Removal of CFC rules for individuals from the legislation has been approved
An amendment to Act No 595/2003 Coll. on Income Tax has been passed through the legislative process and will enter into force on 1 August 2023. Due to this amendment, the rules relating to controlled foreign companies for natural persons (the so-called CFC rules), which were effective from 1 January 2021, have been dropped. The CFC rules will remain in force only in relation to legal entities. According to the proposers of this amendment, the reason for the abolition of these rules is that questions have arisen in practice as to their proportionality and expediency.
The aim of the CFC rules for individuals was to eliminate the avoidance of taxation of individuals' income with the help of companies in countries with low tax burdens (so-called tax havens) to which these individuals divert their income.
A controlled foreign company is a legal entity abroad over which a natural person exercises effective control or has a participation in that foreign controlled company. Effective control means, among other things, the right to decide on the disposition of the company's assets and the proceeds of its assets. Participation means a direct share, indirect share, or indirect derivative share of at least 10% in the share capital of that company, a direct share, indirect share or indirect derivative share of at least 10% in the voting rights of that company or an entitlement to a share in the profits of that company of at least 10%.
At the same time, a controlled foreign corporation is a corporation that is a taxpayer of a non-cooperative state or a corporation that is not a taxpayer of a non-cooperative state and the ratio between the provenly paid income tax or similar tax paid in substitution for income tax of the controlled foreign corporation and the economic result of this company in percentage is less than 10%.
The Income Tax Act also defined exceptions where the CFC rules did not apply to individuals. These exceptions included, among others, a limited amount of income attributable to an individual from a controlled foreign company, which could not exceed EUR 100,000.
Income received by individuals from foreign controlled companies is currently taxed at a rate of 25% or 35% depending on whether the controlled foreign company is a taxpayer from a non-cooperative state.
The explanatory notes to the proposed amendment state that the CFC rules for individuals are not regulated by EU legislation. EU Council Directive 2016/1164 states in Article 1 "Scope" that it applies to all taxpayers subject to corporate tax. The Slovak Republic had the option to transpose the Directive beyond its legal scope, which in this case means applying it not only to legal entities but also to natural persons. Similar transposition took place in the case of five Member States. The proposers are of the opinion that these countries are implementing less restrictive rules than Slovakia.
The OECD states in the BEPS Action Plan (Reform of International Taxation to Prevent Tax Avoidance by Multinational Enterprises) that controlled foreign corporation rules must be introduced for legal entities, but also recognizes the possibility of applying these rules to natural persons.
The opinion of the Ministry of Finance of the Slovak Republic on this proposal shows that the removal of the CFC rules will weaken the fight against aggressive tax planning of individuals in the form of diverting income abroad with low or no tax burden. The Ministry of Finance has also pointed out that in connection with the introduction of the CFC rules for individuals, the Financial Administration has already allocated financial resources to modify tax returns and related information systems. For these reasons, the Ministry recommended that the Government should oppose the proposal. In the submitted explanatory notes, the proposers took the view that the amendment to the Act should not have an impact on the public budget, arguing that it was a new tax from which there had been no income to the state treasury to date.
However, pursuant to the approved amendment to the Act, the CFC rules for individuals will cease to apply with effect from 1 August 2023.
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