Tax incentives-The labyrinth of opportunities and challenges

Tax incentives-The labyrinth of opportunities and challenges

How to navigate this labyrinth?

Tax incentives are one of the examples of state intervention aimed, among the others, at contributing to an encouraging investment climate, more competitive economy, and balanced and even regional development. Over the past few years, we have witnessed various initiatives linked to tax reliefs in terms of reforming the laws that are regulating income tax, corporate income tax, and value-added tax (VAT) systems.

Some of the recent tax changes such as the increase of personal allowances that come into effect on January 1st, 2024, and have received significant media coverage include amendments to the Income Tax Act. Public consultations on the Guidelines for the income tax have been recently closed at the time of writing this article, and the report on the public consultation is expected soon. These proposed changes aim, amongst other goals, to reward employees for their work results while simultaneously providing stronger tax relief for entrepreneurs to retain their workforce, enhance worker efficiency, and contribute to the overall competitiveness of the economy.

On the other hand, there are other tax incentive changes, which are currently receiving less focus in public. One example is the tax incentive according to the Investment Promotion Act, which is primarely focused on tax reliefs to the corporate income tax. The Act is directly linked to the overarching EU Regulation (EU) No. 651/2014 that among the others defines regional state aid which is the aid through which tax incentives are obtained. The mentioned Regulation has changed and came into force on July 1st, 2023 which is very important for the Act, because its implementation into the Act is obligatory, when the approved transition period ends. While certain outlines of the Act have already been expected considering the Regulation, soon it will be evident to what extent the Act will genuinely encourage entrepreneurs to invest. This Act with its aims positively correlates with the National Strategy 2030, defining four development directions:
1. Sustainable economy and society
2. Strengthening resilience to crisis
3. Green and digital transition
4. Balanced regional development.

Alongside these four defined directions, there is a horizontal course of intensive action involving investment in workforce resource.
The first of the four above mentioned development direction is particularly interesting as it emphasizes the strategic goal of becoming a more competitive and innovative economy. The idea of this development direction is to stimulate growth based on improving productivity and further investment in innovations and new technologies. Additionally, the fourth development direction, with its focus on reducing regional disparities in economic progress and establishing even regional development, is noteworthy.

Investment Promotion Act – A good opportunity for entrepreneurs

The Investment Promotion Act is in positive correlation with the National Development Strategy considering its goals and development directions and aims to strengthen the investments and competitiveness of companies. The goal is to encourage investments in long-term assets and the creation of new jobs in all regions of Croatia, with a special emphasis on less developed ones.
Under the Act, an entrepreneur, whether small, medium, or large, has the right to a tax incentive under the condition of a minimum 150,000 EUR investment into a construction and equipment in a three-year period in activities such as:
1. Production and processing
2. Research, innovation and development
3. Business support activities
4. High value-added activities

The investment should in most cases be linked with the increasing of the (production) capacity, and moreover with green and energy efficient investments which relates to the development directions of the National strategy.

The most common additional condition under the Act is that the same entrepreneur, opens at least 5 new jobs related to the investment.

The aid is manifested as a reduction of the corporate income tax rate, which can range from 50% to even 100%, depending on the amount invested and the number of newly opened jobs. The intensity of support depends on the size of the entrepreneur and the location of the investment, ranging from 35% in the Zagreb County region for large enterprises up to 70% for small enterprises in the Pannonian, Adriatic and Northern Croatian NUTS II* regions.

After the devastating earthquake in 2020 centered in Petrinja, Sisačko-moslavačka county was recognized as a region with urge to be additionally encouraged for the faster economic recovery, attracting the working population, further growth and development, having in mind the basic principles of the National Strategy connected to the goal of balanced regional development. Also, the same region is recognised as an important region that should be supported additionally because the region is expected to be the most negatively impacted by the transition towards climate-neutrality.

Therefore, an increase in the aid intensity has been approved, where, in case of an eligible investement in the above mentioned county, an entrepreneur can obtain the aid ranging between 60% and 75%, depending on the size of an entrepreneur. This is a remarkable incentive supportnig investments, opening new jobs, and the developing such a less developed regions.

Investment Promotion Act-what are the challenges?

On one hand, there are evident efforts to encourage investment in less developed regions, but the demands of the private sector industry need to be taken into account, especially those in the manufacturing and tourism sectors, as well as other sectors that form the fundamental pillars of the Croatian economic development. Namely, entrepreneurs in all regions, particularly in less developed ones, face difficulties in finding (qualified) workforce. Guided by market principles, entrepreneurs investing in modernization of their capacities, which is encouraging in the context of the Act. Simultaneously, due to a plant and equipment modernization aiming at productivity increase, either reorganisation of the existing workforce or reduced need of a work force will probably incur. This potentially leads to a labyrinth where there is a struggle to find the way out of the business modernization and investing in more advanced and efficient technology on one side. On the other side of the labyrinth road, there is an obligation of opening new jobs that are not market-justified due to insufficiently available qualified labor force or due to business modernization resulting in those positions being unnecessary or unfilled on the other way.

How to navigate this labyrinth?

Entrepreneurs by themselves or with the hand of advisors for state aid and tax incentives, should be encouraged to calculate the costs and benefits of the Act in the terms of investing in new long-term assets and equipment modernisations whilst trying to fulfil the Act condition of creating new job positions on the other hand.

The possible incentives and the Government’s effort are evident, but the balance between the urge of the productivity and competitiveness increase through modernization, and the obligations of new job creations must be reconciled.

*1 NUTS states for Nomenclature of Territorial Units for Statistics and is usually specified at the level II. Republic
of Croatia has four different NUTS II regions : Panonion Croatia consisting of: Bjelovarsko-bilogorska county,
Virovitičko-podravska county, Požeško-slavonska county, Brodsko-posavska county, Osječko-baranjska county,
Vukovarsko-srijemska county, Karlovačka county, Sisačko-moslavačka county; Adriatic Croatia consists of:
Primorsko-goranska county, Ličko-senjska county, Zadarska county, Šibensko-kninska county, Splitsko-
dalmatinska county, Istarska county, Dubrovačko-neretvanska county; Northern Croatia which consists of:
Međimurska county, Varaždinska county, Koprivničko-križevačka county, Krapinsko-zagorska county,
Zagrebačka county; the fourth one is Zagreb county.

Source – AmCham Yearbook 2023.:
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