CZECH REPUBLIC: An Introduction to Real Estate
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CZECH REPUBLIC: OVERVIEW
I.1 Czech Republic - Great Location, Attractive Investment Opportunity
The Czech Republic, strategically located in central Europe, with political stability, liberal economy, a robust financial sector and a qualified and skilled workforce, has been attracting foreign investments for last decades.
Since 2014 the Czech Republic as a member state of the European Union participates in the European Single Market with free movement of capital, goods, people and services within the whole EU and it remains one of its most open countries for services trade. Due to its location and developed infrastructure, the Czech Republic is logistically attractive for storage and access of goods to and from other markets within the EU.
The Czech Republic is also a member of the OECD, the WTO and the IMF and in this particular situation it is also relevant to mention the membership of the Czech Republic in NATO.
In the beginning of February 2022 OECD ranked the Czech Republic as a country with the least regulations and barriers among all countries in 2021 in its updated Services Trade Restrictiveness Index, indicating an open regulatory environment for trade in services (the indicator remained unchanged compared to 2020).
Not even the COVID-19 pandemic has changed the position of the Czech Republic as one of the leading countries in M&A in the region. Based on preliminary data of both state agencies (e.g. CzechInvest) and professional advisors, the number and deal value of acquisitions have raised significantly in 2021 (Avast, Mall Group and Moneta Money Bank deals were among the biggest in the whole CEE region).
I.2 Czech Republic in 2022
As a country with an open economy the Czech Republic is influenced by all the major world economic tendencies. Thus, increased inflation is anticipated in 2022 - the estimates oscillate around 10% p.a. However, according to the predictions the inflation should subside towards the 2% target level by late 2023. In order to mitigate the inflation, starting in mid of 2021 the Czech National Bank has repeatedly increased the interest rate and currently (May 2022) the two-week repo rate amounts to 5.75% p.a. (the discount rate to 4.75% p.a.).
The full impact of the current refugee crisis due to the war in Ukraine is hard to predict. We believe that the newly introduced unrestricted direct entrance of fleeing Ukrainian citizens to the employment market in the Czech Republic might "cure" the negative effects of the the very low and almost unhealthy unemployment rate (ca 3.5% in December 2021).
Notwithstanding the above, further significant investors' activity is still anticipated for 2022, mainly in TMT, machinery and energy, but also in e-commerce and real estate.
With regard to the real estate market we have seen a lot of investment transactions in the first quarter of 2022. The first quarter investment volume almost equals half of the total annual investment volume in 2021.
The real estate market is, however, becoming negatively influenced by the high interest rates, increasing construction costs and energy prices as well as by the lack of materials which used to be imported from Russia or Ukraine.
The uncertain situation leads to increases in rent and prices of newly built properties and also in more cautious approach by prospective tenants and purchasers (especially private clients in need of mortgage loans). Also rental residential projects which were on the rise might require re-consideration given the high interest rates and not yet adequate rental market.
Still, the real estate and construction sector remained solid and rather untouched by the COVID-19 pandemic and steady growth is predicted also for 2022.
II. LEGAL BACKGROUND AND OVERVIEW
II.1 Foreign Investor’s Treatment and Foreign Investment Protection
In general, Czech law provides for equal treatment of Czech companies and foreign companies and legal entities, both from the EU as well as from other states. They may acquire real estate in the Czech Republic without any restrictions and under the same conditions as Czech legal entities.
The foreign investment protection in the Czech Republic is procured both by bilateral treaties as well as on the level of the World Bank through the Multilateral Investment Guarantee Agency.
The Czech Republic alongside with majority of other European states implements screening of selected investments on national security grounds and takes part in the European cooperation and information exchange mechanism established in October 2020 (based on the Regulation (EU) 2019/452 of the European Parliament and of the Council). The Czech Republic implemented its national screening mechanism based on Act No. 34/2021 Coll. on screening of foreign investments, effective from May 1, 2021. The law is focusing on foreign investors with the ultimate beneficial owner from non-EU countries (and unlike in other areas it applies also to Switzerland and Liechtenstein and Norway, as well as post Brexit United Kingdom). At the same time, the investment typically counts for a 10% or higher share in targeted Czech companies active in sectors important for the security, public, or internal order of the Czech Republic.
Distribution and repatriation of profits by Czech subsidiaries to their foreign corporate parents are not restricted.
All international transfers (e.g. profits and royalties) related to an investment can be carried out freely and without delay.
