The global pandemic induced several changes to the tax systems of countries in Central and Eastern Europe region. The CEE governments have decided not to heavily subsidize the economy through the tax system; substantial tax relief was only available in certain sectors. That said, the Covid recession has put a strain on the budget, which is expected to be compensated by more intensive tax audits.
It seems that most of the governments of the Central European region have so far decided not to finance programs to maintain employment and support businesses through tax increases. Some governments have even decided to reduce the tax burden (e.g. the decrease of personal tax introduced in January 2021 in the Czech Republic). In the future, in the context of pressure on public finances, the governments of the individual countries can be expected to focus on introducing new taxes (such as a digital tax).
Labour costs, personal income tax and wages
In 2021, the employers' taxes and compulsory contributions related to the employment of people were generally reduced, though significant differences prevail among countries in the region. The Czech Republic has returned to progressive taxation, which is applied in Austria, Germany, Slovenia, Croatia and Slovakia, among others. Other countries, such as Bulgaria, Romania, Ukraine and Hungary, still apply a single personal income tax rate.
The regional average of employers’ total wage cost remains unchanged at 160 percent of net wages, but this value varies significantly across countries. Among taxes and contributions, the ratio of employer costs to gross wages averages 15 percent, but there is a difference of more than 30 percentage points between the lowest and highest employer contributions. The two extremes (the contribution burden is below 5% in Romania and above 30% in Slovakia) also highlight the limitations of the comparability of the respective tax systems.
The countries of the region show the largest variance in their wage levels. The minimum wage in the V4 countries ranges between €400-630, it is significantly lower in the Balkans and Ukraine, and no competition to around €1,700-1,900 in Germany and Austria. By 2021, however, the minimum wage in euros has risen significantly in several countries (Bosnia, Serbia and Latvia).
The average wage level in euros increased the most in the private sector, by 14% in Germany, but also by 5-10% in Slovakia, Croatia, Latvia and Northern Macedonia.
There was no change in VAT rates across the region over the past year, with standard VAT rates averaging at 21 percent, but showing major differences across the examined countries. The 27% and 25% standard VAT rates in Hungary and Croatia remain particularly high. By comparison, in Germany, where the average wage is already close to € 4,000, the standard VAT rate is 19 percent.
Before the pandemic, governments aspired to capitalize on growing consumption and other indirect taxes became the prime sources of revenue for public budgets. As this area is the most prone to tax evasion, national tax authorities push for efficient tax collection and fight abuse with digital technology. The objective is to monitor the sales process between endpoints, detect tax evasive transactions, and curb tax fraud. The introduction of online cash registers proved to be an effective tool in whitening the economy.
Corporate income tax
It remains obvious that countries in the region place a very different emphasis on the taxation of corporate revenues: there is a difference of 22 percentage points between the lowest and highest corporate tax rates. Germany has the highest corporate income tax rate (31 percent), the lowest are Hungary and Montenegro (9 percent), while the mainstream corporate tax rate in the countries of the region is typically between 15-20 percent.
However, the limits of tax competition are becoming increasingly visible. On one hand, there is no country where the rate of corporate income tax was lowered, while the European Union also actively seeks to limit tax competition. The EU’s objective is to establish a common framework for corporate taxation, or at least to prevent the applications of the most harmful tax avoidance techniques in the member states. An important tool in this effort is the Anti-Tax Avoidance Directive (ATAD, Directive 2016/1164 EC), which is mandatory for Member States from January 1, 2019. The adoption of this set of EU rules, including those on the restrictions of interest deductions, was the biggest challenge of the past years. The standardization of offshore (controlled foreign company, CFC) is also rooted in ATAD.
The planned introduction of a global minimum tax will fundamentally change the future of corporate taxation and the stage of tax competition between countries. It is clear that there will be fewer and fewer opportunities for multinationals to use profit shifting globally as well as on CEE level. Some of the CEE countries are quite reluctant to welcome the international steps taken towards a global minimum tax (e.g. Hungary), as currently one of their greatest competitive advantages is a low corporate tax rate.
Without exception, CEE countries applying traditional corporate taxation allow the carry-over of losses acquired in previous years and the possibility of standing these against the positive tax base of later years. This option typically can only be used for a predetermined period of time, usually for 5 to 7 years, in some places only for 3 to 4 years. Currently, 7 countries allow unlimited loss carryforward.
Regarding corporate income tax, it is worth noting that Hungary and Lithuania still do not apply withholding tax on capital income. Since 2019, group taxation has also been available in Hungary, which was previously only available in Austria, Poland and Bosnia and Herzegovina.
By 2021, transfer price regulations appeared in the tax regimes of almost all countries, except for Montenegro. The OECD's country-by-country reporting (CbCR), aimed at improving transparency, makes the information needed to assess tax risks available to local tax authorities.
It is obvious that there is a more consistent application of transfer pricing in corporate taxation, which is increasingly extended to local taxation. At the same time, the taxation alternative (introduced e.g. in Hungary, Estonia and Poland) that considers only dividends and capital income withdrawn from the enterprise as basis for taxation, and disregards profits or losses, is becoming increasingly prevalent in some CEE countries.
Regarding transfer prices, the biggest challenge of the past year has arguably been responding to the consequences of the global pandemic. The crisis has transformed expected profit levels, multinationals had to change their pricing structures, and the question remains to what extent the tax authorities will accept or challenge tax bases that will be significantly lower than in previous years.
Mazars publishes every year a regular analysis of tax regimes and monitors tax trends in the CEE Tax Guide, which offers businesses and investors a unique comparison of tax systems in 21 countries in the region. The publication, in which Germany, Austria, Russia and Ukraine are also represented in addition to the Visegrad countries, the south European and the Baltic states, mainly monitors labour costs, indirect taxes, as well as various aspects of corporate taxation and transfer pricing.
Pavel Klein, Tax Leading Partner, Mazars in the Czech Republic
Daniel H. Nagy, Tax Director, Mazars in Hungary