditions for domestic investors, which therefore puts them at a disadvantage. The same conditions should apply to both foreign and domestic investors."

The government has also, until its most recent 10-year tax holidays, excluded domestic firms from tax incentives. Even now, the eligibility conditions for 10-year tax breaks make it virtually impossible for Slovak companies to participate: no private Slovak firm last year had the profits to finance a 250 million euro investment, and a credit crunch has left them with no chance to raise the money externally.

"What will happen when all these incentives for foreign firms cease in eight or ten years time? Will the companies cease with them? If you take them away, especially the ones on environment, then these firms will suddenly have to start making a whole set of heavy investments into meeting regulations, and they may just decide to up anchor and sail away to another country," said Balog.

The government has also been suspected of giving preferential treatment to investors by covering debts for promissory notes issued in the past by privatised state companies. Fixed-line telecom monopoly Slovenské Telekomunikácie (ST), sold to Deutsche Telekom last year for one billion euros, and soon-to-be privatised gas distributor Slovenský plynárenský priemysel (SPP), have both run into problems over disputed promissory notes worth billions of crowns.

While the ST sale contract is confidential, and Deutsche will not say whether the government pledged to cover any promissory note claims against the company, there are expectations that such protection may be written into an eventual agreement on SPP, which is to be sold later this year.

However, legal experts say that the practice of indemnifying against potential liabilities in state sell-offs is standard in many countries. "Generally, all state sales have such guarantees written into them. I would expect the government to have something similar when it comes to SPP," said Marek Staroň of the legal firm White & Case.

Government aware

The government has rejected claims that it is favouring foreign firms over domestic enterprises, but admitted that its focus is very much on foreign firms.

SARIO's Alan Sitár, speaking to The Slovak Spectator before cabinet's approval of the latest set of investment incentives, said: "We want to attract and support new investment into Slovakia, inflows of capital. This measure is not intended to support existing investments," he said.

Peter Benčúrik, spokesman for the Economy Ministry, added June 5, however, that the government had heeded the concerns of Slovak companies over the availability of incentives.

"This is exactly why our new set of incentives was designed to give Slovak and foreign firms an equal chance. And we have also set out strict criteria for everyone to qualify for incentives so that there is a clear process for every investment and who gets granted what," the spokesman explained.

He also rejected suggestions that any foreign investor would be granted preferential treatment in any way on tax breaks. "Everybody is treated on an equal level," he said.

The Finance Ministry failed to respond to Slovak Spectator enquiries on what promises the government had given to US Steel on tax holidays. However, Jozef Mach, a spokesman for the Ministry said: "If US Steel fulfills all criteria for the tax breaks when they apply for them, they will receive them."

The State Aid Office, financed by the Finance Ministry, said, though, that it had received no information on a request for a tax holiday from US Steel.

However, Vladimír Tvaroška, an advisor to Deputy Prime Minister for the Economy Ivan Mikloš, struck a more definite note. "I am sure the government will fulfil any obligations it has concerning agreements with US Steel," he said.

In the meantime, US Steel remains convinced that it can get the tax breaks it wants, and moreover, that it has fulfilled its part of an agreement with the government to ensure it received the holidays.

"We're not going to concede the point that these tax holidays are state aid," said Luptak. "We are sure that we can have these tax breaks."

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