14/8/2023 |Articles are machine translated
Investment incentives. | Photo: Shutterstock
Since the beginning of the system of investment incentives in the Czech Republic in the 1990s, their granting has always been not only an economic but also a political matter. Support for projects has repeatedly been the subject of sometimes acrimonious discussions and the law has been changed many times. The latest amendment to the Investment Incentives Act of 2019 introduced a subjective element to the system by giving the government the ability to decide whether or not to grant an incentive essentially at will. Another amendment is now in the process of being approved, which brings some positive changes. As far as transparency is concerned, it is not yet complete.
In mid-July, the government approved, among other things, a package of applications for investment incentives. Of the ten submitted, two were finally passed: the company Crytur, a manufacturer of components for chips, and Rockwool, which produces technical insulation. Eight others met the criteria set out in the implementing regulation for the Investment Incentives Act, a 2019 government decree – otherwise the Ministry of Industry and Trade (MIT) would not have put them on the government’s table. However, each of the ten applications mentioned above submitted to other ministers has already had a statement from the industry ministry on whether it recommends to approve or reject them.
So what is the situation with investment incentives? Who can apply for them and who cannot? And will the amendment to the law, which is in the process of being approved, contribute to greater transparency in the decision-making process for project support?
Under the Investment Incentives Act, both foreign and Czech entities, both new and expanding on the market, are entitled to incentives. Incentives are granted to companies in the manufacturing industry, technology centres and strategic service centres.
The criteria for an investor to qualify as a (potentially successful) applicant are set out in the implementing regulation to the Act. These parameters should correspond to the government’s vision of the projects to be supported.
The basic conditions to be fulfilled by an investor in the manufacturing sector are the amount of the investment, the number of jobs created and the number of employees with higher education, the region where the investment will be located, cooperation on research and development and some others. The investor must also promise (and then deliver) that the activity, at least to that extent, will be maintained for at least five years. There is no restriction on the basic qualification among incentive applicants as to the type of manufacturing industry; no sector is excluded.
Currently, the Investment Incentives Act of 2019 is in force (or rather, it is the severalth amendment to the Act from 2000), which for the first time since the introduction of this form of incentives in the Czech Republic has significantly changed the way of deciding who gets the incentive. While previously it was the case that an applicant who fulfilled the conditions set out in the law and the accompanying regulation would automatically receive an investment incentive, officials now have the opportunity to reassess all applicants from their subjective point of view.
This is confirmed by the MIT itself. “The Ministry of Industry and Trade submits to the government all projects that meet the minimum legal parameters. The government evaluates the projects based on its own discretion and can agree or disagree with the granting of support,” Marek Vošahlík, head of the ministry’s press department, told Czech Car Industry.
“The fact that from 2019 onwards the government still approves each application after all conditions have been met has several problems. Firstly, it significantly prolongs the whole process, from the previous roughly four months to today’s twelve months, and secondly, it introduces a significant element of non-transparency and uncertainty for investors into the system,” Ondřej Votruba, director of the Association for Foreign Investment (AFI), assesses the current situation.
The fact is that for every unapproved investment, the government attaches a brief one-sentence reason why it decided not to support the investor. This may be, for example, low technological complexity, limited impact on the region and the state, insufficient added value, lack of cooperation with universities or insufficient average gross monthly wages of employees.
Among the projects not approved in July were a plastics processing firm, a digital marketing firm, and a food supplements firm, among others.
The July incentive package was the second on the government’s desk this year. The first also included ten projects, of which two were approved. Last year, one out of thirteen projects passed. According to the MIT, further applications for incentives will be approved in September.
Representatives of rejected investors are usually not interested in commenting publicly on the matter. However, one example from the past can be given. In July 2021, GENERI BIOTECH, a biotechnology company from Hradec Kralove, applied for an investment incentive for “Reconstruction, extension of the operational building and fundamental changes in the overall process of production of in vitro diagnostic devices” after meeting all the conditions set by the legislation. The decision was awaited until September 2022, when a reply was received from the Ministry of Industry and Trade with the justification that “the action will not be fully implemented in an economically and socially vulnerable area”.
