Why Czech Republic's tax system is attractive for expatriate employees?

Tax reform continues to come in waves across the globe.  One common theme of many reforms is tax breaks for low to mid wage earners and surprising tax hikes for high wage earners.  This trend seems to be consistent with the latest out of the Czech Republic. 

New changes to the Czech tax law effective from 1 January 2021 will generally help lower the Czech tax payable for the majority of employees.   However, for individuals who have significant levels of employment or non-employment income, the changes may cause an unwelcome increase in their tax bill.  Just how significant will the tax savings or tax surprise be? As is the answer for many tax questions – “it depends” and we present below further information which will let you know how the changes could affect you or your employees who are taxable in the Czech Republic.

Prior to 2021, the Czech Republic had a tax system that used the bizarre concept of a “super gross” tax base which levied a 15% flat tax on a base consisting of an individual’s gross taxable employment income plus the amount of mandatory social security and health insurance paid by the employer on that income. For employees participating in the Czech social security system, this generally meant that an effective rate of tax ranging from 15% to 20.5% would apply. To allow some level of tax fairness, the Czech Republic also had a 7% solidarity tax which was assessed on gross employment income, net self-employment income or their combination exceeding a relatively high threshold (approximately EUR 63,100 in 2020).

An individual’s other types of income (interest, dividends, rental income, capital gains, etc.) would generally just suffer the 15% flat tax.  This system of taxation was seen as non-transparent as it was hard for an individual to readily know what rate of tax they would pay on their total income and was also seen to favour wealthy individuals who tended to have various types of income which would only be subject to a 15% tax rate.

You say you want a revolution?

The new tax system in place for 2021 implements a simple progressive tax system.  An individual’s total tax base made of different types of income up to approximately EUR 64,200 is taxable at a rate of 15% and any amount of income over this threshold is taxed at a rate of 23%.  One exception to this treatment generally applies to non-Czech interest and dividends which may still be taxed at a flat 15%.  While the changes are interesting, they may not be qualified as revolutionary. Most individuals with average to above average levels of employment income and minor non-employment income may see modest reductions in their tax payable.  For individuals who have high levels of employment income and non-employment income, the change in the tax system may sting a bit as the effective rate of taxation may jump as much as 8%.

Before and after

To illustrate the impact of the changes in the tax system, we present below 3 simplified calculations:

Employment income EUR 45,000EUR 250,000EUR  75,000
Non-employment incomeEUR   5,000EUR   50,000EUR  50,000
Total taxable income EUR  50,000EUR 300,000 EUR 125,000

Czech tax bill in 2020EUR    9,795EUR 63,805EUR 22,940
Czech tax bill in 2021EUR 7,500EUR 63,865EUR 23,615
DifferenceEUR -2,295EUR +60EUR +675

As is visible, the impact tends to be felt the hardest by individuals who have high levels of non-employment income which was subject to just a tax of 15% prior to 2021 but may be now taxed at 23% if an individual also has a relatively high level of employment income.  For expatriate employees who may not be tax equalized on their private income and who receive taxable assignment-related benefits which would tend to push them into the upper tax bracket, it may be important to communicate the change in the Czech tax system so they are prepared for the potentially higher level of Czech tax payable.

The take away

The changes are generally good news for many tax payers and may help the Czech Republic stay at the top of the International Tax Competitiveness Index in the area of taxation of individuals (3rd place in 2020- for more information, please see  https://taxfoundation.org/2020-international-tax-competitiveness-index/).  This will allow the Czech Republic to remain a popular country in the Central and Eastern Europe region for the assignment of expatriate employees, be a designation country for individuals from high tax countries looking for a comfortable place to retire and help employees and individuals in the Czech Republic who have been adversely affected financially by the COVID-19 pandemic.  For more information on how the Czech Republic stacks up tax wise in the CEE region (even before the change), you may want to have a look at Mazars CEE Tax Guide (please see https://eng.mazars.cz/Home/Insights/Mazars-publications/Surveys-and-studies/CEE-TAX-GUIDE-2020-trends-and-facts).