Serbia Tax: Changes made to corporate and personal income tax rules

Changes to Serbia's corporate and personal income tax law that became effective on 27 March 2010 have implications for residents and nonresidents. Most notably, changes have been made to the rules governing the deductibility of expenses, the thin capitalization rules, the taxation of capital gains derived by nonresidents, the availability of tax incentives and various measures relating to personal income tax.


Corporate Income Tax

Tax Deductions – A number of changes have been made to the rules governing deductions:

- Net operating and capital losses may only be carried forward for five years (reduced from 10 years).
- Advertising and promotional expenses are deductible up to 5% of total revenue, while business entertainment expenses are deductible up to 0.5% of total revenue. The deduction previously was limited to 3% of revenue.
- The list of deductible long-term provisions is extended to include "all provisions prescribed in the law," and the expenses of long-term provisions for guarantees and other warranties are deductible on a cash basis (i.e. the actual amount paid).
- Income arising from the release of unused provisions that were not deductible in the period in which they were created is not included in taxable income in the period the income arises.
- The write-off of receivables is deductible provided certain conditions are satisfied, i.e. the receivables previously were included in the taxpayer's income and there is sufficient evidence, including evidence from a court, that the receivable will not be collected. At the same time, a deductible adjustment is allowed to be made where receivables have been due for at least 60 days. The law now specifies that, to be deductible, the write-off of receivables, for which an adjustment was made in the previous tax period, must satisfy the conditions prescribed for the direct write-off of receivables. Thus, it is not possible to write off previously adjusted receivables without tax consequences if the conditions for direct write-off are not satisfied.
- Expenses for impairment losses may be deducted in the tax period in which the assets are disposed of, used or impaired due to force majeure. Previously, these expenses were not deductible.
- Expenditure for health, educational, scientific, humanitarian, religious, environmental protection and sports purposes remain deductible up to 3.5% of the taxpayer's total revenue. However, the law now specifies that a deduction is available only if the funds are paid to recipients registered in the above sectors and are used for the above purposes.
- The threshold for the deduction of cultural expenses is increased to 3.5% (from 1.5%) of total revenue.
- Severance payments are deductible in the year in which they are paid (previously, these payments were nondeductible).


Capital gains derived by nonresidents – Major changes were introduced in the taxation of capital gains generated by nonresident entities from Serbian sources.

Prior to the adoption of the changes in the Corporate Income Tax Law, capital gains derived by nonresident entities from the disposal of qualifying assets in Serbia were subject to withholding tax at the rate of 20% (unless the gains were exempt under an applicable tax treaty). The tax was withheld at source by the Serbian resident payer at the time the income was paid to the nonresident. Where the transaction was carried out between two nonresident entities, the capital gains could not be taxed, i.e. they were outside the scope of Serbian taxation. In practice, resident entities that had to withhold capital gains tax on behalf of nonresident recipients encountered difficulties with capital gains tax compliance, primarily with regard to establishing the exact amount of the gains and the acquisition cost of the assets.

Following the changes, capital gains derived by nonresidents in transactions with both Serbian residents and nonresidents are taxed based on the tax assessment of the tax authorities. A nonresident entity deriving capital gains from the disposal of qualifying assets in Serbia is now required to appoint a tax representative, file the tax return and pay tax based on the tax assessment issued by the authorities. Regulations are expected to be issued that will provide more detail on compliance procedures.


Foreign tax credit – The rules governing the tax credit for foreign (direct and underlying) tax on dividends paid by a nonresident subsidiary are now more detailed. The carryforward period for the above tax credits is reduced from 10 to five years. At the same time, the amended rules introduce a tax credit for foreign tax on interest and royalties paid by a nonresident subsidiary to its Serbian parent company. The tax credit is limited to the amount of tax that would have been due on the interest and royalties in Serbia. Although the introduction of a tax credit for withholding tax paid on interest and royalties represents a major step forward, the credit is only available for taxes paid by a foreign subsidiary on payments to its parent.


Thin capitalization rules – Under Serbia's thin capitalization rules, interest and related expenses on loans from related parties are deductible provided they do not exceed four times equity for companies (10 times equity for banks). Until the recent law change, interest that was nondeductible in the current year could be carried forward and deducted in the following year. This carryforward is now abolished.

Further, under the transfer pricing rules, a taxpayer must demonstrate that interest that is deductible under the thin capitalization rules is also at an arm's length level. Otherwise, an adjustment of taxable income may be required.


