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How to properly tax an individual’s income from securities for 2020

Author: Helena Navrátilová

Adapted from Patria Finance

Income from the ownership of securities (in particular shares, units and bonds) is, by its nature, divided into income from the sale of securities (capital gains or losses) and income from the holding of securities (income from capital assets). Income from the transfer of securities for consideration, including income from shares attributable to units on the dissolution of a mutual fund (“securities”), is reported in the sub-basis of the tax base – Other Income (Section 10 of Act No. 586/1992 Coll, Income from the transfer of securities may be reduced under the Act by the expenses demonstrably incurred, which are in particular the purchase price of the share and the share certificate/security (“purchase price”) and expenses related to the transfer for consideration and the market trading fees for the acquisition of the securities. In addition, the gain on the sale of the securities may be reduced by any loss on the sale of the securities incurred in the same taxable year, provided that the income from the sale of the securities was not exempt from tax. Income from capital assets is mainly interest, dividends and other income (Section 8 of the Act).

Income from the transfer of securities may be exempt from tax if certain conditions are met (Section 4 of the Act). Firstly, income from the transfer of securities for consideration is exempt if the aggregate of all income from the sale of securities by a single taxpayer does not exceed CZK 100 000 in any one tax year. If this amount is exceeded, all income from the transfer of securities is taxable, except for exempt income. The condition for the exemption of such income is that the period between the acquisition and the transfer for consideration of the securities must be at least 3 years. However, the exemption does not apply to income from the transfer of securities which are or were part of business assets within three years of the cessation of the activity in the course of which the income from self-employment is derived (Section 4(1)(x) of the Act). In addition, income accruing to the taxpayer from the future transfer for consideration of a security within three years of its acquisition, and from the future transfer for consideration of a security which is or was part of a business asset within three years of the cessation of the activity from which the self-employment income is derived, even if the purchase contract is not concluded until three years after the acquisition of the security or three years after the cessation of the activity, are not exempt.

Income in the form of a payment of a share from a reduction in the share capital of a corporation should be treated with particular care. If the increase in the share capital was previously made out of profit, then the said income up to the amount of the share in the increase in capital is considered as a share in profit and is reported in the sub-basis of the tax Income from capital assets (Section 8 of the Act). If it is a payment of a share from a reduction in the capital of a corporation, this income must be reported under §10 and at the same time the cost of the share in the corporation, or the portion of the cost that has not yet been applied, must be claimed as an expense (depreciation) up to the amount of the payment from the reduction in capital. If the share from the capital reduction is paid by a corporation that is a tax resident of the Czech Republic, the income is subject to withholding tax upon payment and is not included in the tax return, provided that the taxpayer proves to the corporation the price at which the share was acquired. The same procedure is followed for the payment of (part of) the share premium or premium outside the share capital.

Dividends and profit shares from units (“dividends”) paid by companies which are domestic tax residents are subject to a withholding tax of 15%, which must be withheld and paid by the payer – the joint stock company or mutual fund if the participation in it is converted into a security. Such withholding tax is final and therefore dividends paid by a domestic payer are not reported in the tax return.

Conversely, dividends and profit shares from units (“dividends”) paid to an individual from sources abroad, by a foreign tax resident payer, are included in capital gains income (Section 8 of the Act) and are also subject to a 15% tax. Dividends are not eligible for related expenses, but tax withheld by the foreign payer can be offset. The procedure is that the dividend income is shown on line 38 of the Personal Income Tax Return as gross income from capital assets (i.e. before any foreign tax withholding or charges) and at the same time Schedule 3 of the return “Calculation of tax on income from foreign sources under section 38f of the Act” is completed. In this annex, the tax withheld by the foreign payer is calculated.

In order to do so, it is important to assess whether the tax was withheld in accordance with the relevant double taxation treaty between the Czech Republic and the state of tax residence of the dividend payer. If the dividend tax withheld is higher than the treaty stipulates, only the tax in the amount stipulated by the treaty can always be credited against the Czech dividend tax (§ 38f of the Act). According to the treaty, the simple credit method or the full credit method may be applied (§ 38f(2) of the Act). The simple set-off method means that the tax liability may be reduced by the amount attributable to income from foreign sources, up to a maximum of the amount of tax calculated on that income under the Act. Under the full set-off method, tax may be reduced by the income tax paid in the source State. In most treaties, the Czech Republic applies to its taxpayers a simple credit for tax withheld abroad.

The tax withheld abroad and used to offset Czech dividend tax must be confirmed by the foreign tax administrator (§ 38f of the Act). In justified cases, it is possible for the taxpayer to prove the tax paid abroad also by a certificate of the payer of income, asset manager or depositary of the withheld tax. In practice, such a document is normally accepted by the tax authorities. If the individual receives dividends from more than one state, it is important that the tax credit is made for each state separately (section 38f(8) of the Act).

A similar procedure is followed for the taxation of interest on bonds. The taxation of interest or income on redemption or early repayment of bonds at a withholding tax rate of 15% by the bond issuer who is a tax resident of the Czech Republic is final and the interest income is not reported in the tax return. For interest income from bonds paid to foreign resident payers, the procedure is similar to that for dividends.

