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© The Economist Intelligence Unit Limited 2015 Sponsored by Business risks and opportunities in the Czech Republic An article by The Economist Intelligence Unit A s one of the most mature markets in Central and Eastern Europe (CEE), the Czech Republic continues to offer considerable market opportunities for foreign investors thanks to its high- quality infrastructure, a strong banking sector, robust creditworthiness and a growing middle class. Hence, investors from beyond the EU, such as Visteon Corporation and Amazon of the US, continue to relocate production centres to the Czech Republic in a bid to expand business. Investor interest is clearly alive and well, but the business environment remains challenging because of rising political instability and persistently loose regulatory norms. Red tape and corruption, particularly in public-sector procurement, are also present, though this is far from unique in the region. Policy uncertainty Recent surveys, such as those released by the World Economic Forum, show that concerns over policy instability and taxation are among the most problematic factors for doing business in the Czech Republic. 1 Its tax burden, particularly payroll taxes, is steep by OECD standards, albeit not as high as in neighbouring Slovakia. Furthermore, despite the government’s pledge to streamline the tax system, compliance with taxation requirements is still overly complicated. In 2014 the government introduced a three-tier system of value-added tax (VAT) and approved a third, lower VAT rate of 10% (which came into force on January 1st 2015 and applies to medical drugs, books and baby food), in addition to the two existing rates of 21% and 15%. 2 Moreover, 2015-16 promises to bring a fresh round of sector-specific tax rises (gambling taxes, for example, according to a new bill due to come into force at the start of 2016). 3 Rising cost of business and regulatory change Although the level of corporate taxation is competitive relative to regional peers—19% for most businesses and 5% for investment and pension funds—the cost of doing business is beginning to rise in the Czech Republic. This is partly a result of falling cost competitiveness in pockets of the manufacturing sector—the bulwark of the economy—as productivity gains struggle to keep up with further expected rises in the minimum wage, while international competition for services outsourcing

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Page 1: Business risks and opportunities in the Czech Republic · Business risks and opportunities in the Czech Republic ... Business risks and opportunities in the Czech Republic ... 11

© The Economist Intelligence Unit Limited 2015

Sponsored by

Business risks and opportunities in the Czech Republic

An article by The Economist Intelligence Unit

As one of the most mature markets in Central and Eastern Europe (CEE), the Czech Republic continues to offer considerable market opportunities for foreign investors thanks to its high-

quality infrastructure, a strong banking sector, robust creditworthiness and a growing middle class. Hence, investors from beyond the EU, such as Visteon Corporation and Amazon of the US, continue to relocate production centres to the Czech Republic in a bid to expand business.

Investor interest is clearly alive and well, but the business environment remains challenging because of rising political instability and persistently loose regulatory norms. Red tape and corruption, particularly in public-sector procurement, are also present, though this is far from unique in the region.

Policy uncertaintyRecent surveys, such as those released by the World Economic Forum, show that concerns over policy instability and taxation are among the most problematic factors for doing business in the Czech Republic.1 Its tax burden, particularly payroll taxes, is steep by OECD standards, albeit not as high as in neighbouring Slovakia.

Furthermore, despite the government’s pledge to streamline the tax system, compliance with taxation requirements is still overly complicated. In 2014 the government introduced a three-tier system of value-added tax (VAT) and approved a third, lower VAT rate of 10% (which came into force on January 1st 2015 and applies to medical drugs, books and baby food), in addition to the two existing rates of 21% and 15%.2 Moreover, 2015-16 promises to bring a fresh round of sector-specific tax rises (gambling taxes, for example, according to a new bill due to come into force at the start of 2016).3

Rising cost of business and regulatory changeAlthough the level of corporate taxation is competitive relative to regional peers—19% for most businesses and 5% for investment and pension funds—the cost of doing business is beginning to rise in the Czech Republic. This is partly a result of falling cost competitiveness in pockets of the manufacturing sector—the bulwark of the economy—as productivity gains struggle to keep up with further expected rises in the minimum wage, while international competition for services outsourcing

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2 © The Economist Intelligence Unit Limited 2015

Business risks and opportunities in the Czech Republic

© The Economist Intelligence Unit Limited 2015

is growing.4 For instance, in September 2014 the Czech Republic (and Poland) outdid other destinations in the region as Amazon’s top choices for its latest logistics centres.5

