5 The Treatment of Capital Income: European Union and Countries in Transition*

Sandra Švaljek**

Abstract

This paper deals with the tax treatment of specific categories of income from capital – income from interests on savings deposits and bonds, dividends and capital gains in the old Europe, some countries in transition and in the Republic of Croatia. The aim of the paper is to provide, in rather simple manner, the insight into the type of taxation of these categories of capital income (e.g. taxation by applying a special kind of tax on capital income or inclusion of capital income in the total ), the level of the statutory tax rates and key features of the capital income taxation, so as to enable the comparison of the tax treatment of capital income in Croatia and in the neighbouring countries. Very important issues related to the theoretical background and principles on which the taxation of interest income, dividend income and income from capital gains is based are beyond the ambition of this paper and are, thus, left for some other research study.

Keywords: taxation, capital income, tax harmonisation JEL classification: H2, H24

* This paper was originally published in Privredna kretanja i eknomska politika (Economic Trends and Economic Policy) No. 104, 2005, pp. 28-51. ** Sandra Švaljek, Research Fellow, The Institute of Economics, Zagreb.

Croatian Economic Survey 2005 107 1 Introduction

Every country has its unique tax system, but in analysing the features and impact of the tax systems, as well as in designing or redesigning these tax systems, domestic practice is frequently compared with the solutions in other countries. Since Croatia’s immediate economic and geographic neighbourhood is the European Union and Central, South and East European countries, the research of tax systems in these countries and analyses of their development in time are of a particular interest.

The aim of this paper is to compare tax systems of the countries in the Croatia's neighbourhood and to identify general characteristics and differences among them, as well as to examine the extent to which the Croatian tax system is similar to tax regimes in other countries. Since it is almost impossible to summarise in one place and compare all the features of the tax systems in a group of countries, this paper is focused only on comparing the method of tax treatment of various types of capital income in two groups of countries, encompassing the old EU Member States and some European transition countries1. In addition, the comparison mainly relates only to the current status2, rather than to the changes in the tax systems over time.

Capital income or income from investments is considered to be an income earned by natural persons through their passive investments, i.e. an income earned with no active participation in income creation or in managing business venture. The concept opposite to capital income, which is also referred to as the passive income, is employment income, or active income (IBFD, 1996). Capital income includes income from immovable property, dividends, interest on bank deposits and bonds, rentals receivable under operating leases, etc. The paper discusses tax treatment of the following forms of income – interest on bank deposits and bonds, dividends and capital gains. Tax treatment of capital income is mostly analysed from the perspective of a resident natural person. International aspects of capital income

1 In addition to 15 old EU Member States, certain aspects of the tax systems in 11 European transition countries are also analysed in this paper – Bulgaria, the Czech Republic, Estonia, Latvia, (except for interest taxation), Hungary, Poland, Romania, Slovakia, Slovenia and Croatia. 2 For all the countries, except for Croatia, the data relate to the end-2004 period, while for Croatia, the data relating to 2005 are reported.

108 The Tax Treatment of Capital Income: European Union and Countries in Transition taxation are discussed only in the case of tax treatment of income from interest on savings deposits, since in the taxation of income from interest on savings deposits serious problems arise, concerning the unequal treatment of interest payable to residents and non-residents. In view of the relevance of this issue, a separate chapter is also dedicated to harmonisation of taxation of income from interest on savings deposits in the European Union. Finally, on the basis of a comparison of the tax treatment of the selected forms of capital income in the observed countries, the final conclusions are made.

2 Tax Treatment of Interest on Bank Deposits

The tax treatment of interest on bank deposits in the EU Member States and in European transition countries varies to a great extent. In general, there are four main types of tax treatment of interest on deposits in these countries, as follows:

• taxation by levying a final withholding tax, • taxation within an annual taxation of income, • taxation by levying a withholding tax first and then within the annual taxation of income, • interest exemption.

In the largest number of the old EU Member States, interests on deposits are treated by levying withholding tax, which is considered a final tax, and interest income is not included in the annual tax return. Interests are treated in this manner in eight old EU Member States – Austria, Belgium, Finland, France, Greece, Italy, Portugal and Sweden. In five of these countries (Austria, Belgium, France, Greece and Portugal), taxpayers are entitled to opt for the tax already withheld used as a prepayment i.e. to be included in the annual income tax return and a standard income tax liability to be applied to interest income. The tax rates on income from deposit interest, however, range from 15 to 30 percent.

The two old EU Member States, Denmark and Luxembourg, include interest income in the taxable income, applying the income that corresponds to the overall level of income. In the Netherlands, income is classified into three

Croatian Economic Survey 2005 109 different categories, to which three different tax rates are assigned. One of these tax rates is applied to interest income.

In four old EU Members States (Germany, Ireland, Spain and United Kingdom), withholding tax is levied on interest first, and withholding tax is considered as an advance payment of the final interest income tax. In the annual tax return, withholding tax paid is included in the total annual income tax to which the income tax rate is applied.

Income from interest on deposit is not exempt from income tax in any of the old EU Member States, although in most of the countries non-residents pay either interest income tax at a lower rate or at a zero rate, in accordance with the avoidance agreements. In transition countries, the situation is different. In Slovenia, Hungary and Croatia interest is, as income of natural persons, exempt from income tax for all types of savings, and in Bulgaria, Latvia and Estonia interest income is also not subject to income tax for the majority of the common types of savings. Out of ten selected European transition countries, including Croatia, seven countries that tax interest on bank deposits, levy the final withholding tax.

It may be assumed that a significantly reduced tax burden, as regards interest on savings, in transition countries is a consequence of an attempt to simplify the tax system to the largest extent possible, but it could also be a result of a desire to stimulate savings and decrease need for capital imports as much as possible3.

