Corporate Income Tax Act Amendments to take effect on 1 January 2019

The Slovene Ministry of Finance submitted a draft amendment to the Corporate Income Tax Act for public discussion

The draft amendment to the Corporate Income Tax Act (ZDDPO-2) will transpose into the Slovene national law the Council Directive 2016/1164 laying down rules against tax avoidance practices that directly affect the functioning of the internal market. Pursuant to the aforementioned Directive, a general anti-abuse rule and controlled foreign company rules are to be transposed into the Slovene legislation by 31 December 2018 at the latest.

Taxation of legal persons at EU level

The corporate taxation at EU level is, to a large extent, not uniform, as EU Member States may partly freely regulate their taxation systems for corporate income. The free tax policy-making, especially in the field of corporate taxation, is an essential element of the sovereignty of states and jurisdictions, which can lead to gaps or other frictions in the EU tax system.

There are 28 systems for corporate taxation at EU level, but they are not harmonized due to the possibility of free tax policy-making. With certain directives, the EU has already sought to tackle shortcomings in the interaction of different tax systems and to achieve a fairer and more efficient taxation, however, gaps remain, which enables the reduction of tax bases and the transfer of tax-free or less-taxed income to other countries.

In order to achieve a more unified taxation and to prevent abuse in the field of corporate taxation, the Council Directive 2016/1164 laying down rules against tax avoidance practices that directly affect the functioning of the internal market (hereinafter referred to as “the Directive”) was adopted on 12 July 2016.

The Directive is applicable to all taxpayers that are subject to the corporate income tax (CIT) in the EU, also to permanent establishments of entities resident for tax purposes in a third country if they are situated in one or more EU Member States.

The Directive lays down rules in the following areas:

• general anti-abuse rule,
• controlled foreign company rules,
• rules to tackle hybrid mismatches,
• limitations to the deductibility of interest and
• exit taxation.

The Directive's objective is to prevent tax base reductions in the internal market and the redirection of profits from the internal market as well as to eliminate possible double taxation when applying those rules.

Among the rules listed above, the Directive requires Member States to apply the general anti-abuse rule and the controlled foreign company rules as of 1 January 2019.

In short:

• The general anti-abuse rule is primarily aimed at tax systems where the practice of tax abuse is not regulated by special provisions. The rule should be applied to arrangements that are not genuine. The application of the rule will be unified at EU level, so that the scope and results of the application will not differ in domestic and cross-border cases.
• Controlled foreign company rules have the effect of re-attributing the income of a low-taxed controlled subsidiary to its parent company. Then, the parent company becomes taxable on this attributed income in the state where it is resident for tax purposes.

Situation in Slovenia

The Slovene Tax Procedure Act contains a provision aimed at preventing the abuse and avoidance of tax obligations, which is based on a substance over form approach. In accordance with that provision, invalid legal transactions, fictitious transactions and breaches of law due to a particular act or conduct do not affect taxation. This provision applies broadly to all taxes and is not specifically adapted to the taxation of legal entities, as is the case with the Directive.

The Slovene Corporate Income Tax Act (ZDDPO-2) lays down, however, specific rules for individual legal concepts that protect these concepts from abuse and avoidance, but does not include a general anti-abuse rule, as is laid down in the Directive.

The regulations that have so far governed the taxation of legal entities in Slovenia also do not lay down rules on controlled foreign companies, as stipulated by the Directive.

Proposed Amendments to ZDDPO-2

In order to reduce the practice of tax avoidance, the following amendments to the ZDDPO-2 are proposed in accordance with the Directive:

1. General anti-abuse rule

The general anti-abuse rule, which shall be added to the general provisions of Chapter 1 of ZDDPO-2, stipulates that for the purposes of calculating the corporate tax liability, a Member State shall ignore an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage (claiming tax reliefs, covering tax losses, exemption of income from the tax base, deduction from the tax, withholding tax exemption) that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstance.

In accordance with the Directive, an arrangement shall be stipulated as a random act or activity (e.g. transaction, agreement, measure) and be regarded as non-genuine to the extent that it is not put into place for valid commercial reasons which reflect economic reality.

