Tax reform strengthens Austria's competitive edge

Author: | Published: 24 May 2005
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The Austrian Ministry of Finance hopes to return up to €2.5 billion ($3 billion) a year to tax payers and foreign investors after radical reform of the country's tax laws. The reform aims to make Austria attractive to foreign investors by reducing tax on corporate profits. The law will be effective from January 1 2005.

Before May 1 2004, Vienna sat almost flush on the eastern border of the EU. It was the easternmost limit for foreign commercial investment in Europe while still enjoying EU safeguards. Austria itself shares borders with four of the new EU members: Hungary, Slovakia, the Czech Republic and Slovenia. Hungary and Slovakia, in particular, are easily accessible from Vienna and each of the four new members are enjoying economic growth. The accession of these eastern neighbours into the world's largest trading bloc could have threatened Austria's appeal for foreign commercial investment. By operation of its comprehensive Tax Reform 2005 (the Reform), Austria is poised for tough and effective competition.

Reduction of corporate tax

The Reform will take place following enactment of the new Austrian Taxation Act. In general, the Reform will be effective from January 1 2005. The most touted feature of the Reform is the slashing of Austria's corporate tax rate from 34% to 25%.

On its face, 25% still appears high when compared with Hungary and Slovakia. However, comparisons between flat corporate tax rates are not often useful in themselves. The real value lies in the various and specific incentives, exemptions and deductions that companies can use to lower their total tax burden. On this basis, Austria offers the following further concessions to complete its purpose to provide a highly competitive Austrian tax environment. The concessions compare favourably to other tax regimes in the region, and internationally:

Abolition of business/trade-income tax/net-worth tax
Miscellaneous business and trade taxes were cut in 1994, along with net-worth tax (including corporate substitute inheritance tax). Compared with other countries, for example Germany, corporations are now only required to pay one reduced rate of corporate income tax in Austria (25% as above).

No formal debt/equity ratios
Debt-to-equity ratio rules or thin-capitalization provisions are used to determine whether a company's commercial equity is adequate for the purpose of taxation. If the company's debt/equity ratio is found to be too slim, a portion of its debt to shareholders may be declared as shareholder equity. Shareholder equity is, of course, not deductible from corporate income and is taxed together with other taxable income. In Austria, however, there are no legally stipulated thin-capitalization provisions and the tax regime is rather liberal. So it is mainly left to the shareholders and the company executive bodies to decide which form of financing is the most advantageous in terms of business, managerial and fiscal considerations.

Deduction of interest payments from leveraged share acquisitions
Following the Reform, interest incurred on the acquisition of subsidiaries will be fully tax deductible even if the interest is paid on debt used to finance tax exempt participations in Austrian or foreign subsidiaries. Compared with other countries in the region, this is a big incentive for establishing holding companies in Austria.

In addition, the Austrian Corporate Income Tax Act grants a tax exemption for capital gains from the disposal of participations in foreign companies. The level of shareholding required for the exemption is at least 10%, combined with a holding period of at least one year. However, the shareholder may also opt to treat its participation as taxable.

Set-off of losses incurred by foreign permanent establishments
The Reform will incorporate a 2001 decision by the Austrian Administrative Court of Justice to allow foreign companies to set-off losses suffered by their foreign permanent establishments, including foreign partnerships, against profits they make in Austria for the calculation of income. In turn, later profits of the permanent establishment will have to be considered in Austria once the foreign losses can be used in the country of permanent establishment.

No formal legal controlled foreign company (CFC) regime
A controlled foreign company is generally regarded as a company in which most of its shareholders, and its wielders of substantial control and influence, are resident outside the country where the company has its registered business address. As a general definition, CFC rules impose a tax liability upon resident shareholders for profits generated in foreign corporate entities. Generally speaking, Austria does not have formal CFC legislation. However, in certain circumstances a foreign entity cannot be recognized, even for Austrian tax purposes.

