On 1 January 2008, the Czech government introduced comprehensive tax reforms as a part of major public finance reform package.

The reforms include corporate, individual, energy, inheritance, gift and VAT tax measures and generally represent a shift from direct taxation by lowering income tax rates to indirect taxes via increasing VAT and excise taxes.

The reforms aim to eliminate the government deficit and increase the stability of public finances.

Changes in income taxation (individual and corporate) are the most important for buy to let property investors as they impact on rental income tax rates.

Personal income tax

The way of calculating income tax and its rates has changed. The 2007 progressive scale of 12-32% has been replaced by the flat rate of 15%, which from 2009 will be reduced to 12.5%.

It sounds like a big change, but the net result may not be so dramatic as the way of calculating the tax base has changed.

Until 2007, the tax base was gross salary minus social security payments.

From 2008, the tax base of an employee includes their gross salary, plus all the health and social contributions payable by the employer (which amounts to another 35%).

The employee's social contributions (12.5%) will no longer reduce the tax base. In the case of self-employment, individuals will not be able to deduct their mandatory social and health insurance contribution from the tax base.

This way a new concept of 'super gross salary' was introduced:

Super gross salary= base salary + 35% of base salary
Once the super gross salary has been determined, the 15% tax rate applies to determinate the amount of income tax to be paid.

Effectively, while the tax rate is lower, it will be paid on a much higher tax base. That means most Czechs will end up paying around the same amount of tax.

Personal tax relief has also changed.

The amount increased from CZK600 to CZK2,070 per month. To claim the personal tax relief on a monthly basis you must be a Czech citizen or tax domicile in the Czech Republic. In other cases, the relief can be claimed at the end of the tax year.

An EU citizen could be considered as a tax domicile in Czech only if he fulfils one of the following criteria:

- has permanent residency
- resides in the Czech Republic more than 183 days in the year
- earns 90% of his annual income in the Czech Republic.

Tax for an individual who meets the criteria of permanent residency of the Czech Republic is calculated on his income earned inside the Republic and abroad.

A foreigner, who does not qualify as a permanent resident in Czech pays income tax only on the income earned in the country.

Paying rental income tax in Czech Republic

Effectively, foreign property investors who own properties in the Czech Republic and generate income only from letting out such properties are taxed according to the income tax rate of 15%.

They must prepay tax that will be offset in an annual tax return. The advances are determined on the basis of the previous year's tax return. In the case of a new business, the prepayments are calculated on the basis of estimates made by the owner of the business.

The advance payments have to be made by the 15th of each month and the number of payments depends on the income:

Between CZK 30,000-150,000 - twice annual payments of 40% liability.
Above CZK 150,000 - Quarterly payments of 25% of liability

An allowance is made for expenses incurred against rental income. The allowance is calculated as either a flat 20% of the gross rental income or the actual expenses and is deductible from the gross rental income.

Additionally, capital gains in the Czech Republic are taxed as ordinary income (this applies if a property sold within five years). After five years, the tax liability is 0%.

The tax year in the Czech Republic is a calendar year and annual tax returns must be submitted by 31 March.

The deadline is extended to 30 June if the tax return is prepared and submitted by a registered in Czech tax advisor under the power of attorney.

Corporate income tax

The Czech government has been gradually reducing the corporate income tax rate (CIT) to make the country more attractive for foreign investors.

In 2008, the CIT rate is 21% and will be further reduced to 20% in 2009 and to 19% in 2010. Those reductions will bring the Czech Republic closer to the rates in CEE region (19% CIT applies in Slovakia in Poland) and make the Czech economy more competitive.

Changes in CIT rates are important for property investors who bought properties in Czech via a company as their rental income will be taxed according to new, lower scale.

Summary

Tax reforms have been welcomed by many tax experts, despite the fact that the tax authorities are usually not keen on frequent changes because they create the impression that the system is complicated and opaque.

However, the latest changes are perceived as changes for the better. The reform of public finances is thought to be a vital factor in promoting economic growth and maintain stable macroeconomic environment.

Jan Žůrek, a partner at KPMG, says that the chances are that the Czech Republic's image will improve and its attractiveness for foreign investors will increase: "The new legislation creates a favourable environment for the creation of holding companies, thereby attracting more financial capital."