New Income Tax Act (Introduction of Flat Income Tax - 19%,
recognised as tax deductible items. Additionally, employers' contributions to their employees' DDP also lost its status of non taxable items (for employees). Yet, they can still be deducted from the employers' tax base. This contribution will hence increase employees' tax base, however, it will not constitute a part of the base on which social security benefits are calculated. The Ministry of Finance and the Ministry of Labour are considering providing further incentives to voluntary pension schemes as of 2005 by implementing either tax benefits or state bonuses. The new Act also abolished all tax exemptions of revenues gained from the sale of securities and shares (with the exception of the securities acquired before the new Act became effective). Other exemptions abolished include: revenues of securities issued by the NBS, revenues denominated in foreign exchange, and revenues of mortgage bonds. The Act abolished the option of getting a tax loan as well as limit for the tax recognition of depreciation and leasing costs regarding passenger cars.
The Act recognises provisions for bad debts as deductible items up to 100% of their value (debts overdue 12 months), however, it does not allow the businesses to write off these debts for good.
The initially approved Act stipulated that the yields on pension savings would also be subject to flat taxation as from January 2004. These are savings that people will make within the so-called capital pillar of the pension scheme (fully-funded private pension scheme) in pension administration companies from 2005 onwards. The pensions from the first pay-as-you-go pillar of the Social Insurance Agency were not to be taxed. Later, the revenues (i.e. future pensions) were also exempt from taxation in the Act on Old-Age Pension Savings(see page 67). The proceeds from the sale of a flat or a house are also exempt from income tax subject to the fact that the seller owned the respective real estate and, simultaneously, this house or flat was registered as his permanent residence for at least two years preceding the sale (as before). The Members of Parliament decreased the period to two years from the originally proposed five years.
The new Act is much closer to the international tax law than ever before thanks to its definition and to precision. A marketing year (does not necessarily have to be a calendar year) could be used after the consent from the tax administrator. Besides, depreciation categories have been reduced to 4 (4, 6, 12, 20 years). The abolition of the fifth category should lead to increased investment in real estate. The Parliament also supported and prolonged the entitlement of beneficiaries to receive tax relief (Volkswagen, Bratislava, U.S. Steel, Košice) until the end of 2006, in compliance with the EÚ regulations.
The previous Income Tax Act produced 31.2% of the tax revenues. Several provisions in the new legislation will bring their fruits to the state budget only after 2004, however others will do so as early as in 2004. The overall impact on the state budget in 2004 was estimated by the MF at Sk 20.6bn (down by Sk 12.4bn in the case of income tax and by Sk 8.5bn in the case of corporate tax). This difference is to be offset by higher revenues from the flat VAT at 19% (see page 31) and by increased excise taxes.
A disagreement with the new Act was expressed by the opposition Members of Parliament who claimed that the Act will adversely affect the weakest social groups. The new Act was criticised by the representatives of the Confederation of Trade Unions of the SR who believe tax justice is embodied through progressive income tax, i.e., those who earn more pay more. They argue that the state will cease fulfilling its social role and will be replaced by a market state where there is no room for solidarity. Some opposition parties regarded the new Act as socially unjust, merely exacerbating social inequality. They also espoused the progressive taxation. Other critics argued that the new Act will back financially strong income groups, who do not need it, to the detriment of people with low earnings. Some critics proposed to return the Act to the Government for a revision and also to decrease taxes to handicapped people. The MF says that the aim is not to deform the Act and, hence, the problems of handicapped people should not be addressed in the tax, but in social security legislation. Other opponents claimed that the tax reform would increase the differences in the backward regions where the population is characteristic of low purchasing power. The major problem in these regions is expected to be the single VAT rate. Some members of the Parliamentary opposition agreed with the transfer of tax weight from direct to indirect taxes, but they argued that the change is proceeding very quickly. The representatives of the TU supported the changes to taxes but expressed a reserved stance towards the Government's tax policy, particularly to keeping tax exemptions and to sudden ad hoc changes during the year (e.g., the increase of excise taxes in summer 2003 (see page 32)).
The authors say that the primary aim of the Act was to simplify the tax system and tax legislation, permanently boost sustainable growth of the economy and inhabitants' life standard. The original tax system was, in their opinion, too complicated and the new system is to be more transparent and effective. The latter should also create room for fighting tax evasions as the motivation not to pay taxes will be much lower. The Minister of Finance, Ivan Mikloš, thinks the new Income Tax Act is a pivotal constituent of the tax reform and is convinced that it will bring a fundamental improvement of the business environment, as well as an increased motivation to work, save and invest. He also claims that the flat tax rate is fair: although it does not tax everyone equally, it is spread evenly across all types of income. The Act on the Flat Tax has removed double taxation of income, e.g. profits and shares on profits. Thanks to eliminating a number of exemptions, the Minister thinks, the Act is now going to perform its main, fiscal function.
