Co-authored by Mr. Jiri Dubovsky

Amendment to the Accounting Procedures for Entrepreneurs

In November 2001 the minister of finance of the Czech Republic approved the amendment to the Accounting Procedures for Entrepreneurs. It is one of the most extensive amendments that emerges from the long-expected and already approved amendment to the Accounting Act No. 353/2001 Coll. and that came into effect along with it on 01 January 2002.

We would like to summarise the most significant new provisions that have been approved.

Change of Accounting and Valuation (Section 4 (9) and 7 (4) of the Accounting Act)

The change of the way of accounting and valuation must be accounted as an extraordinary expense or extraordinary revenue at the beginning of the accounting period (Article IV Section I/4 of the Introductory Provisions).

Transformations / Mergers of Companies (Section 27 (1) (d) of the Accounting Act)

The change of the legal form does not effect the change of the valuation of assets and liabilities.

In case of merger of companies, the dissolving company performs re-valuation of assets if it is prescribed by the Commercial Code (through the account 418). The succession company prepares the opening balance sheet and appendix, which (both of them) have to be audited.

Sale of the Company

The sales price shall be accounted on the account 688 as extraordinary revenue while the sold assets and liabilities shall be recorded balanced on the account 588 as extraordinary expense.

Financial Investments

Newly, secondary costs form a part of the acquisition costs (e.g. broker’s commission); however, not the interest for acquisition of financial investments (Article XV of the Introductory Provisions).

If the financial investment is acquired in the form of contribution of assets (in-kind contribution) the acquisition costs of this financial investment are considered the net accounting values of the contributed assets. If the assigned liabilities form, along to the assets, a part of this financial investment and the accounting value of such liabilities exceed the value of the assets, the financial investment is recorded at a zero value. The difference shall be recorded as revenue. This clarification just confirms the method, which is already used in practice.

In accordance with the amendment to the Accounting Act particular securities are valued at real value, which corresponds to the listing or market price. If the securities are acquired for share dealing (trading), their re-valuation should be done, which is accounted in the profit and loss statement.

Long-term Assets

Low-value long-term assets shall be capitalised either on long-term assets account 013 respectively 022 and then depreciated for a life-time period, or they shall be accounted as a nonrecurring expense through the account 518 respectively through material in store (account 112) and consumed material (account 501).

Adjustments to Acquired Assets

This entry arises when acquiring set of assets by privatisation, acquisition or by contribution during the mergers. The description of the transfer of a set of assets shall mean generally the transfer of intangible assets and a larger range of tangible assets, inventories, receivables and other assets. The word "generally" means that, in contrast to the former provisions, a set of assets is considered also when no intangible assets are transferred (because of the fact that the business is performed in leased premises).

Technical Appreciation by a Lessee

Technical appreciation is capitalised on investment account, on which the leased object would belong to and is depreciated during the term of lease. In case of financial leasing the acquisition price of the technical appreciation shall be increased by the purchase price of the leased object after the object is transferred. Depreciation is carried from such increased value. Until now the technical appreciation had been recorded as "other long-term assets" (account 029).

Extraordinary Expenses (Account 588) and Revenues (Account 688)

Contrary to the present regulation these accounts shall not be used so often in the future. For example, differences in inventory, unrealised investments or insurance benefits (indemnification) shall be accounted as other operating expenses (account 548), differences in inventory (account 549) respectively revenues (account 648).

Creation and Release of Adjustments

Creation and release of adjustments shall be accounted as until now on particular accounts of expenses respectively revenues. Expected balancing and dissolution of the revenues accounts have not been approved.

Foreign Exchange Rate Differences of Liabilities and Receivables

The balance sheet accounts for accounting of unrealised foreign exchange rate differences (accounts 386, 387, 454) have been cancelled. Foreign exchange rate differences are accounted directly on expenses respectively revenues on accounts 563 respectively 663, and according to the current legal regulation these differences are also tax effective.

Deferred Taxes

Deferred taxes must be created by all accounting units that are obliged to have their annual accounts audited. All temporary differences between accounting and tax expenses/revenues (e.g. adjustments, reserves) must be considered, along to the time differences of depreciation of the long-term assets. Active and passive deferred taxes are balanced and the outstanding deferred tax liability must be accounted.

When applying for the first time, the deferred taxes relating to the previous years shall be credited to the profit respectively loss of the previous years (accounts 428 respectively 429).

Capital

The account 419 has been newly introduced. Increase and decrease of the capital that was approved but so far has not been inscribed in the Commercial Register yet, shall be accounted to that account.