“I perceived this as a slap in the face from the government, which was clearly looking for a justification to reject the incentives,” recalls Radovan Haluza, head of GENERI BIOTECH, about a year ago. The company had been applying for a corporate tax rebate for ten years, but Radovan Haluza says it is far from certain that the company would have made enough profit in that time for the incentive to make sense. “So we are implementing the project without the incentive. The government has sent a signal about how it thinks about supporting small and medium-sized domestic businesses,” he adds.
GENERI BIOTECH is implementing the project, but like some other companies, it thinks the process is credible. This may discourage potential future investors in the country.
Jan Linhart, Head of Corporate Income Tax Services at KPMG Czech Republic, considers the individual approval of each incentive by the government to be a major weakness of the current wording of the Investment Incentives Act, and he believes that the forthcoming amendment only partially solves this problem. “The government will continue to approve some projects directly. For the remaining part discussed at the ministerial level, the methodology according to which the projects will be assessed is unknown. There is therefore a high risk of non-transparent decision-making, against which investors have only limited possibilities of defence,” says Jan Linhart.
“So far, the general statement about the interest to support investments beneficial for the state lacks clear and measurable criteria, and the forthcoming amendment does not change this shortcoming of the system of awarding investment incentives,” says Luděk Hanáček, partner in the tax and legal department of Deloitte Czech Republic. “Interpretation of the definition of projects beneficial to the state is now carried out in the most costly way for both the state and investors, namely by trial and error, when only in the justification of rejected projects do investors seek an answer to the question of whether their project is the one the state wants to support,” Luděk Hanáček points out.
Ondřej Janeček, a partner in the tax advisory team of EY Czech Republic, also dislikes the power of ministries to decide on investment support. “I am convinced that an additional veto right on the part of the ministries would lead to the Czech Republic being further disadvantaged, as investors will not be able to count on the incentive when deciding where to locate an investment,” he says. And he points out that over the past few years there have already been a number of changes in investment incentives that have led to a significant decline in investment activity as investors have shifted their interest to neighbouring countries.
It is not the purpose of this text to question the Government’s decision. However, the question arises as to whether it would not be more effective for all parties if the rules in the regulation were tightened precisely in the spirit of the objections that are then raised by the government to individual investments. This would have several benefits: ministers or ministry officials would not waste time reassessing projects, the ‘waiting time’ for applicants would be reduced and a signal would be sent to all investors that the granting of incentives is completely transparent.
A number of investors and people from consultancy firms have called for a remedy, i.e. for amendments to the law or regulation that would bring objectivity back into the approval process. And an amendment to the law has indeed started to be drafted. But not quite as desired, the subjective element of decision-making in the legislative process remains.
The amendment to the Act abolishes the obligation for the MIT to submit each application for an investment incentive to the Government for consideration. However, the ministries concerned, which are the Ministry of Finance, the Ministry of the Environment, the Ministry of Labour and Social Affairs and the Ministry of Agriculture, will still comment on the granting of an investment incentive and if they find the investment action insufficiently beneficial for the state, they will express their disagreement and the incentive cannot be granted. Again, there are no clear criteria by which the ‘benefit to the State’ would be assessed. “Rather than making such an elusive decision, it would certainly be better to tighten up the parameters or add more conditions, but there must be some measurable indicators backed by data. For example, the law could list the types of companies that do not qualify for incentives. The idea is to make the approval process completely transparent,” says Ondřej Votruba from AFI.
Defining negatively the industries or firms that will not be eligible for the incentive could prove problematic. However, the amendment to the law defines some industries positively, on the contrary, with the idea that they could – if approved – be eligible for higher support. These are newly created categories of investment projects that respond to the current needs of the Czech Republic, specifically in the areas of health protection (response to the covid-19 pandemic), chip manufacturing, e-mobility and energy saving.
