Corporate Income Tax Laws
The corporate income tax system in Bosnia and Herzegovina is not regulated at the state level. The tax system is under the jurisdiction of two entities, Federation of BiH and Republic of Srpska, and a separate administrative unit, Brčko District of Bosnia and Herzegovina. The year 2016 has brought new Corporate Income Tax Laws (“CIT Laws” or “CIT Law”) to the two entities. The new CIT Laws are applicable for the calculation of tax in the 2016 tax year. Besides the new laws, the Ministers of Finance in both entities issued relevant bylaws in order to regulate specific matters more closely and prescribe a procedure for tax reporting. The new legislation limits deductibility of interest, prescribing more detailed transfer pricing rules and rules on deductibility of expenses of write-off of receivables, and generally reduces the number of available tax relieves. The CIT Laws also prescribe more detailed rules on taxation of permanent establishments of foreign taxpayers. The tax rate remained at 10%, which is one of the lowest tax rates in Europe.
The income of legal entities from another entity or the Brčko District generated through permanent establishments (PE) will be subject to corporate income taxation in the entity in which the PE is registered (with respect to the profit generated in that relevant entity). The CIT Law in Republic of Srpska also considers legal entities from Federation of BiH and Brčko District as subject to corporate income taxation for income generated from real estate in the Republic of Srpska, even if they do not have a registered PE in the Republic of Srpska. Furthermore, both laws more closely define PEs in terms of non-residents as subject to corporate income taxes.
Tax deductible costs
A significant number of provisions of the CIT Law of the Federation of BiH provides for different treatment and more detailed regulation of tax deductible costs. Generally, transactions which are not performed for business purposes, and which are not aimed to generate profit, are not recognized as tax deductible. Only documented expenses which have incurred for the purpose of generating profit can reduce the tax base, provided that they are adequately presented in income statements.
Under the CIT Law of the Federation of BiH, the deductibility of interest paid to related parties is further limited. The interest is deductible if the total amount of loans from related parties does not exceed four times the capital of the taxpayer. If the amount of loans is higher, the proportional part of the interest is deductible. The rules on deductibility of interest do not apply to financial institutions (banks and insurance companies).
In the Republic of Srpska, only interest that is due in the relevant tax year is tax deductible for that tax year. Under the latest amendments of the CIT Law of the Republic of Srpska applicable for calculation of the tax in 2017, the deduction of interest will be further limited to the amount of 30% of the taxpayer’s tax base in the current tax year. This limit relates to interest in general, not only interest payable to related parties.
Provisions for the future mandatory costs related to environmental protection as well as provisions related to expenses expected within the guarantee period for sold goods, are tax deductible. The CIT Law of Republic of Srpska in addition prescribes that provisions for retained deposits and for remunerations and employee benefits are tax deductible.
Donations are not deductible if their amount exceeds 3% of annual income, while business entertainment expenses are deductible up to 30% of their total amount.
The new CIT Laws provide, in both entities, fairly similar conditions under which write-offs of receivables are considered as tax deductible. The write-off of receivables is tax deductible if receivables were not collected within 12 months and if the taxpayer initiated a court procedure or forced collection for the purpose of collection of the receivable, or if it filed a claim in a liquidation or bankruptcy procedure of the debtor. In case that a taxpayer deducted the expenses of written-off receivables and later collected the due, the taxpayer is obliged to increase the tax base for the collected amount.
The write-off of receivables by financial institutions is tax deductible up to the amount of such write-off calculated under the rules set in laws on monetary and banking operations.
Related party transactions
CIT Laws introduced in-depth regulation of transfer pricing.
The CIT Laws prescribe that a taxpayer may apply traditional transfer pricing methods (CUP, Resale Price, Cost Plus) in order to assess if the prices entailed in the transactions with the related parties are established on the basis of the arm’s length principle. Alternatively, the profit split method or the transactional net margin method or any other more appropriate method may be used if traditional methods are not adequate.