II.2 Corporate Entities used in the Czech Republic in Real Estate
A limited liability company and a joint stock company are the prevalently used legal forms when conducting business in the Czech Republic. In real estate, joint stock companies are preferred as holding companies while the majority of limited liability companies are used as project companies (SPV).
The foundation deeds and later changes thereof require participation of a notary public. All companies become existent upon their registration with the Czech Commercial Register, which is (including the Collection of Deeds) publicly accessible through www.justice.cz. Registration of Czech companies’ beneficial owners into the Czech Register of Beneficial Owners is compulsory (in general the information therein is publicly accessible, however some scope only based on proven interest and full scope only to listed entities); from mid 2021 default with the registration obligation triggers both monetary sanctions (public fines) and non-monetary sanctions (such as prohibition to vote or to receive profit).
III. RELEVANT INFORMATION ON SOME TAX MATTERS
III.1 Treaties preventing double taxation
The Czech Republic is a party to numerous multilateral and bilateral treaties preventing double taxation on dividends, interests and royalties. Each foreign investor should review whether and to what extent such treaties apply to its investment.
Generally, the Czech Republic tends to have a "service permanent establishment" clause according to OECD Model Tax Commentary (i.e. permanent establishment is created by provision of services in the territory of the Czech Republic even without the existence of a fixed place of business) under other double taxation treaties.
III.2 No Real Estate Transfer Tax
No real estate transfer tax applies or is collected from transfers and acquisitions of real estate properties.
III.3 Corporate Income Tax - General
Czech resident companies are required to pay corporate income tax on income derived from worldwide sources. Non-resident companies are required to pay corporate income tax on income sourced in the Czech Republic only.
A company is considered a Czech resident for purposes of corporate income tax if it has either its registered seat or its place of management located in the Czech Republic. Foreign companies may also create a permanent establishment for tax purposes in the Czech Republic which is triggered by (i) a fixed place available for carrying out business activities, (ii) long-term provision of services (for more than six months in any 12 consecutive months), or (iii) presence of a dependent agent (all unless an applicable double taxation treaty stipulates otherwise).
The corporate income tax rate in the Czech Republic is 19% and applies to all business profits, including capital gains from the sale of shares (if not exempted).
A 5% corporate income tax rate applies to income of certain investment funds, and a 0% rate applies to pension funds.
There are no regional or local income taxes in the Czech Republic.
III.4 Capital Gains
There is no separate capital gains tax levied in the Czech Republic. Capital gains (i.e. gains from sale of shares and other assets) are included in the corporate income tax base and taxed as regular income in the year in which they arise (unless they are exempt under the participation exemption).
III.5 Dividend Income
Dividends received by Czech tax resident corporations from non-resident entities are subject to a special tax rate of 15% (unless subject to participation exemption).
Dividends paid by Czech tax resident corporations to both Czech resident and Czech non-resident entities are subject to 15% final withholding tax (unless subject to participation exemption and in the letter case of Czech non-resident recipients the withholding tax rate is decreased under the relevant double taxation treaty).
An increased withholding tax rate of 35% applies to dividends paid to entities that are tax residents in other countries than the EU or the European Economic Area (EEA) member states or in a country with which the Czech Republic has not concluded a double taxation treaty or tax information exchange agreement (TIEA).
III.6 Participation Exemption Regime
Dividend income or income from the sale of shares in a subsidiary may be exempt from Czech taxation (i.e. withholding tax when a Czech company is paying dividends, corporate income tax when a company is receiving dividends or generates the capital gain) if all of the following conditions are met:
- the Czech or the EU parent holds at least 10% of the shares of the subsidiary for at least 12 consecutive months; this time test may be met both prospectively and retrospectively;
- the subsidiary is a tax resident of the Czech Republic or another EU member state;
- both the parent and the subsidiary have one of the legal forms listed in the Annex to the EU Parent/Subsidiary Directive (Council Directive 2011/96/EU of 30 November 2011 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States); and
- the parent or the subsidiary are not exempt from corporate taxation or may not choose to be exempt, and the tax rate applicable to their income is greater than 0%.
The exemption also applies when dividends are paid by a Czech subsidiary to a parent in the EEA member state.
The participation exemption may also be applied if the subsidiary is a tax resident of a country where a double taxation treaty with the Czech Republic is in place under similar conditions but with local tax of at least 12%.
III.7 Interest and Royalty Income
Interest and royalties received by Czech tax residents are included in the standard tax base subject to the 19% corporate income tax rate (for individuals 15% or 23% income tax rate applies, dependent on the amount of tax base, except for the interest from bonds where a unified 15% income tax rate applies notwithstanding the amount of tax base).