The CzechInvest agency, which has been in charge of administering the investment incentives throughout their existence, has particularly emphasised the last area, which is intended to contribute to greater energy self-sufficiency. “The currently approved amendment to the government regulation includes among the so-called strategic actions the production of products designed to produce or store energy from renewable sources, to increase energy efficiency or to reduce the energy consumption of buildings. It will now be possible to attract investments in photovoltaic systems, hydrogen production, heat pumps or turbines,” said David Hořínek, spokesman for CzechInvest.
The government as a whole will continue to comment not only on investments in the newly prioritised sectors, but also on all other strategic investments (investments in assets amounting to at least CZK 2 billion, at least half of which will be in new machinery and the creation of at least 250 new jobs) and investments with a high technological intensity.
In these cases, it makes sense. In addition to the tax rebate, these investors in regions with higher unemployment can receive not only material support for the jobs created and the training of employees, but also material support for the acquisition of property up to 20 per cent of the eligible costs. This financial contribution to the acquisition of assets is a direct cost paid from the state budget (unlike the income tax rebate, which is otherwise a key form of investment incentive), so the Cabinet will have the opportunity to assess whether to release funds for this purpose.
It should be added that most applicants in the manufacturing sector do not fall into the category of strategic investments. Once all the conditions are met, they are entitled to tax relief and material support for job creation. The tax rebate is applied for ten years, which means that in order to benefit from the incentive, the investor must be successful quickly and start generating profits as soon as possible.
It has already been said that government consultation is in order for strategic and otherwise significant investors. However, given the fierce competition for investment in the global market, the discussion in these cases should revolve more around whether the incentive can be spiced up in some way to make it more likely that the investor will implement it here.
From the category of selected sectors that deserve special treatment, two projects in particular are currently topical in the Czech Republic, namely Volkswagen’s investment in the construction of a battery factory for electric vehicles in Líně near Plzeň and Onsemi’s investment in the expansion of chip production in Rožnov pod Radhoštěm.
While in the first case the decision by the investor is still being postponed, negotiations with the American company on how to support the project and the implementation process are ongoing, according to the MIT press department. In the case of Onsemi, according to available information, the total investment incentive should represent 22.53 percent of the costs. The public support includes an income tax rebate and material support for the acquisition of tangible and intangible fixed assets.
Most countries in the world have some system of investment incentives. Poland has long been considered our biggest competitor. There, as in the Czech Republic, investment incentives can be used to support projects in manufacturing, research and development, and strategic service centres. Poland’s incentives are more generous than the Czech Republic’s, as tax holidays can last up to 15 years, material support for fixed assets (so-called CAPEX) can be up to 25 per cent, and, unlike the Czech Republic, property tax can be waived.
Slovakia, where it is also possible to support the above three types of projects, is divided into four zones (plus Bratislava, where support is not available). Incentives in Slovakia are also more generous than in the Czech Republic and on average even more generous than in Poland. In all four zones it is possible to get tax holidays, material support for CAPEX and also a property discount (this type of incentive existed in the Czech Republic as well, but was abolished some time ago). With the exception of one zone, it is also possible to get material support for jobs (the so-called job grant).
Investment incentives in Germany, Poland, Hungary and Slovakia. | Photo: Mapchart.net
Hungary also supports similar groups of projects – and the incentives there are more attractive than here. In addition to the income tax rebate (for up to 13 years), the Hungarian system has material support for CAPEX and jobs, as well as for training and retraining. Furthermore, additional cash incentives can be negotiated with the government under the so-called “VIP” incentives.
In Germany, the system is very complicated, firstly because there is still to some extent a division between the former East Germany and West Germany (where a significant number of regions are not supported by incentives) and secondly because, in addition to the federal system of support for the affected regions (the so-called GRW), there is also support at the level of each federal state, which differs from one state to another. The GRW incentives target material support for jobs and machinery instead of tax holidays.
