We continue a series of articles on possible economic opportunities and tax issues for Israelis with overseas interests. In this article, we review Croatia.
By LEON HARRIS, MASA SARICcroatia 88(photo credit: )
We continue a series of occasional articles on possible economic opportunities and tax issues for Israelis with overseas interests. In this article, we review Croatia - in particular, the popular Croatian real estate sector. Our remarks are very general and you should consult experienced professional advisors in each country in specific cases.
The Croatian real estate scene: Croatia is currently on the verge of a property boom. Since gaining independence, there has been strong push to return formerly state-owned land to the original owners or their descendants. Croatia has introduced several reforms to stabilize the market, such as simplified land registration, better infrastructure facilities and regulation of the mortgage market.
Croatia is relatively small country, but has a spectacular 6000 km. coastline on the Adriatic Sea with more than 1,100 islands. As in many central and eastern European countries, the property market is dominated by the capital city, Zagreb.
The most expensive city on the Croatian coast, Dubrovnik, is situated in Dalmatia, an area with significant growth potential and an abundance of tourist resorts. The Kvarner area is popular among Croatians and offers relatively low property prices.
In the office property sector, available office property stock mostly comprises offices in renovated old buildings. Office rent in Croatia is still higher than that of other Central and European countries. There are also several office complexes in other cities in Croatia, Dubrovnik and Rijeka.
The retail property sector is influenced by increasing personal income and rising levels of consumption Consequently, Croatia is now attracting international retailers to the country.
The wealthiest residential areas are situated in the historic city center and to the north in the hills above Zagreb. More affordable, modern residential apartments are located to the south and to the west of the center. Demand to buy apartments is very high among the local population.
The industrial property sector in Zagreb is not very developed, but some developers have projects to build modern warehouses, with a view to making Croatia a significant European logistic operator.
Croatian legal and tax aspects: According to the Act on Ownership, two conditions have to be satisfied for the foreign person to be entitled to acquire and own real estate in Croatia. The first condition is reciprocity, which would be satisfied if Croatian persons can legally purchase and own real estate in the country of origin of the foreign individual looking to acquire Croatian real estate. The second condition is the need for an interested party (potential buyer or seller) to obtain the consent of the Croatian Minister of Justice.
Croatian legal entities owned by foreign persons can acquire real estate in Croatia, regardless of the origin of the owners.
Purchasers of Croatian buildings constructed before December 31, 1997 are subject to real estate transfer tax at a rate of 5% of its current market value.
Transfers of buildings and parts thereof that were constructed or refurbished after December 31, 1997, are subject to VAT at a rate of 22%, not real estate transfer tax.
Transfers of land are outside the scope of VAT and are subject to real estate transfer tax.
Income realized by an individual from the sale of real estate, property and property rights is taxed at the rate of 25% and applicable city tax rate. Taxable income is defined as the difference between the consideration - determined according to the market value of the real estate sold - and the purchase price plus indexation according to the rise in producer prices of industrial products. The costs of sale can be deducted as expenses.
Nevertheless, the sale is exempt if the real estate sold was used for accommodation of the seller or dependant family members.
If an individual sells more than three real estate assets during a five-year period, such activity will be considered trading activity. Consequently, the individual will be obliged to maintain bookkeeping records and will be taxed according to provisions of the Croatian Personal Income Tax Act at progressive rates (15%, 25%, 35% and 45%) on the resulting income.
Legal entities are subject to Corporate Income Tax in Croatia at a rate of 20%. Capital gains are treated like any other income realized by the legal entity and are taxed at a rate of 20%.
Passive rental income derived by individuals from real estate is subject to personal income tax at a rate of 15% after deduction of lump sum expenses of 30% of income. However, if the individual is trading, that person must register, keep books and pay income tax at progressive rates on the difference between income and expenses as well as VAT.
In addition to income tax, a city tax amounting from 0% to 18% is payable, but non-residents are not subject to the city tax.
Rental income derived by entities represents is subject to corporate income tax as regular business profit taxable with at a rate of 20%.
The rental of property is subject to VAT in Croatia at a rate of 22% if the lessor is registered for VAT (voluntary registration or if taxable income exceeded HRK 85,000, approximately €11,600, in the preceding year). However, the rental of housing property in Croatia is exempt from VAT. The provision of accommodation in commercial catering facilities is subject to VAT at a rate of 10%.
How will Croatian taxes interact with Israeli taxes for Israeli investors? This will depend mainly on individual circumstances - see, for example, our article "Tax issues to consider when investing abroad" (Jerusalem Post October 18, 2006). Key issues typically may include: The entity structure; the business model; intellectual property and research and development; finance aspects; income repatriation; exit strategy; management and employees; double tax relief; tax planning and anti-avoidance rules.
Israel does not yet have a tax treaty with Croatia but a draft treaty was signed in September 2006, as well as foreign tax credit rules in the domestic Israeli tax law. In the absence of a treaty, Croatia generally withholds tax at a rate of 15% from overseas payments of loan interest, royalties, fees for market research, business advice and auditor services, but no tax from dividends.
In the case of Croatian property investment, Israeli investors will generally be required to invest via a Croatian company, as explained above. After paying Croatian corporate income tax of 20%, the Croatian company is may distribute dividends of up to 80% of its net rental income or capital gains.
Thereafter, the Israeli tax on such dividends would be:
• 20% for an Israeli resident individual investor holding under 10% of the Croatian company, resulting in a combined tax burden of 36% in principle (20% Croatian tax plus 20% Israeli tax on 80)]
• 25% for an Israeli resident individual holding 10% of the Croatian company, or for an Israeli corporate investor, resulting in a combined tax burden of 40% in principle (20% Croatian tax plus 25% Israeli tax on 80)].
Capital gains from share sales, loan interest, consulting fees and so forth will be taxable at various rates under the laws of both countries - specific advice should be obtained. Croatia has a system of foreign exchange control, so its formalities should be followed.
Israeli investors must also report the existence of their shareholdings in a Croatian company in their annual tax returns. The additional 2007 reportable tax planning regulations seem unlikely to apply if the Croatian company pays at least 20% tax on all types of income or if the draft Croatia-Israel tax treaty is ratified and implemented by then - but this will not be an issue before the 2007 tax year.
leon.harris@il.ey.comLeon Harris is an international tax specialist at Ernst & Young Israel
Masa Saric is an international tax specialist at Ernst & Young Zagreb, Croatia
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