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NEW AMENDMENT DOESN'T LOWER BARRIERS FOR RECEIVING TAX EXEMPTION ENOUGH

Tax incentives fail to inspire investors

After the wretched failure of an April, 1999 tax incentive package to lure foreign investors to Slovakia, a new and ostensibly more attractive draft went into effect January 1. Less than two weeks later, however, foreign analysts had begun to voice their disappointment in the new legislation as well, which they said still made it too difficult for companies to qualify for a tax holiday.
The critics' main concerns have been that the minimum required capital investment was too high, that a rule regarding goods not made in Slovakia was too vague, and that the foreign to domestic capital ratio for joint ventures was not attractive. The Finance Ministry, meanwhile, has admitted shortcomings in the new draft, but has said that more generous terms might endanger budget revenues.

After the wretched failure of an April, 1999 tax incentive package to lure foreign investors to Slovakia, a new and ostensibly more attractive draft went into effect January 1. Less than two weeks later, however, foreign analysts had begun to voice their disappointment in the new legislation as well, which they said still made it too difficult for companies to qualify for a tax holiday.

The critics' main concerns have been that the minimum required capital investment was too high, that a rule regarding goods not made in Slovakia was too vague, and that the foreign to domestic capital ratio for joint ventures was not attractive. The Finance Ministry, meanwhile, has admitted shortcomings in the new draft, but has said that more generous terms might endanger budget revenues.

Minimum not low enough

Under the new changes to the Income Tax Act, companies get a 100% rebate on their payable taxes for five consecutive years (or a 50% tax cut for 10 years) if specific conditions are met. To qualify for the tax exemptions, firms must invest a minimum of 5 million euros ($5,2 million) in capital if they are setting up shop in areas that have an unemployment rate of less that 15%. Companies that invest in regions with unemployment greater than 15% only have to invest 2.5 million euros ($2.6 million).

Mark Gibbins, a partner with the consulting firm KPMG, said that this requirement, which was unchanged from the April, 1999 bill, posed a problem for many potential investors, especially smaller companies. According to Gibbins, the rule that the minimum 5 million euro amount had to be a capital investment and could not be financed through a loan only made matters worse.

"A lot of investors will come here with capital and loans, and because the law says investment must be only in capital, it means that if a project is 75% financed by loans and 25% financed by shares, the investment has to be a 20 million euro project," said Gibbins. "So it's really only big projects that are going to be attracted by the tax holiday.

Leighton Klevana, director of the American Chamber of Commerce, also felt this requirement to be unreasonable, and didn't understand the reasoning behind the decision.

"What about the guy who wants to come in and invest $2 million or $3 million?" he asked. "Their money is just as good - three $2 million investments are just as good as one guy with a $6 million investment. They're all going to be creating wealth and employment in Slovakia."

Unclear and restrictive

Another sticking point was the requirement that a company must export 60% of its production to receive the tax holiday, a rule which would disqualify companies producing goods for domestic contractors rather than for export.

Adding an element of confusion was a clause granting exemption from the export requirement if a company produced a product not previously manufactured in Slovakia.

"They've made this part of the law much more subjective than it was before," complained Klevana. "Who's to say whether something has been manufactured here before or not? This [rule] also subjects an incoming company to a lot of state bureaucracy. One district director with the Ministry of Finance may say 'Yes, you're alright,' and then the producer goes to another who says the opposite."

Considering joint ventures, the new legislation has lowered some barriers but not enough to attract real attention. The law initially stated that 75% of capital had to come from abroad while the remaining 25% had to be put forward by Slovak individuals. The new draft now makes it possible for the Slovak 25% to be held by a Slovak company (instead of an individual), thus making joint ventures more attractive.

But KPMG's Gibbins wasn't impressed. "I would have liked to have seen the 75% joint venture requirement reduced," he said. "Slovakia could have encouraged even more joint ventures with a lower ratio. There's not a magic number that we are shooting for, but a lower ratio would allow for a broader range of joint ventures."

Martin Kapko, director of the Finance Ministry's Foreign Investment Department, admitted that some of the changes fell short of expectations. He said the Finance Ministry had taken a cautious approach to tax cuts in order to safeguard budgetary tax revenues. He also pointed out that this particular legislation was only a small part of the country's total tax reform.

"The tax incentive [for foreign investment] is not as important as the overall major reform of the tax system," said Kapko. "Since I am in charge of foreign investment, I would like the incentives to be competitive with neighbouring countries, but generally tax incentives are not included in the list of important criteria in the selection of an investment location."

Kapko felt the trigger for any influx of foreign investment was the government's approach to privatisation. This process, he said, had already begun with the planned sale of the state telecom monopoly and state-owned banks.

Kapko also saw the reduction in the corporate tax rate, which fell from 40% to 29% in November, as a major concession that put Slovakia on a level more equal to neighbouring countries.

Faint praise

Despite widespread critícism of the tax incentives, some firms praised a change which allowed already established businesses to take advantage of the tax breaks. The former package had only applied to businesses founded after April 1, 1999.

This change has had a direct effect on Emerson Electric, an American company that has been producing automotive and communication components in Nové Mesto nad Váhom (100 km north of Bratislava) since 1995. The company, which currently employs 1,100 people, is planning a $10 million investment into a new production facility slated for completion in July.

George Varmza, managing director for Emerson Electric in central and eastern Europe, said the amendment to the old law allowing established companies a tax break was something he had lobbied for personally.

"Anybody who has been here for five or six years took a big chance on this country during an era when the political situation was unclear," he said. "We made a $5 million investment but got nothing under the old law. We are now able to make an investment in capital equipment and get a tax benefit from it, whereas we weren't able to in the past."

Varmza said that the latest changes in the foreign investment law were heading in the right direction, but agreed with other foreign analysts in criticising the a lack of clarity in the new rules.

Gibbins predicted that only time would show how effective the new law was in attracting foreign investors. "You measure success by looking at changes over a period of time, and if we see a lot of companies going elsewhere because they don't like what they see in the tax regime, it [the law] may need some other changes," he said.

Corporate Income Tax - Comparing Central Europe

Slovakia 29%

Czech Republic 31%

Hungary 18%

Poland 24%

Estonia 0% (in 2002)

SITA

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