Investments vs. Pillar 2
Gross domestic product fell in Q4, unemployment rose to almost 4%, energy prices and higher interest rates are slowing construction, holding back the real estate market and businesses, and new investment is not flowing into the Czech Republic. This last phenomenon is due not only to the uncertain geopolitical situation in the region, rising inflation, wages, energy prices and the downturn in Germany, but also the not entirely competitive public support for new investments. This is not only in comparison with neighbouring countries, which, in addition to tax rebates, also offer cash subsidies for investment, job creation or land at preferential prices in functional industrial zones. Not only have traditional non-European competitors such as Turkey become involved in attracting investment, but more recently the example to follow, the USA, has as well. Their programs (including tax rebates) worth hundreds of billions of dollars in domestically produced green technologies (Inflation Reduction Act) and in the manufacturing and research of electrical components (Chips Act) are designed to attract manufacturing not only back from China but also from Europe, which many manufacturers are happy to hear. The European Union has already lodged an official protest over discrimination against European producers, though it seems not to have been successful.
The EU has responded with its Chip Act, which has been under discussion since last year, but is still going through the legislative process. Its future is unknown.
The current Czech government is also trying – the recently approved amendment to the Investment Incentives Act and the relevant implementing regulation should direct support to projects that “contribute to the Czech Republic’s goals of energy self-sufficiency or, for example, strengthening the European semiconductor ecosystem.”. On the other hand, the same amendment tightens the condition of higher added value (very simply, the requirement to spend funds in the field of research and development) to most of the Czech Republic. Moreover, even if all the specific conditions are met, the granting of the incentive may be vetoed by some of the ministries commenting on the application. Some have had such bad experiences in the past, e.g. with the Ministry of Finance, which does not seem to be a great supporter in general of investment promotion.
But even if the project successfully meets even the most stringent criteria and passes the rigorous assessment of all the relevant institutions, a new pitfall awaits investors: the spectre of Pillar 2. This set of rules, originating in an initiative against tax-aggressive structures poetically called Base Erosion and Profit Shifting (BEPS), simply seeks to ensure an effective tax rate of at least 15% in each jurisdiction. However, this may result in a company with an investment supported by a tax rebate reducing its tax liability on one line thanks to the investment incentive and having to increase it again on the next line through the Pillar 2 mechanism. Although the designers of Pillar 2 are aware that this mechanism catches not only situations where tax avoidance has actually taken place, but also legitimate support allowed by EU regional aid rules, they do not pay much attention to this. In addition to the gradually decreasing substantive carve-out, which can positively affect the effective tax rate of companies with employees and productive assets, they glibly recommend that states replace tax rebates with other public support instruments that will not reduce the effective tax rate.
Pillar 2 may thus have a major impact on the few remaining pro-growth (or anti-decline) tax instruments, i.e. investment incentives and the R&D deduction. Significant changes to the current system would be necessary if the state were to maintain support for new investment and R&D and keep pace with the competition. While some EU Member States are actively modifying the existing rules and replacing tax rebates with rebates on other levies or transforming them into a so-called qualified refundable tax credit (which is booked to income and thus does not affect the effective tax rate), in this country the situation is still quiet.