Although the era of buoyant productivity rates buffered by low labour costs is coming to an end, the outlook is far from gloomy. The latest round of policy measures— instigated to ensure alignment with existing EU norms and International Financial Reporting Standards (IFRS)6—will help the regulatory and investment environment to remain investor-friendly. This includes a new law on public procurement aimed at simplifying existing rules, effective from 2016, as well as the implementation of the Business Corporations Act, effective since January 1st 2014, which will improve contract enforcement and general operational efficiency.7

Nevertheless, the long-promised overhaul of the taxation system as a whole, aimed at easing administrative burdens, remains some way off; a new bill on improving tax collection, which will include new legislation on the electronic registration of sales, is only now being drafted.8 The Czech Republic is by no means alone in this: Slovakia is facing a similar delay in creating a streamlined taxation system (see Slovakia profile).

Unleashing drivers of growthThe Czech prime minister announced recently that the EU will allow the Czech Republic to use unspent funds from the old EU programming period.9 However, a question-mark still hangs over the efficient use of these funds, considering that in 2014 alone the country failed to use an estimated CZK9bn (US$434m).10 Nevertheless, despite the sluggish absorption capacity seen in recent years, EU monies promised for 2014-20 (€22bn or US$26bn, equivalent to around 2% of GDP per year)11 could help to drive a new infrastructure-project boom in areas left wanting in recent years, such as real estate and transport.

Part and parcel of the push for structural reform are greater funding opportunities for small and medium-sized enterprises (SMEs), or companies with fewer than 250 employees. There are about 1m SMEs in the Czech Republic,12 considerably fewer than the estimated 4m SMEs in neighbouring Poland (see Poland profile).

SME density is nevertheless high and provides employment to almost 70% of the labour force,13 particularly in traditional sectors such as manufacturing and retail, which will continue to drive growth in the near term as the economic recovery becomes more evenly balanced between exports and

Standard corporate tax rate(%)

Chart 1

Romania

Sources: European Commission; The Economist Intelligence Unit.

Note: The values for the euro zone and EU28 are simple averages of theadjusted top statutory tax rate on corporate income in 2014.

CzechRepublic

Hungary

Poland

Slovakia

EU28average

Euro zoneaverage

16.0%

19.0%

19.0%

19.0%

22.0%

22.9%

25.3%

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3© The Economist Intelligence Unit Limited 2015

Business risks and opportunities in the Czech Republic

domestic demand. However, the impact of the euro area crisis has weighed significantly on the performance of SMEs, including a slowdown in value-added growth by SMEs.14

SMEs form an important part of the Czech Republic’s return to a sustainable path of economic growth, in line with the government’s Small and Medium Enterprises Support Strategy 2014-2020. If SMEs are to regain their role as a driver of GDP growth, similar to the pre-2008 period, they will need to secure greater access to crossborder trade and financing (from institutional investors such as the European Investment Bank), in addition to improving the absorption rate of EU funds. The country’s disappointing absorption capacity with respect to EU structural and cohesion funds—particularly in 2007-13—remains a challenge.

Despite unfavourable export and import procedures and underwhelming levels of innovation-related entrepreneurial activity, there has been progress in SME participation in public procurement. There has also been growth in crossborder activities, as increasing numbers of Czech SMEs look to tie up with similar businesses in emerging markets in East Asia, such as China.15

Incentivising investmentInvestment incentives are set to remain in place for the foreseeable future. This includes tax breaks, rebates on corporate income and capital gains tax, employment grants and ten-year tax relief schemes covering businesses investing in key sectors such as manufacturing, information technology (IT) software and research and development (R&D).16 Financial assistance for businesses in underdeveloped regions is, however, fast overtaking the need for fresh R&D expenditure. The government has pledged its commitment to attracting new foreign direct investment (FDI) into manufacturing (which accounted for more than 25% of gross value added in the first three quarters of 2014) as well as technological and software development.

The recent amendment to the Investment Incentives Act, which comes into force in the first quarter of 2015,17 will introduce a broader range of schemes targeted at SMEs and microbusinesses operating in the south-east, central and north-west regions that are beset by high unemployment. The focus will be on heavy manufacturing and technology-focused businesses operating in newly designated special industrial zones. As a result, businesses in these areas will be eligible for increased financial aid, cash grants, various forms of corporate income tax relief and property tax exemptions.

EU Cohesion Fund absorption rates for2007-13, as of 2014(%)

Chart 2

Poland

Hungary

CzechRepublic

Slovakia

Romania

Source: European Commission.