In the old EU Member States, the analyses point to a downward trend in tax burden of interest income – in 2004 it amounted to 34 percent in 15 EU Member States, with a standard deviation of 11.1, while according to Gorter and de Mooij (2001) in 2000, the average tax rate on interest stood at 36.7 percent (standard deviation amounting to 14), and in 1990 at 45.9 percent (standard deviation amounting to 11.4). An overview of the interest income tax treatment in the old EU Member States is given in Table 1, and a summary of the interest income tax treatment in 10 selected transition countries is shown in Table 2. However, it

3 For common reasons for allowing tax incentives for savings, see Banks (1996). An overview of the theoretical and empirical studies of interdependence between savings and taxation is provided by Robson (1995) and Bernheim (1999).

110 The Tax Treatment of Capital Income: European Union and Countries in Transition should be noted that in a large number of countries there are differences in the tax treatment of different savings instruments, which are not elaborated and shown in more detail in the table, but may, nevertheless, significantly influence the decisions of the persons concerning their choice of savings instruments. Unequal tax treatment of income from various types of savings is present in France, in particular.

3 Tax Treatment of Interest on Bonds and Dividends

Interests on bonds are, in a large number of countries, treated the same as interests on deposits, and the same method is usually applied to the calculation of bond interest income tax as to deposit interest income tax. In some countries, corporate and government bonds are treated differently, government bonds enjoying a more favourable tax treatment. Taxation of dividends is equal to the bond taxation, or they are partially tax-exempt, in order to mitigate a double taxation of income from investment in shares – first, at the company level, and the second time, at the shareholders’ level.

Tables 3 and 4 show a statutory tax rate, applied to corporate and government bonds and to dividends in the old EU Member States and in some European transition countries.

It should be noted that in the case of the old EU Member States, interests on corporate bonds have equal tax treatment to interests on bank deposits, except in Greece, Italy and Portugal, where higher tax rates are levied on interests on bank deposits. As regards transition countries, in Bulgaria and the Czech Republic corporate bonds are subject to higher tax rates compared to interest on bank deposits.

Croatian Economic Survey 2005 111

2004).

x. pt, and tax allowance on deposits with National National with deposits on allowance and tax pt, tax treatment within the income tax is applied, the the the income tax is applied, within treatment tax Note ngs – final withholding tax at a rate of 25% is levied on on levied is of 25% tax at a rate withholding – final ngs sits and deposits in Postal savings bank bank savings in Postal deposits sits and ngs account (up to DKK 3,000 annually) annually) DKK 3,000 to (up ngs account are not subject to withholding tax, although in case of individual types of types individual of in case tax, although withholding to subject are not

tax is included in the annual income ta - interest income up to EUR 1,500 1,500 EUR up to exemption tax income - interest schemes savings housing in investment on - tax relief - possibility of including the withholding tax on interest on the of including - possibility levied tax is withholding investments depo on euro interests on 15% of - tax rate of 4% and investments savings on return imputed base is the - tax tax base from the 17,600 of EUR - tax allowance tax-exem are savings accounts special on - interests Bank Savings withholding tax rate tax rate withholding - taxpayers may choose the tax treatment within the income tax income the within treatment the tax - taxpayers may choose the investments, of types of individual the case - in 48.09% being rate highest marginal permitted is amount of investment 25% worth credit them and a tax tion of Individuals in Europe, Amsterdam (loose leaf) (as at 20 November IT savi for child's - exemption IT interest earning of by the costs base is reduced - the method method Taxation category” IT sits in old EU Member States States EU Member in old sits the highest marginal tax rates are indicated. xation within income tax; IWT = withholding 30% 0-15% 0-15% 0-15% 0-25% IWT IWT liability tax income in the is included 15% of the amount interest in on tax - withholding liability tax income in the is included 15% IWT of the amount interest in on tax - withholding liability tax income in the is included 20% of the amount interest in on tax - withholding 0-15% 0-15% FWT bank deposits “regular” on interest of 1,500 of EUR amount in the - exemption 0-15% 0-15% IWT savi of types individual on is tax relief - there 0-10% 0-10% FWT 0-30% tax income final the in included 20% may be a rate of tax at - withholding FWT source to the interest relative of treatment tax - different 0-25% 0-25% FWT the than are lower rates these rate, if reduced tax rate or a income a standard of choosing - possibility 0-25% 0-25% FWT interest earning of by the costs base is reduced - the 0-25% 0-25% FWT are exempt - certain types of interest Tax rate Tax rate non-residents 1 rate rate 25% 15% 59% 29% 25% 20% 42% 27% “third 30% 0-25% 40% 45% FWT 30% 0% 40% 44.31% 44.31% 0-25% 38.95% IWT principle, in - interests, 0-15% residents Tax Treatment of Interest on Depo Tax If a progressive income taxation is applied, 1 Table 1. Table 1. Austria Belgium Denmark Finland France Germany Greece Ireland Italy Luxembourg Netherlands Portugal Spain Sweden United Kingdom Source: IBFD (2004a): Guide to European Taxation Volume VI: Taxa Legend: FWT = final withholding tax; IT = ta Note:

112 The Tax Treatment of Capital Income: European Union and Countries in Transition d 2004),

office in EU are tax-exempt in EU are tax-exempt office Note ntries, Amsterdam (loose leaf) (as at 20 November interest on the basis of granted loans and credits credits and loans granted of basis the on interest deposits and savings instruments of Romanian banks are tax banks are tax Romanian of instruments savings and deposits stitutions with a registered with stitutions terest on investments before 1 December 2001 2001 December 1 before investments on terest 25% is paid on interest on the basis of granted loans and credits, which is include is which credits, and loans of granted basis on the on interest paid 25% is