Statutory Audit Requirement for the Annual Accounts

The statutory audit requirement for annual accounts has been newly specified. The following are bound to the statutory audit requirement:

  • Corporations; and
  • Other business companies and partnerships (also unlimited and limited partnerships) as long as at least two of the following three criteria are met on two consecutive balance sheet days:

    1. Total balance sheet exceeds CZK 40 million. The term total balance sheet was not specifically defined by the new law. It can be presumed that this refers to the gross value of assets.
    2. Net turnover exceeds CZK 80 million. Net turnover was also defined vaguely by the new law (presumably the total of all profits entered in account class 6).
    3. More than 50 employees on the average during the accounting period.

If two of the three criteria are met, even foreign entities doing business in the Czech Republic and individuals who are entrepreneurs and use double-entry bookkeeping are subject to the statutory audit requirement.

Annual Report and Legal Obligation to Disclose

The contents of the annual report are defined in Section 21. The annual report must contain details for at least two directly consecutive accounting periods.

Companies, which are not bound to the statutory audit requirement, are not required to prepare an annual report. Section 21 (a) of the Accounting Act continues, however, to require that all companies listed in the Commercial Register publish an annual report in addition to the annual financial statement. This contradiction has not been eliminated by the new law.

The Ministry of Finance has already expressed an opinion, which ignores this contradiction and purports the law to express the following:

  • Companies facing a statutory audit requirement are obligated to:
  • Disclose the annual financial statements as well as the auditor’s report by depositing these in the file of documents at the Commercial Register; and
  • Prepare the annual report and disclose it by depositing it in the file of documents at the Commercial Register.
  • Companies not subject to the statutory audit requirement are not required to prepare an annual report. Therefore, they cannot be required to disclose one. They are thus required only to disclose the annual financial statement by depositing it in the file of documents at the Commercial Register.

The failure to prepare the annual report and the failure to fulfil the duty to disclose means, according to the new Accounting Act, that accounting is not complete. This results in the possibility of a penalty of up to 6 % of the gross balance sheet total being imposed. In addition, it follows that the auditor will have to qualify the auditor’s report.

Value Added Tax Refund to Foreigners

Foreign entrepreneurs (corporate entities and individuals) who are not allowed to carry business in the territory of the Czech Republic are entitled to VAT refund on selected goods purchased in Czechia (e.g. lubricants, diesel fuel, repairs of vehicles incl. spare parts, guarantee repairs). The prerequisite for this claim is the reciprocity principle. For these purposes the Ministry of Finance of the Czech Republic has published in July 2001 the list of countries, to whose applicants the Czech Republic shall grant VAT refund entitlement. Germany is classified in this list among other states.

However, according to the newest announcement of the ministry of finance, the Czech Republic as of 31 August 2001 does not grant this VAT refund entitlement to German applicants due to the fact that even the German side does not refund VAT to Czech applicants. Should any VAT refund have been granted to applicants from Germany before 31 August 2001, it will not be necessary to remit it. On the contrary, the tax will be newly granted to the applicants from France and the Netherlands.

Currently, the VAT refund in the Czech Republic is granted to the applicants from the following states: Belgium, Denmark, Finland, France, Holland, Ireland, Luxembourg, Hungary, Austria, Sweden, Switzerland and Great Britain.

CURRENT CHANGES

Amendment to Investment Incentives Act and Income Taxes Act

Amendment to Investment Incentives Act

Investment Incentives Act (see News 3/2001) has been amended by the Act No. 453/2001 Coll. with effect from 30 January 2002. We have summarised the most significant changes:

  • The amendment abolishes the investment incentives in the form of subsidies to municipalities for infrastructure site support. This incentive is replaced by a possibility to transfer the technically facilitated site to the investor for a privileged price.
  • According to the former wording of the law it was possible to lower the investment expenditure from CZK 350 million to CZK 175 million, if the investment plan was implemented in a district where the unemployment rate was by at least 25 per cent higher than the average unemployment rate. The amendment lowers the minimum investment expenditure to CZK 100 million; at the same time, however, increases the relevant unemployment rate. This rate must exceed the average unemployment rate by at least 50 per cent, in order to invest only the lowered minimum amount.
  • Newly among other general conditions for granting of an investment incentives belongs the acquisition of long-term tangible and intangible fixed assets during the investment plan earliest as of the day of submission of the application for investment incentives.
  • The condition of environment friendly production is defined more precisely. Upon filing of an application the environmental ministry is qualifying these conditions.
  • The decision on the undertaking of the investment incentives will not specify the highest possible amount of the investment incentives, but so-called acceptable rate of public allowance, which will be ascertained by the Office of Fair Trading (Úøad pro ochranu veøejné soutìže).

