On January 1 2017, Croatia woke to a new and reformed tax system that the government hopes will end the frequent and endless amendments to tax laws and finally set the foundations for an attractive investment environment.
The government has delivered a comprehensive reform by changing as many as 15 tax-related Acts. Most of the provisions entered into force on January 1 2017 with certain exceptions that will take effect in 2018 or 2019.
The reason for this change is the high tax burden in Croatia in comparison to surrounding countries. Moreover, the tax system offered too many tax deductions, reliefs and exceptions with questionable effect. The task force set up by the government in April 2016 identified that 44 changes were made to tax regulations between 2012 and 2015 that led to a state of tax uncertainty – a significant obstacle to both domestic and foreign investment.
With this latest comprehensive tax reform, Croatia introduced changes to the following regulations:
- Value Added Tax (VAT) Act;
- Corporate Income Tax (CIT) Act/Profit Tax Act;
- Personal Income Tax (PIT) Act;
- Real Estate Transfer Tax (RETT) Act;
- Contributions Act;
- Local Taxes Act;
- Motor Vehicles Special Tax Act;
- Tax Advising Act;
- General Tax Act;
- Fiscalisation Act;
- Administrative Fees Act;
- Excises Act;
- Customs Office Act;
- Tax Administration Act; and
- Act on Administrative Cooperation in the Area of Taxes.
Given the extent of amendments and the fact that they are yet to be implemented, below is a general outline of the important aspects.
The government's task force found that taxpayers with a small turnover had a high tax burden, a tax rate that was too high for certain goods and services, and a high tax burden on imports of some categories of machinery and equipment. Therefore, in order to decrease the overall tax burden, enhance the economy, simplify administration, build a stable, sustainable and easy tax system and provide stability to taxpayers, certain amendments to the VAT Act have been made.
Instead of three tax rates (25%, 13% and 5%), only two will be in use (25% and 13%), with certain goods and services reallocated.
Pursuant to the Council Directive (EU) 2016/1065, the tax on vouchers is introduced, but will take effect from January 1 2019.
The threshold for mandatory registration for VAT has also increased to HRK 300,000 ($43,000), which will be applied from January 1 2018. As of January 1 2017, the registration period for voluntary registration into VAT system has been decreased from five to three years.
In addition, it will now be possible to apply a tax deduction of 50% to advance VAT payments for the acquisition or lease of motor vehicles when the value does not exceed HRK 400,000.
For real estate exempt from VAT payments it will be possible to opt for VAT taxation provided that the taxpayer is registered for VAT at the moment the transaction occurs and has the right to deduct the advance VAT payment.
Other amendments, inter alia, relate to import and customs issues, reciprocity in refunding VAT to third parties, new measures in case of suspicion of abuse of VAT ID numbers and the responsibility of taxpayers in case of fraudulent activities, mandatory content of an invoice, as well as certain changes in the penalty section of the VAT legislation.
Corporate income tax (profit tax)
The tax reform intends to reduce the tax burden for all taxpayers, particularly supporting start-ups and encouraging the development of small entrepreneurship.
Thus, the tax rate has been decreased from 20% to 18%. For entrepreneurs with income lower than HRK 3 million, the rate will be further discounted to 12%. Small taxpayers with an annual income lower than HRK 3 million will also have the option to choose the possibility to calculate the profit tax by using the cash method.
For the sake of fiscal sustainability, some interventions into the tax base (extension) have to be made and therefore the tax relief for reinvested profit has been removed because only 0.70% of taxpayers actually used this option. In this respect, some changes in the recognised tax deduction will also take effect: representation expenses will change from 70% to 50%, whereas personal transportation expenses will be amended from 50% to 30%, but the latter will only enter in force from January 1 2018.
There are new provisions regarding the advance pricing arrangements, and it will be possible to agree on an interest rate between affiliated companies by either using a transfer pricing method or the interest rate prescribed by the finance ministry. In order to bypass the obstacle in form of bankruptcy and distraint proceedings, the government has redefined certain conditions for writing off receivables and given the possibility to banks to write-off bad placements without having to initiate bankruptcy or distraint procedures (the latter will only be possible to be carried out during 2017).
Personal income tax
While the VAT Act and Profit Tax Act were amended, there is an entirely new Personal Income Tax Act. This is because a high tax burden on salaries was identified, which impacts negatively on the competitiveness of highly educated employees. In addition, the taskforce's analysis emphasised the need for simplification of processes to determine and report personal income tax.
Among the many changes in the Act, the tax rates have changed from 12%, 25% and 40%. The new rates are:
- 24%, applying to a monthly salary up to HRK 17,500; and
- 36%, applying to income above HRK 17,000.
These rates are reduced by 50% for certain taxpayers – pensioners and employees resident in certain local jurisdictions with a low development rate and in Vukovar.
The basic personal allowance has also been increased from HRK 2,600 to HRK 3,800. However, the calculation of the allowance has been changed, which will initially make the payroll calculation a bit more complex than it was until now.
Another novelty is the introduction of two new terms: annual income and final income. Annual income is all income derived from employment, independent activity and other income, except income that is considered final and it will be determined through the annual tax return. The tax rate for annual income is 24% for an annual tax base up to HRK 210,000 and 36% for the base exceeding this amount. The final income is considered to be income derived from property and property related rights, capital and insurance and it will be, depending on the source, taxable using rates of 12%, 24% and 36%, where such taxpayers will not be able to use the personal allowance deduction nor submit the annual tax return. Many provisions regarding the annual tax return were unclear and subject to interpretation, which has been attempted to be resolved by these amendments. Categories of taxable and non-taxable income have been redefined as has the definition of family members that may be considered as supported family for purposes of tax deduction.
The Act also introduces the electronic tax card that will decrease the administrative burden with the tax offices.