Czech-source interest and royalty income received by Czech tax non-residents is subject to 15% withholding tax, unless subject to domestic exemption or a double taxation treaty stipulates otherwise. An increased withholding tax rate of 35% applies to interest and royalties paid by Czech tax residents to entities that are tax residents in country other than the EU or the EEA member state or in a country with which the Czech Republic has not concluded a double taxation treaty or TIEA.
Interest and/or royalty income is exempt if it is paid by a Czech resident to an EU resident recipient who is a beneficial owner of the interest and/or royalty income, provided that for at least 24 months before the payment:
- the payer is at least a 25% parent-subsidiary or at least a 25% direct sister relation to the recipient of the income and
- the interest and/or royalty is not attributable to a Czech permanent establishment of the recipient.
The exemption is applicable subject to approval by the tax authorities.
III.8 Transfer Pricing
Any agreements between the related parties and prices agreed for services or goods under such agreements should be done on "arm's-length" principle, where, generally, the pricing methods under OECD guidelines should be followed. Such prices are often subject to tax audits by tax authorities whereas the incorrect transfer pricing and subsequent adjustments may lead to additional tax exposure and penalties imposed by the tax authorities.
III.9 Thin Capitalisation Rules
Thin capitalisation rules apply in the Czech Republic and may limit the tax deductibility of interest payments on debt financing from related parties and in certain cases from third parties (e.g. back-to-back financing).
The thin capitalisation rules encompass the following:
- thin capitalisation applies only to related-party loans;
- the debt-to-equity ratio for related-party loans is 4:1 (6:1 for financial services industry), i.e. interest on such part of the related-party loans by which the principal of these loans exceeds four times the accounting equity (based on Czech GAAP) of the debtor is tax non-deductible;
- the tax-deductibility test applies to all financial costs on loans (e.g. interest plus other related costs, such as bank fees);
- unrelated-party loans (e.g. bank loans) guaranteed by a related party are not considered related-party loans for thin capitalisation purposes.
III.10 ATAD Interest Stripping Rules
The EU ATAD rules (Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market) limiting deductibility of interest expenses have been implemented on top of the other applicable rules. The ATAD interest deductibility rules apply to all interest expenses, i.e. on borrowings from related and unrelated parties. The ATAD test applies only to the interest expenses that successfully passed all other tax deductibility tests, whereas the ATAD rules can result in additional interest expenses being disallowed for tax deductibility purposes.
Based on these rules, any 'net borrowing costs', defined as the excess of tax deductible borrowing costs over related taxable borrowing income, is only tax deductible up to the higher of:
- 30% of a taxpayer’s earnings before interest, taxes, depreciation, and amortisation (EBITDA) as defined for tax purposes, or
- CZK80 million per year.
The borrowing costs include various types of interest-like expenses, such as actual interest expenses, expenses that are similar to interest, deemed interest expenses included in hedging instruments, interest element included in the financial leasing costs, interest capitalised in the value of assets and subsequently included in tax depreciation and foreign exchange costs related to interest.
Any interest costs treated as tax non-deductible due to these rules may be carried forward for an indefinite period of time and used as a deduction in the years where the threshold has not been reached.
III.11 Controlled Foreign Companies (CFCs)
The corporate income tax base of the company can also be increased by income generated by foreign direct or indirect subsidiary of the company under the CFC rules.
III.12 Research and development (R&D) allowance
Under the current rules up to 100% of specific R&D expenses (or costs) incurred in a given tax year may be deducted from the tax base as a special tax allowance. These costs are therefore deducted twice for tax purposes: once as a regular tax-deductible cost and then again as a special tax allowance. An additional 10% may be applied as an allowance from the difference by which the current year qualifying costs exceed those of the prior period.
IV. NEW LEGISLATION FOR REAL ESTATE AND CONSTRUCTION
IV.1 New Building Act
New Building Act No. 283/2021 Coll. has become part of Czech law, becoming effective gradually with the first part having become effective from July 30, 2021 (inter alia abolishing old construction bans) and with full effect from July 1, 2023. However, the Czech government passed the draft bill to be presented to and approved by the Czech Parliament with the aim mainly to postpone effectiveness of its part relating to creation and reforming of the system of building authorities for a year.
IV.12 New Rules For Investors in the Development in Prague
On January 27, 2022, the Prague City Council adopted a new Methodology of Participation of Investors in the development of Prague - Methodology, representing the first unified concept for the entire city of Prague, which introduces quite a few changes.