85.3%

76.3%

63.2%

60.1%

56.3%

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Business risks and opportunities in the Czech Republic

© The Economist Intelligence Unit Limited 2015

Endnotes1 World Economic Forum (2014), The Global Competitiveness Report 2014–2015, p. 166. Available at: http://www3.weforum.org/docs/WEF_GlobalCompetitivenessReport_2014-15.pdf

2 “Reduced VAT rate comes into effect as of January 1”, www.czech.cz, January 2nd 2015. Available at: http://www.czech.cz/en/Business/Reduced-VAT-rate-comes-into-effect-as-of-January-1

3 “Czech ministry looking to raise gambling taxes from 2016-report”, Reuters, December 17th 2014. Available at: http://www.reuters.com/article/2014/12/17/czech-tax-gambling-idUSL6N0U10W420141217

4 “Minimum wage to rise substantially”, Prague Post, September 28th 2014. Available at: http://www.praguepost.com/economy/41785-minimum-wage-to-rise-substantially ; http://radio.cz/en/section/business/amazon-plans-another-czech-logistics-centre; http://www.dw.de/poland-takes-up-german-slack-for-amazon/a-18134306;

5 “Amazon plans another Czech logistics centre”, Radio Prague, September 15th 2014. Available at: http://radio.cz/en/section/business/amazon-plans-another-czech-logistics-centre

6 IFRS, IFRS application around the world; jurisdictional profile: Czech Republic. Available at: http://www.ifrs.org/Use-around-the-world/Documents/Jurisdiction-profiles/Czech-Republic-IFRS-Profile.pdf

7 “Czech Republic: significant obligations under the New Act on Business Corporations “, Lexology, February 7th 2014. Available at: http://www.lexology.com/library/detail.aspx?g=7e5977f3-409e-48b1-ba89-543f54468493

8 “No polls, but important political events ahead of Czechs in 2015”, ČeskéNoviny.cz, January 1st 2015. Available at: http://www.ceskenoviny.cz/news/zpravy/no-polls-but-important-political-events-ahead-of-czechs-in-2015/1164137

9 “CR has chance to use EU money allocated for 2007-13-PM Sobotka”, ČeskéNoviny.cz, December 19th 2014. Available at: http://www.ceskenoviny.cz/news/zpravy/cr-has-chance-to-use-eu-money-allocated-for-2007-13-pm-sobotka/1160820

10 “Czechs fail to use 9 billion Kč”, Prague Post, January 2nd 2015. Available at: http://www.praguepost.com/czech-news/43615-czechs-fail-to-use-9-billion-kc

11 “EU Cohesion Policy 2014-2020: Will EUR 167bn of EU funds give CEE a boost?”, Erste Group, March 3rd 2014. Available at: https://www.erstegroup.com/en/Press/Press-Releases/Archive/2014/3/11/EU-Cohesion-Polica-2014-2020~Research-Zentral-Osteuropa

12 OECD, Financing SMEs and Entrepreneurs 2014, September 4th 2014. Available at: http://www.oecd-ilibrary.org/industry-and-services/financing-smes-and-entrepreneurs-2014/czech-republic_fin_sme_ent-2014-12-en

13 European Commission, 2014 SBA Fact Sheet: Czech Republic. Available at: http://ec.europa.eu/enterprise/policies/sme/facts-figures-analysis/performance-review/files/countries-sheets/2014/czechrepublic_en.pdf

14 European Commission, A partial and fragile recovery: annual report on European SMEs 2013/2014. Available at: http://ec.europa.eu/enterprise/policies/sme/facts-figures-analysis/performance-review/files/supporting-documents/2014/annual-report-smes-2014_en.pdf

15 EU SME Centre, EU SME Centre Central and Eastern Europe Road Show: Czech Republic. Available at: http://www.eusmecentre.org.cn/content/eu-sme-centre-central-and-eastern-europe-road-show-czech-republic

16 CzechInvest, Investment Incentives. Available at: http://www.czechinvest.org/data/files/fs-04-investment-incentives-68-en.pdf

17 “The Czech Republic as an attractive location for Shared Service Centers”, presentation by Ondrej Votruba, CEO of CzechInvest, October 16th 2014. Available at: http://www.absl.cz/docs/2014-10-16-conference/05-czechinvest-votruba.pdf

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5© The Economist Intelligence Unit Limited 2015

Business risks and opportunities in the Czech Republic

While every effort has been taken to verify the accuracy of this information, The Economist Intelligence Unit cannot accept any responsibility or liability for reliance by any person on this article or any of the information, opinions or conclusions set out in this article.