INVESTMENT-related tax breaks in Slovakia will end as of September 1, 2002 according to an obscure law quietly passed by parliament at the end of June.
Because the country's planned entry into the European Union requires the elimination of such tax breaks, investors will henceforth have to rely on the good will of the State Aid Office to see past state tax break commitments honoured and future investment aid dispensed.
A handful of foreign companies have enjoyed generous tax relief of up to 10 years recently, taking advantage of Slovak legislation that allowed them to invest money they would otherwise have paid in taxes.
The new changes have caused deep concern among investors, with most contacted by The Slovak Spectator refusing comment until the impact of the new tax break rules became clear.
But Radomír Jakubec of the car parts maker Plastic Omnium told the Sme daily that "this is something that truly astounds every investor, because it does not create stable conditions and arouses uncertainty."
The EU does not allow the use of tax relief, but does permit other forms of state investment support such as regional state aid, says the European Commission. The EU expects candidate countries to follow suit before entering the 15-member bloc as planned in 2004.
As unhappy as many in Slovakia may be to see the credits vanish, in some cases only nine months after they were approved by parliament, few see any option.
"As I see it, we have no other choice, we have to change these rules," said Ján Tóth, senior economist with ING Barings bank.
Legislation for stimulating investments, which has gone through a number of changes since being introduced in 1999, has offered investors as much as 10 years of 100 per cent tax holidays. The country has argued the tax breaks were necessary if Slovakia was to compete successfully for foreign investors with neighbouring countries, which have been offering such holidays for several years.
"The aim of the law has been to attract foreign direct investment," said Ludmila Bizočová, head of the tax section at the Finance Ministry, adding that "in 2001, eight organisations used it."
An amendment to the income tax law now cancels breaks to companies founded after September 1, 2002, while tax relief approved before will be converted to a form of state aid under a change to the law on international cooperation and aid in tax administration.
"Tax breaks will be provided under the same conditions as before, only they have to be converted in line with [Slovakia's] State Aid Law," said Bizočová.
The main change in the channeling of state support will be the establishment of a state system to provide aid calculated from the size of investments a given company has made over time.
"Investors will pay all their taxes, but they will receive state aid from the donor - usually the Economy or Finance Ministry," explained Miroslav Hladík, head of the State Aid Office.
Companies currently using tax relief packages must ask the State Aid Office for permission to continue, but will eventually have to give up the advantage with EU entry, possibly as early as 2004.
"With respect to upcoming EU entry, our negotiators have already started talks with companies which use the relief. They are planning to convert their holidays to some kind of state aid. After EU entry, only EU legislation will be valid - that's all," said Bizočová.
Converting tax breaks to straight state aid could cause serious problems, as two of Slovakia's most significant foreign investors - Volkswagen and US Steel - are technically ineligible for such aid under EU rules on 'sensitive industries'.
However, because of the key roles these two companies play in the Slovak economy, the European Commission has agreed to allow the conversion of their tax breaks into state aid as well, at least for now.
After negotiations with EC representatives, Deputy Prime Minister for Economy Ivan Mikloš said: "We managed to agree on Volkswagen, so that should be a closed affair," adding that progress had been made in negotiations with US Steel, but that further talks were necessary.
Neither Volkswagen nor US Steel would comment on this story, opting to wait until the matter is finally resolved.
Firms should have known
While affected companies might not be completely happy with the legislative changes, analysts say they must have been aware of trends in Slovakia towards EU integration, and could not have expected that their tax haven would last forever.
"It can be assumed that they knew that Slovakia was approximating its legislation [to EU standards] and that sooner or later, it would have to convert the tax holidays to some other form," said Bizočová.
Marián Vitkovič from the Economy Ministry's business environment section said Slovakia's new EU-compatible state aid system would be based on the economic strength of each of the country's regions.
Under the new system, the level of state aid companies get will be set with reference to where they are located. A special investment map of Slovakia will divide the country into four regions, according to various economic indicators.
The percentage of state support companies are eligible for will be higher in regions with greater unemployment and lower per-capita GDP.
Initially, Bratislava region will have the lowest support level at 20 per cent, meaning that the state can provide aid worth 20 per cent of an investment project. All other areas, which have traditionally received far less investment than the Slovak capital area, have levels set at 50 per cent.
The map system, valid from March 1, 2003, will be updated every five years or less, assuming EU entry, explained Hladík.
Hladík argued that "the new system should contribute to attracting foreign investors, because the rules will finally be clear and the business environment stabilised. Foreign investors will regain confidence, and that will be a great advantage."
Analysts, however, said that other factors besides tax breaks would remain more key to any growth in foreign investments.
"Slovakia will be attractive even without these changes, it will attract investors mainly because of its EU membership. Tax relief is not the most important factor. I don't see a big difference - in principle, state aid is the same thing as tax relief," said Istrobanka analyst Marek Senkovič.