The general anti-abuse rule is applied only when all other rules set out in the ZDDPO-2 (e.g. rules on transfer pricing or controlled foreign companies) prove ineffective in preventing the acquisition of a tax advantage.

2. Controlled foreign companies

A new chapter X.b. is added to ZDDPO-2, which includes the concept of controlled foreign companies and is divided into two groups of rules.

The first group contains provisions regarding the definition of a controlled foreign company, including the definition of critical association and the level of taxation in the country of tax residence, and the treatment of income re-attributed to the parent company.

The definition of a controlled foreign company consists of two main defining elements, which must be cumulatively fulfilled. The first is based on the participation in and entitlement to the profit, while the other one on the actual taxation as compared to the possible taxation in Slovenia. Thus, an entity not subject to taxation under ZDDPO-2 shall be regarded as a controlled foreign company where the following conditions are met:

• the taxpayer by itself, or together with its associated enterprises, holds a direct or indirect participation of more than 50 percent of the voting rights, or owns directly or indirectly more than 50 percent of capital or is entitled to receive more than 50 percent of the profits of that entity; and
• the actual corporate tax on profits paid by the entity is lower than one half of CIT that would have been charged on the entity's profits under the applicable corporate tax system in Slovenia in accordance with ZDDPO-2.

The definition of a controlled foreign company is, therefore, based on the criterion of critical association between the parent company and the foreign company, and on the criterion of the taxation level in the country of tax residence of the foreign company. It should be noted that this chapter does not apply to foreign permanent establishments of taxpayers, since, according to ZDDPO-2, the income or profits of the foreign permanent establishment are included in the taxpayer’s tax base pursuant to the general provisions of this Act, in accordance with the scope of the tax liability.

Furthermore, this group of rules also foresees the implementation of provisions regarding the treatment of income of controlled foreign companies, namely its inclusion in the tax base of the taxpayer, i.e. the parent company. Then, the parent company becomes taxable on this attributed income in the state where it is a resident for tax purposes.

The types of income of a controlled foreign company re-attributed to the parent company are exhaustively listed in the draft amendment to the ZDDPO-2. The taxpayer's tax base shall include non-distributed income of the controlled foreign company, which is derived from the following categories:

• interest or any other income generated by financial assets,
• royalties or any other income generated from intellectual property,
• dividends and income from the disposal of shares,
• income from financial leasing,
• income from insurance, banking and other financial activities,
• income from invoicing companies that earn sales and services income from goods and services purchased from and sold to associated enterprises, and add no or little economic value.

The amendment to ZDDPO-2 also provides for exemptions from the obligation to include the exhaustively listed types of income in the tax base of the parent company. In accordance with the Directive, the rule on re-attribution of the controlled foreign company’s income shall not apply where the latter carries out a substantive economic activity supported by staff, equipment, assets and premises. The same is true if one third or less of the income received by a controlled foreign company is considered one of the exhaustively listed types of income.

The second group of rules contains provisions regarding foreign losses or, that is to say, their inadmissibility to be included in the taxpayer's tax base; the proportionality of the included income with regard to participation; the time of inclusion; the prevention of double inclusion of income in the taxpayer’s tax base and the recognition of the deduction of the actually paid foreign tax, i.e. prevention of double taxation.

In accordance with the Directive, the losses of the controlled foreign company shall not be included in the taxpayer's tax base but may be carried forward in accordance with the national rules on carryforwards and coverage of tax losses.

The income to be included in the tax base is calculated proportionally in relation to the taxpayer's participation in a controlled foreign company, which simplifies the arrangement and prevents any possible double taxation. It is stipulated that the income is included in the taxpayer's tax base in the tax period in which the tax period of the controlled foreign company ends.

Further provisions serve to prevent or eliminate double taxation by reducing the base for a certain income by way of tax exemption or deduction from the tax with regard to the tax paid abroad.  It is necessary to ensure that there is no double taxation of this income.

Entry into force and application

The general anti-abuse rule and the controlled foreign company rules must be transposed into the Slovenian national law no later than by 31 December 2018. The envisaged entry into force of the Act Amending the ZDDPO-2 is 1 January 2019.