Non-resident owners of property in Croatia who have plans to rent it out should consider domestic and double tax treaty rules on taxation of permanent establishments.
While most double tax treaties concluded by Croatia state that it may tax income derived from real estate (including rent) situated in Croatia, for years Croatia has not specifically regulated this possibility in relation to non-resident companies. Aside from the general rule on taxation of permanent establishments’ (PE) profit, there has been no specific rule on taxing such income. On the other hand, Croatia regularly taxes income from property derived by non-resident individuals. After making certain steps towards taxing non-resident companies’ real estate income back in 2019, the practical effect remained unclear.
The domestic PE provision was supplemented with a rule saying that “irrespective of other conditions and deadlines relating to a permanent establishment, profit or income derived by a non-resident company from real estate situated in Croatia may be taxed.” No specific rule or further explanations have been provided about the type of relevant tax or the taxation procedure.
Does any non-resident company’s income from real estate automatically create a taxable PE in Croatia? Or would such income be subject to withholding tax? In the latter case, it seemed odd that the new provision is added to the PE rule.
One could argue that the intention of the lawmaker was to tax a non-resident company as if it owned a PE in Croatia. But this would jeopardize the general definition of a PE, which Croatia applies in its domestic legislation and in all double tax treaties it has signed: a PE is created when a fixed place of business where a company wholly or partly carries out its business. This assumes the existence of a place of business, which must be fixed (i.e., established at a distinct place with a certain degree of permanence), and that the company’s business must be carried out at this fixed place of business (usually by personnel who, in one way or another, are dependent on the enterprise).
Without personnel carrying out business in Croatia, a non-resident company should have no taxable presence in the form of a PE in Croatia.
The matter has been addressed in an official opinion of the tax authority, which referred to the OECD commentary about the PE rule, pointing out, rather interestingly, that business carried out through a fixed place of business commonly assumes dependent personnel performing business activities in the state where the PE is located.
The opinion further quoted the OECD commentary saying that determining the existence of a PE belonging to an enterprise must be made independently from the determination about which Double Tax Treaty provision applies to the profits derived by that enterprise. It is clear that the rule on taxation of particular income (e.g. income from real estate) should not be linked to the question of the existence of a PE.
Finally, the opinion pointed out that commencing any activity, including renting out a property in Croatia, must be reported to the tax authorities within the prescribed deadline of 8 days. The report should enable the authorities to determine the potential existence of a PE and related tax liabilities.
It follows that real estate taxes would be based on the existence and activity of a PE and in no circumstance be separated from conditions and deadlines related to the PE (as implied in a 2019 supplement to the PE rule). It is also important to emphasize that in the case of non-residents from double tax treaty-covered jurisdictions, the Croatian Tax Authority would not be able to ignore the PE rule set in the international tax treaty. The Model Double Tax Treaty is clear: rented tangible property will not, as such, constitute a PE if there is no fixed place of business maintained for such a letting activity.
It may be concluded that the purpose of the domestic rule on taxation of real estate income has been to enable the tax authority to review non-resident companies’ activities (including the renting of properties) in Croatia for PE purposes. The wording of the respective rule, however, has been somewhat clumsy and left the practice unclear.
Non-resident companies renting a property in Croatia should remember, though, that they have a reporting liability towards the Croatian Tax Authority shortly after commencing the renting activity.
By Tamara Jelic Kazic, Partner and Coordinator of Tax Group, CMS CEE
This article was written before the advent of the war in Ukraine and was originally published in Issue 9.2 of the CEE Legal Matters Magazine on March 1, 2022. More current articles on developments in Ukraine can be found in our #StandWithUkraine section. If you would like to receive a hard copy of the magazine, you can subscribe here.