If the Czech Republic does not have an effective double taxation treaty with the source state, the income may be taxed twice, both in the Czech Republic and in the source state.

Foreign currency income from abroad that is reported in the tax return must also be correctly converted into Czech currency. For these purposes, taxpayers who do not keep accounts most often use the single exchange rate announced for a given calendar year by the General Tax Directorate, which sets it as the average of the CNB exchange rates valid for the last day of each calendar month of the tax period. Another option for currency conversion is to use the CNB daily rates. However, the two methods cannot be combined. The purchase price of a security denominated in a foreign currency must be converted at the relevant exchange rate applicable for the year or on the date of acquisition of the security.

Cost price

When selling securities where the proceeds are subject to tax, the cost of the shares and ordinary certificates and the cost of other securities on acquisition for consideration must be correctly determined. In the case of a gratuitous acquisition (e.g. by gift or inheritance), the cost price is the price determined in accordance with Act No. 151/1997 Coll., on the valuation of property. In the case of the same type of securities that are acquired successively for consideration, the cost price may be determined in three ways. Either the actual acquisition price of each individual security is used, or the acquisition price is determined by a weighted arithmetic average (the weight is the nominal value converted to the same basis), or by a pro rata method, in particular where the taxpayer realises both exempt and non-exempt income, where the acquisition prices of securities of the same type and from the same issuer are divided in the same proportion as exempt and non-exempt income. The method of determining the purchase price that can be claimed as a tax expense against the proceeds from the sale of the securities may significantly affect the amount subject to tax, but the Income Tax Act does not provide a rule.

Securities in SJM

Spouses who have securities included in their community property (SJM) can decide which of them will report the income from holding or selling the securities on their tax return. Only one spouse will be taxed on this income. The spouses may choose to have one spouse tax the income from holding the securities (usually dividends or interest on bonds) and the other spouse tax the income from the sale of the securities. They can change the allocation of that income for taxation in the following year. If the securities were contributed to the business assets of one spouse, the related income must be taxed by that spouse.

In the event that, due to an extension or settlement of the SPS, securities that were part of the SPS become the sole property of only one spouse or, conversely, securities owned solely by one spouse become part of the SPS, such income from the settlement or extension or reduction of the SPS is not taxable. The time of the original acquisition of the securities will be decisive for the assessment of the time test for the tax exemption of income arising from the subsequent transfer of such securities.

Reporting of exempt income

Since 2015, individuals have been required to report to the tax authorities income in excess of £5 million. CZK and is exempt from income tax (it is not reported in the tax return). This exempt income may arise either from the acquisition of securities by gift or inheritance or from their sale after the expiry of the time test for exemption from income tax. Notices of exempt income must be filed within the same time limits that apply for filing a tax return. Exempt income accruing to the community property is reported by only one spouse.

Certificates and other hybrid securities

In practice, there are a number of securities which cannot be clearly classified under a certain type of securities specifically defined by Czech legislation (hereinafter referred to as “certificates”). When taxing the income from a certificate, whether on sale, on redemption by the issuer or on maturity, etc., it is necessary to assess, according to the basic legal characteristics of the particular certificate, whether it is income from the holding or sale of the security or another type of income.

Exchange of shares

When a share is exchanged by the issuer for another share of the same total nominal value, the time test for exemption is not interrupted; the same applies to an exchange of shares, a merger of companies or a division of a company, provided that the relevant legal conditions are met. In the case of acquisition of shares in exchange for a time certificate (with the same owner), the time test for tax exemption is calculated from the date of delivery of the time certificate or its registration in the shareholder’s property account.

Taxation of income from the holding and sale of securities by corporate taxpayers

For comparative purposes only and in a very simplified form, here are the basic features of the taxation of income from securities by corporate taxpayers. All income from the holding and sale of securities is taxable for corporations. Such income may be reduced by related expenses to the extent and in the amount allowed by the Income Tax Act.

Income from the holding and sale of securities is included in the corporation’s profit or loss reported on line 10 of the tax return. Consequently, exempt income, income subject to withholding tax and income included in the separate tax base are excluded from the general corporate income tax base. The tax base is furthermore excluded from the tax base for expenses related to exempt income.
Exempt income from securities is income derived by a parent company from the sale of shares of a subsidiary in which it has held at least 10% of the share capital for at least the immediately preceding 12 months, and other conditions for exemption must be met, such as a certain legal form of the company, the level of taxation of the subsidiary’s income, etc., the company’s qualified tax residency, and others. Income from profit shares (dividends) is exempt under similar conditions, and these conditions can be met retrospectively.

Dividends from sources in the Czech Republic that do not meet the conditions for exemption are subject to a withholding tax of 15%.

Dividends and other income from the holding of securities arising from abroad may be taxed in the source state under the relevant double taxation treaty, with the tax being withheld and paid by the dividend payer. Dividends from foreign sources are included in a separate tax base. The tax withheld from such income abroad is credited against the Czech tax attributable to the dividends so taxed, provided that the taxpayer proves that the tax withheld abroad was withheld in the amount specified in the relevant double taxation treaty.

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