A number of views agreed that the flat tax rate will bring the greatest benefits to taxpayers with above-average income and to inhabitants and families with children with below-average income.
However, in contrast with the whole tax reform, the flat tax rate decreases the tax burden of all income groups. Conversely, the tax reform as a whole (including the single VAT flat rate, excise taxes) will tax more families without children and individuals with an average income between Sk 11,500 to Sk 21,000. This fact was hurled with criticism. Contrary to the unpopular parts of the reform, the Income Tax Act will raise the income of the working population and in the medium term eliminate the adverse effects caused by the higher VAT and excise taxes, which will thus not be so painful in the following years.
According to the MF, the lower tax should bring significant positives. The companies will retain more funds that could, e.g., be invested. It is also reasonable to expect a lower degree of tax evasions, increased investment (incl. foreign investment) and new jobs for the unemployed. In the Finance Minister's opinion, Slovakia will hence have an unrivalled tax system among all OECD and EU countries. Slovakia's competitiveness and attractiveness will rise. Even before the adoption of the core act of the whole reform, the country received recognition from reputed experts and institutions. The Slovak tax reform is, e.g., recommended by the IMF. Positive effects of the flat tax will bring fruits within this Cabinet's mandate, however, the forecasted significant betterment will not come immediately as the purpose of the reform is to bring benefits in the medium term.
The Minister of Finance thinks that the success of the Slovak companies will also be reflected in the increased demand for workforce, which will raise wages and purchasing power. Many economists regard the flat income tax rate, together with the single VAT rate, to be the biggest change of the tax system since 1993. There were also voices calling for an even lower rate than 19%. The Finance Minister admitted that a decrease could be possible in the following years.
There are several countries in Europe with a flat income tax rate. Estonia implemented a flat tax of 26% in 1994 (additionally, as from 2000 the country does not levies any taxes on corporate profits reinvested in the country), followed by Latvia with 25% in 1995. In 2001 the flat tax of 13% was adopted in Russia. As of the beginning of 2004, it has also been introduced in Ukraine, also at the rate of 13%. The example of Estonia shows the positive impacts of flat tax on economic growth, purchasing power, corporate profits and the state budget balance (surplus).
The President did not sign the Income Tax Act and returned it to the Parliament recommending it not to pass the Act as a whole. In his mind, the implementation of the flat tax would be advantageous only for taxpayers with income over Sk 25,000 a month, which represents about 11% of all taxpayers. The increase of the tax deductible item will help only 13% of taxpayers with low income. The President further reasoned that the flat income tax hand in hand with the single VAT rate does not decrease the tax burden. The Parliament outvoted the President's veto on 4 December 2003.
The Income Tax Act became effective on 1 January 2004.
Evaluation of the Experts’ Committee:
The new Income Tax Act introducing a flat tax rate of 19% received many positive attributes: one of the most important and most reformatory acts in recent years, a flagship of Slovakia's economic reforms, a fiscal revolution, a fundamental and brave act, the clearly most positive element of the tax reform, a unique and principal tax reform leading the right direction, etc.
The new Income Tax Act will have a positive influence on many areas. A relatively low tax and a simple tax system without complicated exemptions and provisions will provide the economy with new vigour, create prerequisites for a healthy economic growth, render stimuli for local business as well as domestic and foreign investment, help the labour market, and discourage taxpayers from tax evasions. The implementation of a simpler tax legislation and administration was necessary due to the work overload of Tax Authorities. The Act also increases the country's competitiveness. The tax reform, in particular, the flat tax has improved Slovakia's image abroad and generated many comments in renowned world media. The experts appreciated the shift of emphasis from direct to indirect taxes. Many also think the flat tax is fairer. A positive is the fact that after the implementation of the flat tax of 19% and increase of deductible items, no taxpayer will pay higher taxes than before.
Several experts deemed it possible that the tax rate was lower, which would provide Slovakia with an even larger competitive advantage in the region and will come close to the rates in some of the former USSR countries. The lower income tax rate should be implemented such that indirect taxes remain stable. At present, all taxpayers' savings from income taxes will be expended on higher VAT and excise taxes (Note: this does not apply to all social layers). Initially, it may be difficult to defend the flat tax if the revenues are lower than anticipated. A significant positive effect will however be manifested in the medium term, when it is expected that the purchasing power of the majority of the population will rise. The Income Tax Act dominates in its orientation pro futura.
There were contradictory views regarding the tax assignments, the abolition of the lump-sum tax and the implementation of lump-sum expenses for tradesmen.