Generous corporate tax deductions and incentives
Further, in an effort by Austria to lure technology companies, those active in research and development will be eligible to receive even greater tax incentives. These are:

  1. Research and development allowance
    Austria will provide a tax-free allowance of 25% or 35% for development or improvement of inventions that prove valuable to the domestic economy. Generally speaking, the allowance is provided in the form of an attractive 125% tax deduction for the cost of research and/or development of the product. This provision is of interest to research and technology companies due to the expected corresponding profits in this industry. But not only R&D companies will benefit. The allowance is also widely available, due to the broad definition of expenditure for research and development that is applied.
  2. Invention premium
    In addition, a further premium of 10% is available for the cost of investments required to discover new inventions. The Austrian Economic Recovery Law 2002 provided this before the Reform was drafted. This provision allows companies to claim 10% of the investment costs necessary to procure new inventions as a tax-deductible amount. Companies are also eligible for a further research premium of 3%. As with the R&D allowance, the invention must be valuable to the Austrian economy. It is not incumbent on the company's researchers to establish this link in either case.

Pharmaceutical companies have already used both these high-tech tax provisions to great effect, creating research clusters in many areas in Austria. These two allowances can be claimed for the same expenditure on both R&D and invention, but not at the same time. And, as with R&D above, a broad definition of development expenditure will be applied.

New group relief rules

Austria's previous Organschaft model was old fashioned and cumbersome. It required the completion of special agreements between companies to establish their relationship, and therefore their tax liability. The legislative conditions were often difficult to meet and, even when they were met, the resulting tax benefits were not immediately available. The Reform will scrap the Organschaft model and will replace it with a new, simplified group tax system, which will allow groups of companies to pool their profits and losses and to be taxed accordingly.

What constitutes a tax group?
The Reform will allow companies to form groups for the pooled assessment of their taxes. To constitute a group of companies and take advantage of this provision, the Reform requires that the following conditions be met:

  • The tax group must have a registered business address in Austria. This is achieved when the tax group is headed up by an organization or business that is registered with the relevant Austrian authorities and when the group head is liable in Austria for the assessment of its taxes. A registered business address is the organization's address as it appears on the organization's formation documents.
  • The group leader will normally be an Austrian corporate organization or similar but it may also be a cooperative or mutual insurance association or bank that is subject to unlimited taxation. Alternatively, it may be an Austrian registered branch of a foreign corporation listed as an entity in the EC Parent Subsidiary Directive, or similar. Joint ventures will also be permitted to lead tax groups in certain circumstances.
  • The leader of the tax group must hold a minimum of 50% of both the voting rights and the registered share capital in the participating subsidiaries (compared with a 75% participation rate required by the previous Organschaft model).
  • A tax group must be formed in the financial year before the year in which it begins operation. It must be registered as a tax group. Further, the group must operate as a tax group for at least three financial years, otherwise the benefits of joining the tax group of companies will be omitted retrospectively.
  • The concept of the Austrian regime regarding tax groups of companies is flexible. Even if a subsidiary meets the conditions to be part of the tax group, it is at the taxpayer's sole discretion to file an application and to have the subsidiary in the tax group or not.

Benefits offered by tax groups for foreign investors
Foreign investors will draw particular benefit from the Reform's group tax system. The Reform will allow all profits and losses of the group, regardless of their origin, to be attributed to the head of the group, regardless of its level of participation. It will allow losses incurred by a group's foreign companies to be offset against its profits in Austria, lowering the group's assessable profit and therefore its tax burden.

The Reform's group taxation provision will appeal to groups of companies looking to invest, in particular, in the new EC member states. It will encourage investors to take advantage of the benefits offered by Austria's neighbours and other new EU member states (low labour and production costs, for example) while at the same time capitalizing on Austria's advantages (lowest EU property tax rates and highly developed infrastructures) and its tax reform. Group taxation will apply both to Austrian resident companies and to foreign operations with the dual aims of preventing companies in Austria from relocating and establishing an investor-friendly climate for non-Austrian businesses.

Competition continues

EU tax harmonization is still little more than a talking point and member states, including Austria, will continue to compete to attract their share of foreign investment. Austria's reform is a response, in part, to the growing potential for EU investment after expansion of the EU.

Austria's reform will result in making profitable businesses even more profitable. Companies looking to capitalize on the increased competition between EU member states should consider Austria as a strong contender. To take full advantage of the new law, investors should review the position of their headquarters, their investments (in particular Austrian share acquisitions, and mergers and acquisitions) and the structure of their international interests for January 2005 and beyond.