In all countries, there is a minimum amount of investment or number of new jobs created as a condition, which varies depending on the region and the project. A complete comparison is beyond the scope of this article, but in general it can be said that the Czech Republic comes out worst in the comparison of the V4 countries. The criteria for incentives are the most stringent in the Czech Republic, not only for projects in manufacturing, but quite extremely so for projects in research and development. These are set so badly that, in order to receive direct support, investors have to invest many times more money and employ many times more people than in other countries. Given the widely presented priority of attracting these projects in particular, this is surprising.
Author: Ondřej Votruba, Executive Director, AFI
In 2021, the OECD countries agreed on a minimum global corporate tax of 15 percent (known as Pillar 2) for all companies with a global turnover of at least EUR 750 million. The European Union has prepared a joint directive, which all member states are obliged to transpose into national legislation by the end of 2023.
“The original, basically laudable motivation was to avoid minimising taxation of huge international corporations such as Google or Facebook, but the rules will also affect a large number of companies benefiting from tax holidays under investment incentives and, of course, also a large number of companies that benefit from double deduction of research and development expenses,” points out Ondřej Votruba, Director of the Association for Foreign Investment (AFI).
OECD. | Photo: Shutterstock
Ondřej Janeček, partner of the tax advisory team of EY Czech Republic, also considers this upcoming legislation a blow to the motivational effect of investment incentives in the form of tax rebates, and adds: “The government is not reacting sufficiently to this fact and the Czech Republic may become even less attractive for new investments.”
According to AFI, the first sign of government activity to prevent a devastating effect on attracting new investors to the Czech Republic and the operation of many existing companies (regardless of whether they are domestic or foreign investors) appeared only this summer. At the request of the Ministry of Industry and Trade, AFI is now preparing a paper that should describe possible solutions.
There are several possible ways to legally circumvent this restriction and preserve some advantages for the companies we want in the Czech Republic – and thus remain competitive in terms of the investment environment. “A number of European countries are implementing some of these routes. These include converting tax holidays into partial material support, i.e. a tax bonus, a social and health insurance rebate or a personal income tax rebate,” says the AFI chief.
The Inflation Reduction Act, which came into force in the US in January, foresees spending nearly USD 400 billion on energy security and combating climate change. Of this amount, USD 270 billion is to be provided in the form of tax incentives for both producers and consumers. The support thus covers both investment in renewable energy sources and electromobility.
As of 10 August this year, more than 100 projects worth a total of USD 75 billion have been announced for construction/manufacturing, which are expected to create 63 800 new jobs. These projects are mainly in the battery industry, with investments from both US companies (Tesla, Ford, GM and others) and foreign investors (LG, Honda, Hyundai, Toyota and others). Most of the investment has so far been in Georgia, with the states of Georgia and Michigan expected to create the most jobs through new projects.
Inflation Reduction Act 2022. | Photo: Shutterstock
The project with the largest value (USD 5.5 billion) will be located in Arizona near Phoenix. It involves the construction of a battery factory for electric vehicles by the South Korean company LG Energy Solution, with production of batteries for electric vehicles to start in 2025, and production of batteries for energy storage systems to start the following year. According to the NY Times, LG said its decision was driven in part by the very inflation-reduction law that includes federal incentives for electric vehicle production and sales and battery manufacturing in the United States. In addition to federal incentives, investors also receive significant incentives at the state level.
It is a federal law passed last year to provide roughly $280 billion to support domestic research and manufacturing of semiconductors in the US. The largest-ever investment in this area was announced by Taiwanese chipmaker Taiwan Semiconductor Manufacturing Company (TSMC), which promised to invest $40 billion in chip manufacturing plants in Arizona. TSMC’s two factories will create 4 500 direct jobs in Arizona.