Investment in Central and East European Cou in the tax liability tax liability in the exempt & - on paid is 35% of tax - withholding FWT FWT are tax-exempt Latvia in a registered office with institutions by credit paid - interests FWT FWT to in relate - exemptions FWT term accounts, current on - interests method method Taxation posits in Transition Countries 0% 20% 10% 0%-15% 0%-15% FWT of tax - withholding Tax rate Tax rate residents residents residents 0% / 15% 0% / FWT tax-exempt is deposit on interest of - a large portion

non-residents

rate rate 0% 0% 0% 20% 19% the same as for 0% / 1% 0% / 0% / 25% 0% / the same as for 0% / 26% 0% / 26% 0% / FWT in by credit paid - interests residents Tax Treatment of Interest on De Tax Table 2. Table 2. Bulgaria Croatia Czech Republic Estonia 15% - 0% Hungary 0% Latvia the same as for Poland Romania Slovakia Slovenia Income Tax Act (Official Gazette 177/04). Legend: FWT = final withholding tax Source: IBFD (2004b): Guide to European Taxation Volume V: Taxation

Croatian Economic Survey 2005 113 2004).

s, progressive income tax is levied on dividends dividends on is levied tax income s, progressive stic manufacturing companies are tax-exempt are tax-exempt companies manufacturing stic of small and medium-sized companies is companies and medium-sized of small Note to dividends taxation Note to dividends return on savings and investments of 4% and investments savings on return Dividends in EU MemberEU States Dividends in (the highest marginal rate being 45%) and 60% of dividends is tax-exempt is tax-exempt dividends of and 60% 45%) rate being marginal (the highest - social are additionally levied on dividends and bonds (at a rate of 10%) (at a rate of bonds and on dividends levied are additionally taxes - social allowance is a tax-free - there - tax allowance of EUR 19,252 from the tax base from the 19,252 of EUR - tax allowance ownership in share is a significant there if rate is applied tax - lower permitted 1 0% level shareholders’ at the dividends on levied tax is - no 42% 5,210 is EUR for exemption - threshold 30% dividends for exemption - limited 25% dome in new shares of - dividends 29% relief tax is certain - there 40% 45% dividends of of 50% amount in the -permitted tax-exemption dividends of 40% amounts to - imputed rate 32.5% dividends of percent 1/9 to amounts tax credit - imputed 12.5% - in the case of qualified companie 38.95% 38.95% of EUR 1,500 an exemption plus of dividends, 50% for tax-exemption - permitted 44.31% 44.31% taxation to is subject dividends ½ of - only 28% / 43% 28% / 42,400 exceeds DKK income if shares rate is applied - higher 15% / 25% 15% / certain conditions) (under after 1994 issued sh ares to rate is applied - reduced 25% / 30% 25% / imputed base is the - tax Dividends tax tax Dividends tion of Individuals in Europe, Amsterdam (loose leaf) (as at 20 November

1 0% 0% 42% 30% 59% 40% 25% 15% 29% 25% 45% 30% 12.5% 44.31% 44.31% tax rate 15 + 10% 10% 15 + 10% + 48.09% to taxation is subject the dividends of half - only rporate and Government Bonds and Government bonds bonds Government the highest marginal tax rates are indicated. tax tax

1 bonds bonds 0% 25% 15% 59% 29% 42% 30% 20% 45% 30% 40% rate 12.5% 44.31% 44.31% 38.95% 15 + 10% 10% 15 + Tax Treatment of Interest on Co Corporate Corporate If a progressive income taxation is applied, 1 Table 3. Table 3. Austria Belgium Denmark Finland France Germany Greece Ireland Italy Luxembourg Netherlands Portugal Spain Sweden Kingdom United Source: IBFD (2004a): Guide to European Taxation Volume VI: Taxa Note:

114 The Tax Treatment of Capital Income: European Union and Countries in Transition nt of dividends by the amount of amount by the dividends of nt

Amsterdam (loose leaf) and IBFD (2004a): Guide to on, only in the case of companies operating in operating companies of in the case only on, Note to dividends tax Note to dividends

dividends of domestic companies and certain foreign foreign certain and companies domestic of dividends t to taxation only at the company level level at the company only t to taxation is calculated by increasing the amou by increasing is calculated lower rate is applied to dividends from foreign sources sources foreign from to dividends is applied rate lower DividendsTransitionCountries in

companies companies

special economic zones and free ports free ports zones and special economic the paid withholding tax (at a rate of 25%) and by a 40% reduction reduction by a 40% and 25%) tax (at a rate of withholding the paid

0% to taxati subject are - dividends 0% final is dividends distributing company by the payable on dividends - tax 0% subjec are - dividends 25% 50% base - taxable 15% / 33% 15% / to is applied rate - lower 2004), Income Tax Act (Official Gazette 177/04). 20% / 30.5% 30.5% 20% / -

Investment in Central and East European Countries, Dividends tax rate tax Dividends & 0% 0% 0% 0% 0% 26% 19% tax rate tax rate rporate and Government Bonds and dividends tax rate stood at 15%. sterdam (loose leaf) (as at 20 November 0% 0% 0% 0% 0% 0% 25% 15% 26% 25% 19% Tax Treatment of Interest on Co ratetax bonds Corporate bonds Government 1 As of 1 January 2005. until end-2004, 1 Taxation of Individuals in Europe, Am Source: IBFD (2004b): Guide to European Taxation Volume V: Taxation

Note: Table 4. Table 4. 15% Bulgaria 20% 0% Croatia Czech Republic Estonia Hungary Latvia Lithuania 19% 0% Poland 20% 5% Romania 1% 1% Slovakia Slovenia

Croatian Economic Survey 2005 115 In the old EU-Member States, the treatment of corporate and government bonds is similar, except in Luxembourg, where certain zero-coupon government bonds are tax-exempt. In contrast, a considerably large number of transition countries, provide for a more favourable tax relief on government bonds, compared to the corporate bonds – Bulgaria, the Czech Republic, Latvia, Lithuania and Poland. In all these countries, the interest on government bonds is completely tax-exempt. Differences in tax regimes with respect to government bonds in these two groups of countries may be accounted for by a greater need of the governments in transition countries for financing debt and by their inherited preference for the government sector4.