CIT Laws introduce the obligation of a taxpayer to hold proper transfer pricing documentation at the moment of filing the tax return. The Tax Administration (TA) may ask the taxpayer to present the transfer pricing documentation and the taxpayer has to provide it within the legal deadline (30 days in the Federation of BiH and 45 days in the Republic of Srpska). In addition, taxpayers that are involved in transactions with related parties in a volume exceeding the prescribed limit (app. EUR 250,000 in the Federation of BiH and EUR 350,000 in the Republic of Srpska) have to prepare a transfer pricing report and file it to the TA enclosed to the tax return.
Both in the Federation of BiH and Republic of Srpska, taxpayers may reduce their tax for 30% if they invest at least 50% of their profit into fixed assets in the current tax year. The incentive is related to investments into the equipment and immovable property that will be used in the production process. If a taxpayer sells the assets used for a tax credit within three years after the purchase, they are obliged to pay the tax that was credited in proportion to the value of the asset.
In the Federation of BiH, another tax credit is still available to taxpayers who invested in their fixed assets amounting to at least EUR 10 mil. within five consecutive tax years. The amount of tax credit is 50% of the assessed tax.
If taxpayers in the Federation of BiH using tax credits for investment into fixed assets distribute the dividend before the expiration period of three years following the tax credit period, they will be obliged to pay unpaid tax with additional penalty interest. Similarly, taxpayers have to pay credited tax if they use losses from previous years to reduce the tax base in two years following the tax credit period.
Another tax incentive is introduced to boost employment in the Federation of BiH. Taxpayers are allowed to deduct the double amount of salaries paid to new employees as an expense. In order to use this benefit, the terms of the employment have to be established for at least 12 months full-time and the employee could not be employed by the taxpayer or its related party within the previous five years.
The CIT Law of the Federation of BiH prescribes that a taxpayer may use only one tax incentive for investment into fixed assets per year. However, the investment tax credit may be used simultaneously with the tax incentive for employment of new employees.
It appears that a more favorable tax treatment in Bosnia and Herzegovina is for investors who primarily invest in production activities rather than in commercial activities.
An accelerated depreciation for the depreciation of assets used for environmental protection purposes is still available in the Federation of BiH. The depreciation rates for such assets may be 50% higher than regular depreciation rates (depreciation rates are prescribed in a range between 5% and 40%).
The CIT Laws introduce withholding tax to all service fees paid to residents of non-treaty countries. The withholding tax rate is 10%. Service fees paid to residents of treaty countries are subject to withholding tax only if paid for services listed in the CIT Laws (consulting, accounting, audit etc.) Also, it is prescribed that the withholding tax is payable even in cases when consideration is paid in kind.
Interest, dividends, royalties and rental fees for leasing of movable and immovable property paid to non-residents are subject to tax at a 10% tax rate. By exception, dividends distributed to foreign shareholders by a resident of the Federation of BiH are subject to tax at a 5% tax rate.
The transfer of profits generated through a PE is not subject to any withholding tax. However, a PE is required to pay a corporate income tax at a 10% general CIT rate before the transfer of profits.
Administrative expenses allocated to a PE by its non-resident parent are deductible in the percentage of the PE’s income in the total income of the parent company. For the purpose of allocating expenses, non-residents may use the allocation keys they find appropriate. By exception, interest and royalties paid by a PE established in the Republic of Srpska to its foreign parent are not tax deductible expenses for a PE. Interest and royalties paid to other related parties are deductible under the general rules set by the CIT Law.
Capital gains are regulated more closely, in particular in the Federation of BiH. Non-residents generating capital gains from the sale of immovable assets located in the Federation of BiH, the sale of shares in the local entity and the sale of IP rights, are obliged to pay the tax in the Federation of BiH. Non-residents are obliged to file the tax return and to assess and pay the capital gain tax within one month after the sale of the property. If a non-resident taxpayer fails to pay capital gains tax, the buyer of the property as well as the target company in the Federation of BiH are liable for tax payment.
Non-residents generating income in Republic of Srpska from the lease of immovable property, or capital gains from sale of immovable property, have to file an annual tax return and pay the tax under the general rules set by the CIT Law. Capital gains of non-residents from the sale of shares in the Republic of Srpska may be subject to tax in the Republic of Srpska if the property of the local company consists mainly of immovable assets located in the Republic of Srpska.