Already granted investment incentives and started procedures for granting of investment incentives shall be governed according to the former wording of the law. However, in the case of audit on the observance of investment incentives’ conditions, the new legal regulation shall be reasonably applied.

Amendment to Income Taxes Act

Along with the amendment to the Investment Incentives Act, the amendment to the Income Taxes Act has been approved. It comprises the deeper specification of the conditions, under which an income tax relief shall be applied based on the undertaking of the investment incentives.

  • From a modified wording of specific conditions for income tax relief it results that the taxpayer applying the relief can not merge with another entity nor overtake the equity of a company, which shall be dissolved without liquidation, and thus in the period, for which the relief can be applied.
  • The income tax relief shall be applied during five or ten taxable periods while the first year when the tax relief can be applied is the year when the general conditions for granting of investment incentives were fulfilled. A new provision has been introduced, according to which the tax relief can be applied at the latest for the taxable period, during which the three-year period after the issuing of decision on the undertaking of the investment incentives lapsed. Should the deadline for redemption of general conditions is prolonged, the start for applying of the tax relief is also prolonged; however, at the maximum by 2 years.
  • The amount of applied relief can not be reviewed in total summary, but also for individual taxable periods. The proportion between the applied relief and already invested expenses in individual taxable periods can not exceed the amount of the acceptable rate of public allowance stated in the undertaking of the investment incentives. At the same time the tax relief in total summary can not exceed the acceptable rate of public allowance. This provision shall be applied also for the taxpayers who have been already granted the decision on the undertaking of the investment incentives.
  • Should any condition of maximum reduction of a tax base is infringed (e.g. depreciation deduction, tax loss carry forward, bad receivables tax adjustments in the maximum high), newly the entitlement to a tax relief is not dissolved, but the taxpayer is obliged to file supplementary income tax returns for all taxable periods, in which the condition was not fulfilled. New wording of the provision shall be applied also to taxpayers, who have already applied the tax relief before the effective day of the amendment.
  • Further, the amendment reduces the tax assessment period in cases of granting of an investment incentives in the form of income tax relief from former 15 to 10 years after the end of the calendar year, during which the right to use a tax relief was first validated.

Amendment to Road Tax Act

The Czech Parliament has approved an amendment to the Road Tax Act (act No. 493/2001 Coll.), which provisions shall be generally valid since 2002 taxable period. This amendment above all prolongs the current advantages for the vehicles meeting the emission limits Euro 2 and Euro 3. Based on the amendment the decrease by 25 per cent of the tax rate for vehicles meeting the Euro 2 limit (except for personal vehicles) and 50 per cent decrease for all other vehicles meeting Euro 3 limits o 50 % is prolonged till 31 December 2003. Further, an increase of the tax rate by 15 per cent has been approved for all vehicles registered in the Czech Republic till 31 December 1989.

EXPECTED CHANGES

Expected Changes of the Law in Connection with the Preparation of Joining the European Union

In connection with the admission of the Czech Republic to the European Union, the proposals of the laws’ changes concerning the legal requirements on the Czech tax legislation are being discussed in the parliament and on the government level. It concerns especially changes of the Income Taxes Act, Excise Duties Act, Value Added Tax Act and Road Tax Act. However, the above-mentioned changes are supposed to be approved at the moment of the admission of the Czech Republic to the European Union. With respect to the tax planning henceforth, we have summarised the most significant expected changes for you:

Income Taxes Act

The proposal of the amendment implements the European Union directives into the Czech legal system, above all the directives regarding the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares, and directives regarding the system of taxation applicable in the case of parent companies and subsidiaries. However, the amendment shall come into effect on the day of the Czech Republic’s admission to the European Union.

From the tax point of view, merger, divisions, transfers of assets and exchanges of shares in companies from different member states should be reviewed neutrally, i.e. in the same way as in case of the same transactions between domestic (inland) companies. Particular provisions of the Income Taxes Act’s amendment shall not be allowed to be used if the reason or one of the main reasons of such transaction is lowering or evading of a tax liability, especially in case that there are apparently no economical reasons for such transaction (increase of effectiveness, re-structuring).

Concerning the taxation of parent companies and subsidiaries, particularly the following regulations have been proposed:

  • Profits, which a subsidiary distributes to its parent company, shall not subject to withholding tax if the parent company holds a minimum 25 % share in the subsidiary’s registered capital for a continuous period of two years.
  • The parent company’s expenses related to the ownership of a share in a subsidiary shall not be considered as tax deductible. Interest on credits and loans accounted within 6 months before acquiring of a share shall be considered as expenses directly related to acquisition of such share, unless the taxpayer proves that this credit or loan is not connected with acquisition of such share.