4 Harmonisation in the Field of Taxation of Income from Interest on Saving Deposit in the EU

Taxation of income from interest on savings deposits of natural persons in the European Union is still not subject to harmonisation, although a partial regulation has been achieved by the introduction of the Directive on Taxation of Savings Income in the Form of Interest Payments. The Savings Directive5 was adopted only in 2003 and it entered into force as at 1 July 2005, although the preparation of regulations, which would bring about a certain degree of tax harmonisation in this area, began as early as in the 1960ies (Oravec, 2002). The attempts for the tax harmonisation to encompass taxation of income from savings interest result from the fact that the existing principle of interest taxation is the principle of the country of residence, which is violated by the fact that tax authorities may assess interest yield only in the country, but not abroad. Consequently, depositors take out savings in other countries and do not report return on these savings in the country of residence, which results in a loss of potential tax revenues for the home countries, as well as in a flight of capital (Härtel, 2000).

4 Explanation of the unfavourable impact of government securities tax exemption on efficiency and fairness in distribution may be found in Norregaard (1997). 5 Council Directive 2003/48/EC of 3 June 2003 on Taxation of Savings Income in the Form of Interest Payments was published in the Official Journal of the European Union, 26 June 2003.

116 The Tax Treatment of Capital Income: European Union and Countries in Transition However, the EU Member States did not manage, for many years, to reach an agreement concerning the method of harmonising the tax treatment of interest income. The institute of banking secret represented a special restriction on harmonisation, which individual countries did not wish to waive (Luxembourg, Belgium and Austria). During 2000, a proposal of the Directive providing for an exchange of information was made, i.e. for the introduction of exchange of information between the EU Member States. A transitional period was proposed for Belgium, Luxembourg and Austria, during which they may apply the withholding tax regime, which subsequently must be replaced by the system of information reporting.

The ultimate aim of this Directive is to enable savings income in the form of interest payments made in one Member State to beneficial owners who are individuals resident in another Member State to be made subject to effective taxation in accordance with the legislation of the latter Member State. It is believed that the aim of this Directive can best be achieved by targeting interest payments made by economic operators established in one Member States to or for the benefit of beneficial owners who are individuals resident in another Member State through an automatic exchange of information between Member States concerning interest payments. The scope of this Directive should be limited to taxation of savings income in the form of interest payments on debt claims and, in particular, income from government securities and income from bonds or debentures, including premiums and prizes attaching to such securities, bonds or debentures, and interest accrued or capitalised at the sale, refund or redemption of such debt claims, to the exclusion of the issues relating to the taxation of and insurance benefits, as well as to interest on certain transferable bonds (to avoid negative impacts on the market) during the transitional period, for bonds issued before 1 March 2001.

As regards the Directive on income from interest on savings deposits, it should be emphasised that it does not deal with the taxation of interest income of domestic depositors, but exclusively with the tax treatment of interest income of non- resident individuals, that it does not deal with interest income of individuals resident outside the European Union and that the Member State of which an individual tax payer is resident can decide whether or not interest income is

Croatian Economic Survey 2005 117 taxable. The Directive, therefore, does not require the Member States to harmonise the manner of taxation or the amount of tax burden relating to interest income.

5 Tax Treatment of Capital Gains

All old EU Member States have some form of capital gains taxation6 in place, either in the form of a special tax on capital gains or within the framework of income tax. In this paper we will examine both types of capital gains taxation, and that for capital gains on all types of assets whose realised gains are taxable. Table 5 gives a clear overview of the basic elements of capital gains taxation in those countries. As shown in the Table, although all the selected countries have some form of capital gains taxation, the manner of taxation and the level of capital gains taxation in those countries differ greatly7.

The selected countries can be classified into two groups: those that tax capital gains together with other forms of income and countries which apply a special tax on capital gains. In nine old EU Member States (Austria, Denmark, Finland, Germany, Italy, Luxembourg, Portugal, Spain and Sweden) capital gains are integrated in total taxable income and taxed at rates in accordance with the statutory tax rate. In two Scandinavian countries with the so-called dual income taxation8 capital gains are added to income from capital and are subject to capital income tax. In the remaining six old EU Member States (Belgium, France, Greece, Ireland, The Netherlands, and the United Kingdom) there is a special tax rate for capital gains.

Depending on the type of assets, tax rates levied on capital gains can differ within a single country in the same way as they do between different countries. Assuming that in countries in which capital gains are taxed by progressive income tax rates,

6 Capital gain is the difference between the purchase price and the selling price of asset (IBFD, 1996). 7 For details concerning capital gains taxation pattern, see Messere (1993). For the effects of capital gains taxation on efficacy, income, capital gains realisation, propensity to assume risks, savings and investments, the price of assets, prosperity, portfolio structure and distribution, see e.g. Auten (1999), Zodrow (1995), Sandmo (1985) and Poterba (2001). 8 For the reasons for the introduction and the characteristics of the dual system of taxation, see Hamaekers (2003).

118 The Tax Treatment of Capital Income: European Union and Countries in Transition capital gains are subject to maximum tax rates, the Table shows that the tax rates range between 5 percent for specific types of assets in Greece and 59 percent in Denmark.

