capitalization rules apply to credits (loans) involving related parties. 4.2 Related parties’ transactions Transactions between related parties must comply with the arm’s -length principle (that is, by applying fair market prices). Otherwise, the tax administrator may adjust the tax base of the party involved in the transaction by the difference between the price actually charged and the fair market price and may assess additional tax and impose related penalties (including late payment interest on the additionally assessed tax). Certain exceptions to this rule relate to the interest on credits and loans. According to the Guidelines of the Czech Ministry of Finance, OECD Transfer Pricing Guidelines apply in the Czech Republic. 4.3 Permanent establishment Income derived through a permanent establishment of a foreign company located in the Czech Republic is regarded as Czech- source income. A permanent establishment is defined as a “fixed place of business through which the business of an enterprise is wholly or partly carried on.” A place of management, a branch, an office, a factory, a workshop and a mine, an oil or gas well, a quarry or any other place of extraction of natural resources are always considered fixed places of business. Providing services such as consultancy or management will create a permanent establishment if the services are rendered in the Czech Republic for more than six months in any consecutive 12-month period (unless a Double Taxation Treaty states otherwise). Similar rules generally apply to a construction site, an assembly line and other installation projects (but Double Taxation Treaties often

impose specific conditions as far as construction sites are concerned). A foreign company or individual who has a permanent establishment in the Czech Republic is obliged to register with the Czech Financial Authority and to file annual income tax returns. 4.4 Withholding taxes Withholding tax is applied to certain types of income earned by Czech tax residents and to a number of Czech-sourced types of income earned by Czech tax non-residents. The tax rate is 15 percent. However, the withholding tax rate applicable to the Czech sourced income of Czech tax non-residents as stipulated by the ITA may be reduced by the relevant Double Taxation Treaty. In case of income from Czech sources paid to taxpayers who are tax residents from countries that are not EU and EEA members, did not conclude a DTT with the Czech Republic, and did not conclude a bilateral agreement on exchange of information concerning income tax with the Czech Republic or a similar agreement on a multi-national basis, the withholding tax rate is increased to 35 percent. Taxpayers and EU residents can file an income tax return in which related expenses can be applied and withholding tax is considered an advance payment. However, this is only possible for certain types of income, namely royalties, interest, income from contractual penalties and remuneration for members of statutory bodies. No withholding tax is applied to dividends if the payer and recipient qualify as a subsidiary and a parent company within the meaning of the EU Parent Subsidiary Directive (for further details see Harmonisation with EU Tax Legislation below) and in certain cases of

ILN Corporate Group – Establishing a Business Entity Series

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