Do you know your business partner?

When making payments for services, interest, royalties, or dividends abroad and you are unable to prove the beneficial owner of that income, the income may be subject to withholding tax of 35 %. How can be the beneficial ownership proven and which documents are required by the tax authorities? As the company paying the income is liable for any incorrect tax withheld, please find out more in our News.

In 2018, the concept of beneficial ownership of income was introduced in the Slovak Income Tax Act to prevent tax avoidance. Whenever payments for services, interest, royalties, or dividends abroad are made, the payer should be aware of the business partner before paying such income.

If a withholding tax applies, the taxpayer paying the income is responsible for the tax to be withheld and paid to the tax authorities. In other words, it is the paying company that is responsible for proving the beneficial owner of the income. Otherwise, it will be obliged to withhold a 35 % tax in Slovakia.

Tax residence of the recipient

As first, it is necessary to prove the tax residency of the recipient of the income, which can be done by means of a tax residency certificate. A 35 % withholding tax applies in cases, in which the recipient taxpayer is resident in a non-cooperating state.

The beneficial owner of income

It is necessary to provide proof of the beneficial owner of income before making any payments. We strongly advise against making payments without the required documentation.

In August 2023, the Financial Directorate of the Slovak Republic published a new information on the manner, form, scope, and frequency of proving the beneficial owner of income. This information sets out the minimum documentation requirements, which tax authorities expect in connection with proving the beneficial owner of income.

The recommended scope of documentation to be provided by the taxpayer varies according to the level of risk involved in each case. The information contains several examples of risk indicators relating to the recipient of taxable income, and the taxable income itself, which can be used to assess whether a transaction is low-risk, medium-risk or high-risk.

(1) Low-risk case

In low-risk cases, a written declaration, signed by the beneficial owner or other credible means of proving the owner is deemed sufficient.

(2) Medium-risk case

For medium-risk cases, a written declaration should be supported by a questionnaire completed by the beneficial owner of the income, together with publicly available information such as financial statements or annual reports.

(3) High-risk case

In high-risk cases, the taxpayer must provide additional documentation in addition to a written declaration and a questionnaire to prove the beneficial owner of the income.

Samples of a written declaration, a questionnaire as well as examples of other supporting documents are included in the published information.

The taxpayer does not have to submit documents proving the beneficial owner of the income to the tax authorities automatically, but only based on request from the tax authorities during a tax audit.

Market price

Last but not least, we would like to draw your attention to transfer pricing compliance for related party transactions. Double tax treaties only protect  arm’s length income. If the arm’s length principle is not satisfied, part of the income which is not at arm´s length can be subject to double taxation. Therefore, for interest, royalties as well as services, we advise to prepare a comparability analysis, even in cases in which the EUR 10 million¹ threshold has not been reached.

Conclusion

For both VAT and direct tax purposes, knowledge of the business partner has become an increasingly important part of the compliance practice. The paying taxpayer is liable for the collection of the tax, including penalties. Every business entity should, therefore, try to eliminate the risk of incorrectly withheld and paid taxes. In addition to regular verification of supplier lists and health checks, we recommend having a complete proof of a tax residency of the recipient of the income and proof of beneficial ownership for each payment. A 35 % withholding tax including penalties (currently more than 12 % p.a.) are significant amounts, especially when the statute of limitation for international transactions is up to 10 years.

¹ EUR 10 million is the threshold for the full transfer pricing documentation which includes a mandatory comparability analysis.