The majority, or ten old EU Member States, differentiate between short-term and long-term capital gains, i.e. income from the sale of assets in a short period of time following its acquisition is considered speculative gain and as such is to be treated less favourably than any long-term capital gain. As shown in Table 5, which lists the types of assets subject to and the types of assets exempt from this tax obligation, it is evident that different treatment of short-term and long- term capital gains is particularly common in case of real estate. However, the distinction between short-term and long-term capital gains differs substantially and ranges between 2-10 years in case of real estate, and six months and three years in case of other assets.

In nine old EU Member States, a threshold has been set in the form of an amount of money which represents a limit for taxpayers’ capital gains tax exemption. Although in the past a number of countries used an adjustment of capital gains tax base to ensure that only real gains and not nominal gains are taxed, this type of tax base indexation is present in only two countries (Ireland and Portugal). Similarly, most of the countries do not permit capital loss deductions, while four of the remaining five countries (Denmark, Ireland, Luxembourg, the Netherlands, and Sweden) allow only a limited capital loss deduction from the taxable base. Five countries allow, subject to certain conditions, deferred capital gains tax.

Table 6 shows tax treatment of capital gains with respect to the type of assets, where taxable assets are considered those assets which are explicitly indicated as taxable, with the exception of those explicitly indicated as exempt. Information given is based on the publications of the International Bureau of Fiscal Documentation (IBFD), which offer a relatively detailed overview of tax legislation in European countries (IBFD, 2004a and 2004b). In view of a variety of different tax reliefs and special tax treatments for various types of assets in different countries, the overview in Table 6 should be construed as illustrative only. In addition to taxable or exempt assets, and differentiation between short-term and long-term capital gains, the number of years from the acquisition of assets on the basis of which a gain can qualify as a short-term or long-term, respectively, are indicated.

Croatian Economic Survey 2005 119

no no yes yes conditions conditions Roll-over relief relief Roll-over same different yes no no no yes, under certain gains from with of assets deduction deduction Capital loss loss Capital category income category income as at 20 November 2004); IBFD (2004c): rates for different types types rates for different yes, from speculative oration, foreign corporation and to long-term capital gains no no no yes gains yes, from capital yes ate is 20 percent. estate inflation s are subject to a higher, 20 percent rate. no no of real yes, in case yes yes yes yes Threshold Adjustment for for Adjustment Threshold e standard capital gains tax r ares. Other taxable capital gain , share-like financial instruments and hold ings, share-like in domestic companies and partnerships are subject to a no no no no yes, no yes yes yes yes

xation of Individuals in Europe, Amsterdam (loose leaf) (balance l income taxation; S = special tax term and long-term gains gains long-term and term le of a significant share (over 25 in a domesticle of a significant share (over percent) corp ins on the sale of unlisted sh Different treatment ofshort- (1) 45% 45% no no no no no 33% 33% yes no no no no / / 20% no no no no no / 38% 40% 50% 40% l gains are subject to a higher, 33 percent rate. Rates Rates 20 / 40% 20 / in Old EU Member States 12.5 percent. Gains on the sale of shares 12.5 , the highest marginal tax rates are given. applied to tax base, max. base, tax applied to xation; ICIT = included in capita of S IIT IIT IIT ½ of the average rate ICIT 2005) since 29% (28% taxation Taxation of Capital Gains S 16.5 S 2 S 5

3 4 IIT 12.5 IIT 5 40 percent tax rate after a 60 percent tax exemption. on the sale of real estate. Other taxable capita In case of progressive taxation of income Belgium – the reduced tax rate of 16.5 percent applies to any sa Greece – the reduced tax rate of 5 percent applies to capital ga Ireland - capital gains on the sale of undeveloped land are subject to a 40 percent taxation. Th Italy – the standard capital gains tax is Table 5. Table 5. Type Austria Belgium Denmark IIT 59% Finland France S 26% Germany IIT 47.48% Greece yes yes Ireland no no Italy yes no no yes yes Luxembourg yes no yes no S Netherlands no no 25% Portugal 45% Spain IIT ICIT Sweden 30% no yes no yes no Kingdom United yes yes, S yes European Tax Handbook, Amsterdam Source: IBFD (2004a): Guide to European Taxation Volume VI: Ta Legend: IIT = included in income = IIT ta Legend: Notes: (1) (2) (3) (4) (5)

120 The Tax Treatment of Capital Income: European Union and Countries in Transition

ASSETS ASSETS EXEMPT EXEMPT - large number of exemptions of exemptions - large number - real estate serving as the principle residence in the last two years the last residence in as the principle - real estate serving 10 years - real estate > 15 years > - land 1 year securities) > assets (and - other debtor domestic by a issued - bonds - undeveloped assets > 5 years assets - undeveloped 3 years - shares > krone bearing in Danish denominated instruments debt other and - bonds rate interest the minimum above interest rate period a 2 day within transferred instruments financial - derivative owner by the residence as used country house - house, flat and 10 years - real estate > > 1 year bonds and including shares - movable property, 1 other assets > estate > 10 years, – real from business assets - withdrawing year > 1 year period contractual transactions, - derivative assets types of - other - real estate serving as taxpayer’s principle residence residence as taxpayer’s principle - real estate serving - real estate serving as taxpayer's principle residence as taxpayer's principle - real estate serving - real estate intended for dwelling after > 2 years of continuous use > 2 years of continuous after for dwelling intended - real estate e Type of Assets in Old EU Member States Member EU Old in Assets of e Type on repayment of shareholders' stakes of shareholders' on repayment e, motor vehicles and household household e, motor vehicles and ied substantial shareholding shareholding substantial ied ASSETS - business assets - business - business assets - business - assets which are not exempt are not which - assets - real estate < 10 years 10 years - real estate < 15 5 - years between base reduced the < 15 years, - land 1 year securities)< assets (and - other a qualif - shares constituting or gains gains liquidation - company < 5 years assets - undeveloped person legal a foreign to sold - portfolio DKK 133,700 exceeds value whose shares unlisted - other property - intellectual 10 years - real estate < < 1 year bonds and including shares - movable property, other assets estate < 10 years, - real from business assets - withdrawing < 1 year < 1 year period contractual transactions, - derivative shares - unlisted liability companies limited or in partnerships - shares trademark or registered - goodwill - real estate except furnitur - movable property appliances appliances - business assets and business portfolios portfolios business and assets - business