Tax incentives – Various changes are made to Serbia's tax incentives:

- Investment in fixed assets – A taxpayer that invests in fixed assets used for its registered business activities is entitled to a tax credit equal to 20% of the investment, up to 50% of the assessed tax in the year of the investment (for small enterprises, the credit is 40% of the investment, up to 70% of the assessed tax). The tax credit is not available for investments in furniture, passenger cars, electrical appliances, etc. Unutilized tax credits may be carried forward for 10 years. However, if the taxpayer disposes of the assets within three years of the date of purchase, it will lose the tax credit retroactively and will have to pay the under-stated tax.

Under the amendments, a taxpayer that disposes of an asset for which a tax credit was granted is no longer entitled to carry forward any unutilized tax credits related to the asset if the disposal takes place between three years and 10 years from the purchase date. The taxpayer will lose the right to carry forward any unutilized credits in the year of disposal of the asset.

Taxpayers are no longer granted a tax credit for acquiring assets that are already in use in Serbia, although a tax credit will continue to be granted for imported new or used assets, for the purchase of new assets in Serbia and for investment in real estate.

Finally, the amended law clarifies that the right to the investment tax credit may not be transferred to another taxpayer, even if there has been a change in status (e.g. merger, etc). Previously, the law was not clear on this issue. This amendment is consistent with the tax practice and interpretation of the tax authorities in the previous period.

- Tax credit for investments in specific industries – Taxpayers whose predominant business activities are in industries listed in the law (e.g. metal processing, agriculture, car production, textile manufacturing, etc.) are entitled to a tax credit equal to 80% of their investment. The credit is not otherwise limited and may be carried forward for 10 years. Under the changes, the tax credit does not apply to assets already in use in Serbia and all the rules relating to the use of the general tax credit for investment in fixed assets also apply.

- Tax incentive for large investments – A taxpayer that invests in assets in the prescribed amount and employs 100 new employees is entitled to a tax incentive in proportion to the value of new assets for a 10-year period. The amendments to the Corporate Income Tax Law increase the minimum investment required from RSD 600 to 800 million and specify that a contribution of assets by a founder to the capital of a company in accordance with the capital increase rules also qualifies as an investment (in that case, the assets are valued at their (fair) market value).

Assets that previously were used in Serbia are not taken into account for purposes of this incentive and assets that do not meet the requirements to qualify for the tax credit for investment in fixed assets do not qualify for the incentive.

- Investment in under-developed areas – A taxpayer carrying out activities in an under-developed area (previously referred to as an "area of special interest") is exempt from income tax for five years provided more than RSD 8 million (increased from RSD 6 million) are invested in the assets used in the registered business activities and the taxpayer employs at least five persons for an indefinite period of time. The same rules as apply for the incentive for large investments regarding founder contributions, previously used assets and assets that do not qualify for the tax credit for investment in fixed assets apply to investments in under-developed areas.

- Tax credit for new employees – The tax credit for hiring new employees for an indefinite period of time is abolished.


Related party status – The minimum shareholding for related party status is reduced to "50% and over," rather than "over 50%" of participation/voting rights. A party is related to a taxpayer if it has control or significant influence on the business decisions of the taxpayer. Control for these purposes is ownership of 50% or more of the shares or individually the largest percentage of shares/stake. Influence on business decisions exists where there is control, as well as when a party related to the taxpayer holds 50% or more or individually the largest share of votes in the taxpayer's management bodies.

Tax period – A taxpayer may request a tax year other than the calendar year. If approved, the tax period must be used for at least five years.


Personal income tax

A number of changes have been made to the Personal Income Tax Law, which are also effective as of 27 March 2010:

- The rate of capital gains tax on the sale of real estate assets and securities is reduced from 20% to 10%.
- The rate of tax on income from capital (i.e. income from dividends and interest) also is reduced from 20% to 10%.
Dividends are subject to tax at a flat rate of 10%, which is applied on the gross amount of the dividend. Although the previous rate was 20%, taxable income for Serbian tax residents was 80% of dividends/shares in profits, resulting in an effective tax rate of 16%.
- Serbian tax residents are required to declare their worldwide income and pay annual income tax on the portion of income in excess of the nontaxable level, at progressive rates of 10% and 15%. Income from capital (i.e. dividends and interest) is not included in annual income. Previously, the law prescribed a higher nontaxable threshold for foreign nationals compared to Serbian nationals, but under the amendments, a uniform nontaxable threshold (i.e. three average annual salaries) applies to all tax residents in Serbia. The progressive tax rates apply as follows: income up to six times the average annual salary is subject to a 10% tax and income exceeding this amount is subject to a 15% tax. The changes to the annual income taxation rules apply to the taxation of income generated in 2010.