Foreigners captured by the Czech tax system

The new tax rules bring some obvious benefits to foreigners working in the Czech Republic, but several of its provisions are far from clear at first glance.

The expatriate population living and working in the Czech Republic forms a large base of people who decided to make the Czech Republic their temporary or permanent home and as such, these expatriates are also subject to Czech taxes. A lot of expatriates found the recent tax system changes, which bring a flat tax of 15 percent (or 12.5 percent as of 2009), beneficial and have made their own estimates of what they would save on taxes and how they would spend the surplus of their net funds. However, the tax reform was not only about the tax rates, but also brought other rules worth mentioning.

Due to media coverage in the last couple of weeks, one of the most visible foreigner-unfriendly rules was already tackled. What I am talking about is the personal tax deduction. On an annual basis, an amount of Kč 24,840 (or Kč 2,070 monthly) can be deducted from taxes. However, this deduction was allowed only to Czech tax residents and to Czech tax nonresidents who derive at least 90 percent of their income from Czech sources, meaning 90 percent of their income is subject to tax in the Czech Republic. Elements of income that are not subject to taxation, which are tax-exempt or where withholding tax is applied, are not included in the above 90 percent rule.

Passing the test After realizing that the personal tax deduction was not applied in their January payroll, a number of foreigners raised complaints about the discriminatory character of the above rule. The problem was that many payroll departments requested that foreigners prove their tax residency status in the Czech Republic to get the personal tax deduction. What many of the payroll accountants and officials at financial authorities do not yet fully understand is that the term “Czech tax resident” is not the same as the term “Czech national.” Czech nationals living and/or working abroad may become Czech tax nonresidents and foreigners living and/or working in the Czech Republic can become Czech tax residents. It is a facts-and-circumstances test and, if it is met, the foreigner can claim the monthly tax deduction. All EU and non-EU citizens have this possibility.

In most cases, it is possible to determine who is a Czech tax resident and who is not. A foreigner living and working in the Czech Republic, having a family here and spending more than 183 days in a calendar year in the Czech Republic will almost always be a Czech tax resident. The issue, however, is how to prove this to the payroll department. Confirmation from the Czech tax authorities is obviously the best way, but as the financial authorities generally refuse to issue such confirmation before the year end, the employer can accept a declaration of the employee or can assess the facts and circumstances of each individual case, and if the employer has such satisfactory evidence, there is no need to require official confirmation. The position that some payroll departments took— strictly requiring the tax residency confirmation—is, on the other hand, quite reasonable from the employer’s point of view, as the employer would be responsible for incorrect payroll withholdings.

Changes already pending Fortunately, the government has recently addressed the above issue in two ways. There is an amendment to the Income Taxes Act that should become effective in summer, which allows any nonresident to apply the personal tax deduction. However, in order to address the issue until the amendment becomes effective, the Ministry of Finance (MF) issued a measure on Feb. 7, 2008, that allows application of the personal tax deduction for all tax nonresidents in their monthly payroll. Therefore, in practice this issue has been successfully resolved in the benefit of Czech tax nonresidents.
Needless to say, there are also other tax deductions that are unavailable to nonresidents who do not fulfill the 90 percent rule—the tax deduction for dependent spouses without or with limited income, tax deductions for children, and other deductions.

More than just salary taxes Finally, it is worth stressing the consequences of becoming a Czech tax resident. Once a foreigner declares himself or herself to be a Czech tax resident, or asks the authorities for a confirmation of Czech tax residency, he or she consequently has to tax his or her worldwide income in the Czech Republic. However, as I mentioned, tax residency is a factsandcircumstances test, and foreigners may have to tax their worldwide income in the Czech Republic even without this declaration or confirmation. And this might be an important message to be delivered to the expatriate population, especially if they deregistered from tax residency in their home countries—usually, for example, in France or Italy—without declaring their worldwide income in the Czech Republic.

One may think that if he or she is a Czech tax resident but has only employment income from a Czech employer taxed through Czech payroll, everything is all right. But it is important to note that interest on foreign bank accounts, dividends, and income from renting or selling a house or flat in the home country might also need to be reported and taxed in the Czech Republic. And this is true even if the tax was withheld abroad or if it concerns U. S. citizens who keep filing for taxes in the U. S. wherever they may live.

Harder to hide And yes, the Czech financial authorities can really find out about this other income. While the German approach of using the secret services to track down bank accounts in Lichtenstein would probably not be applied in the Czech Republic (although one never knows), the EU Savings Directive on interest income, for example, is applied throughout most of the EU and also, based on bilateral agreements, in some non-EU countries, including some popular tax havens. Thus foreign banks, for example, will report the interest income to the authorities of the individual’s country of tax residency. Therefore, carefully reviewing one’s tax residency status seems to be a good step to avoid trouble with the Czech financial authorities and to enjoy spending the surplus cash brought by the tax reform with peace in your heart.