Tax Treatment of Capital Gains as Regards th Table 6. Table 6. TAXABLE Austria Belgium Denmark assets - business 3 years - shares < Finland France Germany assets - business Greece Ireland

Croatian Economic Survey 2005 121 residence, if total profit is residence, if profit in total invested eur, if profits are reinvested in similar in similar reinvested are profits eur, if rtain value, zero or reduced coupon reduced or value, zero rtain 's principle residence, if total profit is invested in is invested profit if total residence, principle 's 0 November 2004); IBFD (2004c): European Tax ASSETS ASSETS EXEMPT EXEMPT

- under certain defined conditions, various forms of assets may be exempt (e.g. may be exempt (e.g. of assets forms various conditions, defined certain - under - real estate serving as taxpayer - real estate serving

- real estate > 5 years 5 years - real estate > residents by domestic issued - bonds entrepren an individual of - tangible assets assets in the following 3 years following assets in the as taxpayer's principle - real estate serving the acquisition of the same assets within 2 years same assets within of the the acquisition tangible movable property below a ce below property movable tangible types various for deferral etc.) and residence, principle vehicles, motor bonds, of assets the acquisition of the same assets within 2 years same assets within of the the acquisition tion of Individuals in Europe, Amsterdam (loose leaf) (as at 2 ASSETS

- business assets - business - real estate intended for business activity of the taxpayer (90% of capital capital of (90% of the taxpayer activity business for intended - real estate gains) - land 5 years - real estate < and partnerships in companies - shares - securities instruments - derivative - real estate < 2 years 2 years - real estate < -< 6 months movable property shareholding - substantial (50%) property industrial and - intellectual year bonds < 1 - shares, - private assets intended for dwelling (2/3 of capital gains) gains) of capital (2/3 dwelling for assets intended - private - assets < 1 year continued Table 6. Table 6. TAXABLE Italy Luxembourg assets - business Netherlands Portugal shareholding - substantial 50%) - real estate (only Spain Sweden United Kingdom exempt - assets not Source: IBFD (2004a): Guide to European Taxation, Volume VI: Taxa Handbook, Amsterdam.

122 The Tax Treatment of Capital Income: European Union and Countries in Transition It can be concluded that business assets and short-term capital gains on the sale of real estate and securities and stakes are the most commonly taxed items, while items exempt from taxes are usually capital gains on the sale of real estate used as a principle residence and long-term capital gains on the sale of real estate, securities and stakes. In some countries, such as for instance in Belgium and the Netherlands, capital gains tax is levied only on a limited number of very specific types of assets, so for all practical purposes it can be claimed that capital gains tax does not exist in those countries.

Although it could be argued that, in view of numerous capital gains tax exemptions in the old EU Member States and different tax rates on capital gains on different types of assets in some countries, tax legislation creates significant non-neutrality between capital gains on different types of assets, comparisons in time point to a progress towards greater neutrality (Journard, 2001). The introduction of a dual system of income taxation in the Scandinavian countries has contributed to equality in tax treatment of capital gains on different types of assets, even in tax treatment of different types of capital income. Still, it is obvious that in formulating capital gains taxation, the authorities are not governed by the principles of assets neutrality and equality in tax treatment of different types of assets, but by fiscal and political objectives, irrespective of the mentioned principles. In the area of capital gains taxation in the EU, there is currently no initiative aimed at harmonisation and no essential changes can be expected to take place in this area any time soon.

The selected eleven transition countries are also familiar with the concept of capital gains taxation. In Lithuania, Poland and Romania capital gains are subject to a special tax, while in other countries they are subject to integrated taxation together with other forms of income. Generally, capital gains in Hungary are taxed as income, but almost all types of capital gains are subject to a uniform flat rate.

As shown in Table 7, which gives an outline of the basic characteristics of capital gains taxation in transition economies, capital gains tax rates differ greatly among countries, ranging from 1 percent in Romania to 50 percent in Slovenia. In most transition countries, however, capital gains tax stands at around 20 percent.

Croatian Economic Survey 2005 123 Unlike the old EU Member States which as a rule allow certain degree of tax exemptions, among transition countries only Hungary and Lithuania envisage tax exemptions for capital gains up to a certain threshold value. Tax base inflation adjustment is permitted in Bulgaria, Slovenia and Croatia, while capital loss deduction is permitted in Slovenia to the amount of capital gains and in Croatia, provided capital gains are taxed within the framework of income tax and as such, capital losses reduce the tax base. Roll-over relief is allowed in Hungary and in Poland.

Table 8 shows the types of assets which are subject to capital gains tax obligation, as well as assets exempt from this type of tax obligation in transition economies. Compared with the old EU Member States, it would appear that fewer assets generate income which is subject to capital gains tax, and that there are fewer exemptions. This somewhat simpler and more neutral taxation of capital gains in the transition economies might be due to the fact that capital gains in these countries is less burdened with tradition, compared with the old EU Member States.