Value Added Tax Act

Harmonisation of the Czech Value Added Tax Act with the law of European Union should be guaranteed by the amendment to the Value Added Tax Act, the proposal of which is currently ready for discussion. Besides the changes governing the need of different claiming of value added tax in case of member states’ tax subjects and EU non-members states’ tax subjects, the amendment contains for example the following proposals:

  • The amount of turnover decisive for the mandatory registration should be lowered to CZK 300,000.00 for three successive calendar months or CZK 1,200,000.00 for a calendar year.
  • In case of certain services, as a place of taxable supply should be newly considered a place of the recipient’s registered seat or eventually a permanent residence.
  • A possibility of VAT refund before the registration even in case of tangible and intangible long-term assets resulting from own activity has been proposed.
  • Basic tax rate shall be stipulated in the amount of 22 % and the lowered tax rate in the amount of 5 % as so far. The proposed tax rates are in compliance with the EU regulations, according to which the basic rate should be at least 15 % and the lowered rate at least 5 %.
  • After the admission to the EU, services will be generally subject to basic tax rate, which should be applied to all services except for those of a production type stated in the appendix to the law where the lowered tax rate should be applied. That means that e.g. telecommunication services, lease of real estate, software, research and development, legal services, accounting services or tax advisory, which until now are subject to the lowered tax rate should be subject to basic tax rate. Further, on the contrary to the current wording of the law, the basic tax rate should be also applied in case of construction and building operations except for residential constructions.
  • The extent of products, to which the lowered tax rate should be applied, will be reduced. The most extensive group of products, which belongs to the 5 % tax rate are certain groceries. The lowered tax rate shall be applied also in case of certain products intended for disabled persons and for healthcare system and further for books, newspapers, journals, music and goods intended for use in an agricultural production. The lowered tax rate on heat energy should remain till 31 December 2007.
  • In case of financial lease contracts the same tax rate should be applied as for the goods or real estate, which is subject of the contract, i.e. generally 22 %. The rate applies to the input price and to the lease margin as well. The exception for a lowered tax rate on a lease margin in case of passenger vehicles has not been proposed because it would be in conflict with the Sixth Directive of EU.
  • Certain changes should also occur even in case of tax exemptions of taxable supplies stated in the law, which are currently included in the Section 25 of the Value Added Tax Act. In case of financial activities it is not distinguished for the purposes of tax exemptions by whom the taxable supplies are provided. On the contrary to the current situation neither mediation of savings nor mediation of supplementary pension insurance will be tax exempt. Further, so-called factoring and forfeiting may not be considered as exempt taxable supplies.
  • Extension of a time-limit, during which the transfer of a structure is liable to tax, from two to five years after acquisition or approval of the transferred structures has been proposed. Transfer of lands should remain always tax exempt; however, tax exemption should not newly apply to transfer of building lands for which, as well as for structures, the time-limit of 5 years applies. Regarding the rent of a real estate and a structure, which is not a real estate, application of the basic rate has been proposed if the rent is not tax exempt.
  • In case of a sale of an enterprise to a taxpayer, it shall not be recognised as an exempt taxable supply but the taxable supply will be considered only a sale of an enterprise to a person who is not taxpayer.
  • Tax exemption shall not apply newly to a lease of safe deposit boxes and a rent of permanently installed equipment and machines, i.e. equipment and machines that are consistent part of structure but that are depreciated individually and in a different depreciation group than the structure.

The new law should come into effect basically on 01 January 2003 except for those provisions that will come into force on the day of admission of the Czech Republic to the European Union.

Excise Duties Act

The amendment contains especially increase of the excise duties rates in the Czech Republic by a single application to the level of the European Union at the date of the Czech Republic’s admission to the EU with the following exceptions, which were granted during the negotiations in Brussels:

  • Preservation of the transitory period for achieving of the EU minimum tax rate common for tobacco products till the end of the year 2007.
  • Permanent exception for adoption of the growers’ distillation – 50 % tax rate on spirit in case of small distilleries.

Further, the following changes that should come into effect already on 01 January 2003 have been proposed:

  1. Excise duties should be newly assessed at the moment of final sale. Consequently, wholesale prices should be stated without excise duties.
  2. These goods, in the meantime tax exempt, should be stored in the so-called tax stores till the moment of its delivery to the final consumer. These buildings shall be strictly controlled to avoid tax evasion. It will be necessary to accurately document the transactions of the goods in the store. Entrepreneur of such tax store will have to obtain a licence from the customs directorate and pay a bail security.
  3. Collection and administration of excise duties will pass from the competency of tax authorities to customs administration that will also control the goods in tax stores.
  4. Tax return will have to be filed by the 25th day of the month following the month, during which the goods would be delivered from the store to the final consumer. The tax will be due within 30 days after filling of the tax return.