124 The Tax Treatment of Capital Income: European Union and Countries in Transition no yes estate estate Roll-over relief relief Roll-over thin 5 years from the date of of date the from 5 years thin no no of real yes, in case no of real yes, in case yes deduction deduction Capital loss loss Capital s, Amsterdam (loose leaf) (as at: 20 November 2004), no no no no no no no taxation of any gain on the change in the price of assets, inflation in case the sale takes place wi are given.

s a different tax treatment in place for short-term and long-term no no yes yes, from gains no no no yes yes no Threshold for Adjustment taxation is considered to be rposes by the taxpayer or maint ained members of his/her immediate family and in case the yes yes yes yes no no no no no no yes no yes yes term and long-term gains gains long-term and term Investment in Central and East European Countrie

& income taxation; S = special tax y profit tax. Here, capital gains Different treatment ofshort- ion, on income on receipts from distribution or option to purchase own shares, while any income on the sale of real estate (1) ars from the date of its acquisition - indicating that there i come as capital income or property or property rights income. 1 January 2005. Until end-2004, the tax rate on income on the sale of assets and property rights stood at 35 percent. Income question was used for dwelling pu 32% 50% capital gains on the sale of shares and other securities. Rates Rates 10% /19% 10% /19% 20% / 45% 20% as of 2007 2007 20% as of 15% / 25% or 20% or 20% / 25% 15% 26% in 2004, 24% in 24% 2004, 26% in 2005, 22% in 2006 and 2006 in 22% 2005, pplied to the majority of capital gains. xation; ICIT = included in capital taxation taxation S IIT IIT IIT IIT IIT/S of Taxation of Capital Gains in Transition Economies

5 3 2

4 gains. The 20 percent rate is used if the taxpayer chooses to pa real estate or property right in question was sold after three ye irrespective of the fact whether the legislation refers to such in on the sale of real estate is tax exempt if the real estate in and property rights is subject to a 25 percent tax rate as of In case of countries in which progressive taxation of income is used for capital gains taxation, the highest marginal tax rates In Hungary, a uniform 20 percent rate is a In Poland a lower tax rate of 10 percent is used to tax gains on the sale of movable property, real estate and property rights In Slovenia, capital gains are taxed first at the rate of 30%, with this tax being included in the final tax obligation. purchase, while a higher, 19 percent rate is used to tax In Croatia, a lower 15 percent tax rate of is levied, after deduct Bulgaria IIT 29% yes no yes no no no yes Table 7. Type no 29% Bulgaria IIT no yes Croatia no Czech Republic no no Estonia 25% yes no no Latvia IIT yes 15% no no S Lithuania yes Hungary no no Poland 1% no Romania S no 19% no IIT Slovakia yes Slovenia Source: IBFD (2004b): Guide to European Taxation Volume V: Taxation Income Tax Act (Official Gazette 177/04). included in income = IIT ta Legend: 1) 2) 3) 4) 5)

Croatian Economic Survey 2005 125 ter 3 years from the date of acquisition of date the from 3 years ter

ASSETS ASSETS - sale of own apartment of own apartment - sale - shares and other securities, real estate > 1 year real estate securities, other - shares and EXEMPT EXEMPT - housing serving as taxpayer’s residence > 2 years taxpayer’s residence as - housing serving assets > 5 years - other - property which is not taxable taxable is not which - property - shares listed on the Bulgarian Stock Exchange Stock Exchange Bulgarian on the listed - shares ownership 5 years of use or > of 3 years > - basic > 1 year ships and vehicles, aeroplanes - motor 5 years - real estate > > 6 years companies stakes in joint-stock shares, - securities, companies > 5 years - stakes in other the for residence permanent to purchase used gains are if capital - real estate, 5 years after the 1 year before and relatives between taxpayer and his/her purchase is money if the for business purposes, used not and land building - apartment, or land apartment, building another years to purchase 2 within used - country house > 2 years 2 > - country house programs restitution - various purposes own for taxpayer used by the - movable property in entity in the capital of the over 10% owns the taxpayer 1 year, unless - shares > 3 years the past the times over 24 unless exceeding estate and shares, except real - property deduction personal basic of the amount - real estate used for dwelling by the taxpayer or by maintained members of members maintained by or taxpayer by the for dwelling used estate - real family immediate his/her af sold right property or estate - real etc. spouses, between rights property and estate real of - sale - real estate, shares and stakes > 3 years and stakes > 3 years shares - real estate, - real estate and registered movable property > 3 years property movable registered - real estate and Investment in Central and East European Countries, (balance as at Amsterdam (loose leaf) 20 November & ted liability companies and companies liability ted the Type of Assets in Transition Economies or option to purchase own shares, own shares, purchase to or option taxpayer’s residence < 2 years taxpayer’s residence k companies and stakes in limi and stakes k companies an Taxation Volume V: Taxation ASSETS fficial Gazette 177/04). - real estate < 1 year 1 year - real estate < - other assets < 5 years assets < 5 years - other futures contracts contracts futures - movable property – cars, aeroplanes, boats, shares and stakes < 1 year stakes boats, shares and – cars, aeroplanes, - movable property 5 years - real estate < < 6 years companies stakes in joint-stock shares, - securities, companies < 5 years - stakes in other - securities - movable property assets of entrepreneurial - withdrawal 5 years movable property < rights, and property - real estate, realised in the tax period tax in the realised of date the from 3 years within sold if gift, by acquired estate - real the donor from acquisition and taxed by a 20 percent profit tax) tax) profit percent 20 a by taxed and rights property or estate real of - sale distribution on profit in the - shares Tax Treatment of Capital Gains with Regard to -profit on the sale ofbusiness assets (treated as regular operating income 1 Status after 1 January 2005. 1) Table 8. Table 8. TAXABLE Bulgaria Croatia - real estate Czech Republic < 1 year and ships vehicles, aeroplanes, - motor Estonia exempt - assets not Latvia Lithuania shares including - property Hungary - real estate Poland Romania securities other - shares and Slovakia of joint-stoc - shares Slovenia as serving - housing and stakes < 3 years shares - real estate, Source: IBFD (2004b): Guide to Europe 2004), Income Tax Act (O Note:

126 The Tax Treatment of Capital Income: European Union and Countries in Transition 6 Concluding Remarks

In the preceding chapters simple comparisons are given of the basic legislative provisions in connection with the taxation of income from interest, dividends and capital gains in the old EU Member States and several transition countries. To avoid unnecessary complication of the comparisons given, no attempt was made in general to examine theoretical concepts on which taxation systems in the reference countries are based. Nevertheless, even a simple comparison may lead up to some conclusions.

As regards taxation of income from interest on savings deposits, the old EU Member States clearly tend to tax this source of income with relatively high rates, ranging from 15 to 59 percent. However, in an effort not to discourage savings, many of these countries allow for certain tax exemptions and tax reliefs for certain types of savings. By contrast, the transition countries are trying, as much as possible, to exempt savings income from taxation and tax mainly savings income earned in foreign banks.

The old EU Member States tend to treat similarly income from corporate and government bonds, with the rates of taxation on interest on bonds being equal or lower than those on income from interest on savings deposits. Transition countries, on the other hand, impose higher taxes on corporate bonds than on income from interest on savings deposits, though these rates are generally still lower than those found in the old EU Member States. Government bonds are mainly tax exempt in these countries.

Taxes on dividends in the old EU Member States are equal or lower than taxes levied on bonds, which can be explained by the efforts of these countries to mitigate double taxation of dividends. In the transition countries, taxes on dividends are as a rule lower than in the old EU Member States, with not a few of them providing for a full tax exemption for dividends.

The largest diversity can be found in capital gains taxation, both in terms of the level of taxation, the form of taxation and the treatment of capital gains on different types of assets. Differences in capital gains taxation are particularly large in the “old” Europe, probably attributable to traditionally different taxation

Croatian Economic Survey 2005 127 practices in each of these countries. Taxation of capital gains in transition countries is much more uniform and there is a smaller number of the types of assets which are subject to this type of taxation in these countries.

Croatia stands out as a country with a particularly lenient capital income tax policy; income from interest on savings deposits is fully tax exempt and so are dividends and bond yields, with only few types of assets being subject to capital gains taxation. However, when compared with other transition countries, such tax treatment of capital gains is not unusual. It should be noted that on the European Union level there are no regulations that would require harmonisation of tax burden for this type of taxes.

Literature

Auten, Gerald, 1999, “Capital Gains Taxation” in The Encyclopedia of Taxation and Tax Policy, Joseph Cordes, Robert D. Ebel i Jane G. Gravelle (ed.), The Urban Institute Press, pp. 58-61.

Banks, James, 1996, “Tax Incentives for Saving” (shortened version of an article published in New Economy, December 1996), titled “Putting TESSA in the Dock”, http://www.ifs.org.uk/pensions/taxincentivesforsaving.html

Bernheim, B. Douglas, 1999, “Taxation and Saving”, NBER Working Paper Series, no. 7061, http://www.nber.org/papers/w7061.

Gorter, Joeri i Ruud A. de Mooij, 2001, “Capital income taxation in Europe, Trends and -offs”, CPB Series, CPB Netherlands Bureau for Economic Policy Analysis, The Hague.

Härtel, Hans-Hagen, 2000, “EU-Zinsbesteuerung weiterhin ungeklärt”, Wirtschaftsdienst 7/2000.

Hamaekers, Hubert, 2003, “Taxation Trends in Europe”, IBFD Asia-Pacific Tax Bulletin, February, pp. 42-50.

IBFD, 1996, International Tax Glossary, IBFD Publications BV.

128 The Tax Treatment of Capital Income: European Union and Countries in Transition IBFD, 2004a, Guide to European Taxation Volume VI: Taxation of Individuals in Europe, Amsterdam (loose leaf).

IBFD, 2004b, Guide to European Taxation Volume V: Taxation & Investment in Central and East European Countries, Amsterdam (loose leaf).

IBFD, 2004c, European Tax Handbook, Amsterdam.

Joumard, Isabelle, 2001, “Tax Systems in European Union Countries”, OECD Economics Department Working Papers, no. 301.

Messere, Kenneth C., 1993, Tax Policy in OECD Countries: Choices and Conflicts, IBFD Publications BV, Amsterdam.

Narodne novine, Zakon o porezu na dohodak (Income Tax Act), NN 177/04.

Norregaard, John, 1997, “The Tax Treatment of Government Bonds”, IMF Working Paper, no. 25, March 1997.

Official Journal of the European Union, 2003, Council Directive 2003/48/EC of 3 June 2003 on taxation of savings income in the form of interest payments, 26.6.2003, L 157/38 – L 157/48.

Oravec, Peter, 2002, “Taxation of Interest Income in European Union Countries”, BIATEC, Národná banka Slovenska, Vol. X, 7/2002, pp. 19-24.

Poterba, James M., 2001, “Taxation, Risk-Taking and Household Portfolio Behaviour”, NBER Working Paper, no. 8340, http://www.nber.org/papers/w8340.

Robson, Mark H., 1995, “Taxation and Household Saving: Reflections on the OECD Report”, Fiscal Studies, 16(1), pp. 38-57.

Sandmo, Agnar, 1985, “The Effects of Taxation on Savings and Risk Taking”, Handbook of Public Economics, vol. I, A. J. Auerbach i M. Feldstein (ed.), Elsevier Science Publisher B.V. (North-Holland).

Zodrow, George R., 1995, “Economic Issues in Taxation of Capital Gains”, Canadian Public Policy – Analyse de Politiques, 21, pp. 25-57.

Croatian Economic Survey 2005 129