Road Tax Act

At the beginning of this year the Parliament discussed the governmental proposal of the Road Tax Act that included besides the minor legislative and technical changes also proposals of changes in connection with the admission of the Czech Republic to the EU. These changes concerned especially approaching of tax rates to the level common in most EU member states. It consisted in the increase of the tax rate by 20 % for passenger vehicles with the cylinder volume over 2000 cubic centimetres and also decrease of the tax rate by 40 % for a period of three years after the first registration of the vehicle and decrease of approximately from 5 to 10 % in case of vehicles with the total weight over 12 tons.

The Parliament approved and passed to the Senate a version of the law’s proposal without significant part of the above-mentioned changes. The approved amendment contains after all only minor changes or adjustments that resulted from legislative changes of other laws. However, as a significant change may be considered the provision, according to which the vehicles with the total weight of at least 12 tons registered in the Czech Republic that are intended solely for a transport of a load, irrespective whether they are intended or used for business or not, should become subject to tax. The effectiveness of the amendment has been proposed to 01 January 2003.

ACTUAL TOPIC

Accounting and Tax Treatment of Unrealized Foreign Exchange Rate Differences

As of 01 January 2002 the Czech Accounting Act has been amended. Accordingly the Czech Ministry of Finance release a new degree, which governs the chart of accounts and the accounting procedures for entrepreneurs. This degree, which is also effective since 01 January 2002, prescribes the number of individual accounts, its content, the procedure how to account specific business events and above all it prescribes the accounting methods.

In accordance with the Accounting Act all receivables and liabilities in foreign currency must be re-calculated into the Czech Crowns. Thus, the records are kept in two currencies. Such re-calculation shall be done during the accounting period as well as at the annual accounts. Further, the Accounting Act prescribes that the re-calculation shall be done according to the Czech National Bank exchange rate valid as of the day of annual accounts, i.e. the balance sheet day.

The fundamental change consists in the accounting and presenting of unrealized foreign exchange rate differences.

The degree (Accounting Procedures) valid until 31 December 2001 stated that the unrealized foreign exchange rate differences, which were ascertained during the closing of accounting books as of the day of annual accounts, were accounted in the appropriate assets and liabilities accounts. Therefore, such unrealized foreign exchange rate differences did not influence the accounting result. Should there be an unrealized foreign exchange rate loss, the company was obliged to create a reserve for this particular loss. However, such reserve was not considered as tax deductible expense. On the contrary, unrealized foreign exchange rate gains were not accounted.

As of 01 January 2002 the new degree prescribes to account the unrealized foreign exchange rate differences, which were ascertained during the closing of accounting books as of the day of annual accounts, directly in to the particular accounts of revenue and expense. Therefore, such re-valuation directly influences the accounting result. The balance sheet accounts for this re-valuation shall not be used anymore, i.e. the unrealised currency differences would not be entered in the balance sheet as now, but in the profit and loss statement. Therefore, the new degree represents fundamental change in the accounting method.

As a result, until 31 December 2001 realised foreign exchange gains were taxable and foreign exchange rate losses were considered as tax deductible expense. As of 01 January 2002 the unrealised foreign exchange rate differences, which were ascertained during the closing of accounting books as of the day of annual accounts, shall be also tax effective.

It should be mentioned that the Czech Income Taxes Act do not explicitly consider the tax treatment of the unrealized foreign exchange rate differences. Therefore, there are further negotiations between the Czech Chamber of Tax Advisors and the Ministry of Finance in this respect. The Czech Ministry of Finance holds its position and consider the unrealized foreign exchange rate differences also for tax purpose.

However, we do not agree with such approach and therefore, we are trying to solve the tax implication of unrealized foreign exchange rate differences for our international clients beside the Chamber of Tax Advisors and the Ministry of Finance. It should be borne in mind that recently the Czech Crown considerably strengthened, which would have a negative impact of the liabilities in foreign currency, i.e. the re-calculation would result in their taxation (currently 31 %). As good news could be stated that upon conducting a deep legal analysis it seems that we have the legitimate solution how to treat the accounted unrealized foreign exchange rate differences for tax purposes in order to avoid their taxation.

While all reasonable care has been taken in the preparation of this News issue, VORLÍÈKOVÁ & PARTNERS accepts no responsibility for any errors it may contain, whether caused by negligence or otherwise, or for any loss, however caused or sustained, by any person that relies on it. Nevertheless, further professional advice should be sought before a specific decision is adopted.