In this article, we will focus on a specific method of income tax collection pursuant to Section 43 of Act No. 595/2003 Coll. on Income Tax, as amended (hereinafter referred to as the “Income Tax Act”) i.e., tax collection by withholding, or “withholding tax,” as we will refer to it throughout this discussion. We will focus specifically on the application of withholding tax in the healthcare and pharmaceutical sectors, which applies to services provided by holders to healthcare providers. Although the Income Tax Act introduced withholding tax for these specific transactions in healthcare as early as January 1, 2015, our experience shows that this is an area where there remains a great deal of uncertainty and conflicting opinions regarding its application—not only on the part of the relevant state authorities, but also among experts and taxpayers. In our practice of providing legal services, we encounter opinions and interpretations of the legal framework by financial authorities that are contradictory and unduly broad. However, it is precisely due to the application of such broad interpretations that withholding tax may be applied even in cases where it should not be applied, which subsequently causes problems for taxpayers and puts them at a disadvantage in the market.
Our law firm has been intensively focusing on withholding tax issues, particularly in the healthcare and pharmaceutical sectors, since 2016, both by representing taxpayers in tax audits and subsequent tax proceedings, and by providing comprehensive guidance on processes and procedures for taxpayers directly affected by pharmaceutical withholding tax.
In a series of articles on this topic, we will present readers with an overview of the legal framework and the most common problems and questions that affected entities encounter when applying withholding tax. In this context, affected entities often deal with complex situations complicated by various peculiarities of legal relationships, the services provided, the temporal scope of legal norms, or potentially involved international elements and other factors that influence income taxation and the fulfillment of other related legal obligations. For this reason as well, we recommend that the affected taxpayers develop internal regulations that uniformly govern procedures for this specific taxation in accordance with the applicable legal framework.
In this introductory article, we will begin with a general overview of the issue and its legal framework, clarifying the relevant terms.
Withholding tax pursuant to Section 43(3)(o) of the Income Tax Act
Withholding tax is a special method of collecting income tax that applies only in cases exhaustively defined in Section 43 of the Income Tax Act. In the healthcare and pharmaceutical sectors, withholding tax is applied pursuant to Section 43(3)(o) of the Income Tax Actto monetary and non-monetary payments, provided these are made by the holder to a healthcare provider, except for such payments if they are made for clinical trials. A distinctive feature of this tax collection is that the entire amount (value) of the benefit provided is taxed, without deducting any related expenses. By withholding and remitting the withheld tax, along with filing the relevant notifications, the tax liability on such income is considered settled.
The method of applying (collecting) withholding tax depends on whether the healthcare provider receives monetary or non-monetary consideration. The withholding tax rate in these cases is 19% or 35%. Certain benefits exhaustively defined in Section 9 of the Income Tax Act are exempt from tax, and these benefits do not need to be taxed or reported in the notifications submitted to the tax administrator.
When does the obligation to tax income by withholding under Section 43(3)(o) of the Income Tax Act apply to you?
First, it is necessary to determine whether withholding tax applies to the relevant transaction at all. To this end, it is necessary to assess whether the prerequisites required by the Income Tax Act (so-called substantive conditions) are met, which can be identified as:
- the provider of the payment acting as the holder
- the recipient of the service in the position of a healthcare provider
- the definition of monetary and non-monetary services subject to withholding tax, i.e., the subject of withholding tax
- the source of income and the related application of double taxation treaties.
Only by simultaneously fulfilling all substantive legal requirements can withholding tax be lawfully applied, and these requirements should be examined individually for each transaction, because failure to meet even one of them will result in withholding tax not being applied.
The basic requirements for the application of withholding tax are as follows:
1. The provider of the service must be a “holder”
Withholding tax applies only to supplies provided by an entity with the status of a holder within the meaning of Section 2(y) of the Income Tax Act, which means the holder of a drug registration, the holder of a license for wholesale distribution of drugs, the holder of a license for the manufacture of drugs, a pharmaceutical company, a holder of a license to provide pharmacy care, a manufacturer and distributor of medical devices, a manufacturer and distributor of dietary foods, or a third party that facilitates the provision of services by these entities, who need not be a related party to the entities listed above in terms of ownership, personnel, or similar ties. Thus, any person who merely mediates the provision of services from the holder may also be considered a holder (even if they do not operate in the healthcare sector or even if they would otherwise be considered a healthcare provider), provided that the ultimate recipient of the benefit is a healthcare provider (e.g., a marketing or event agency, a hospital, a healthcare facility, etc.).
2. Recipient of the service, who must be a healthcare provider
The recipient of a monetary or non-monetary service must always be considered to be the natural or legal person who is the final recipient of the service, i.e., the person who derives actual financial benefit from the service provided. A healthcare provider is defined under Section 2(z) of the Income Tax Act as a healthcare provider who is considered a healthcare provider under Act No. 578/2004 Coll. on Healthcare Providers, healthcare professionals, professional organizations in healthcare, and on amendments to certain laws, or an employee thereof, regardless of their job classification, or a healthcare professional. It is necessary to examine and identify in each individual case whether the person receiving monetary or non-monetary benefits has the status of a healthcare provider, even if that person is a foreign national.
Effective January 1, 2020, the Income Tax Act was amended to stipulate that only income earned by a healthcare provider as a natural person is subject to withholding tax, and such income falls under the category of “other income” pursuant to Section 8 of the Income Tax Act. Thus, income earned by a healthcare provider—whether a legal entity or a natural person—that constitutes income from employment pursuant to Section 5 of the Income Tax Act (e.g., an employment relationship) or income from business activities, from other self-employment, from leasing, and from the use of a work or artistic performance (Section 6 of the Income Tax Act), or income from capital assets (Section 7 of the Income Tax Act) are not subject to withholding tax.
We hold the view, which also takes into account the position of the Financial Directorate of the Slovak Republic, that the provision of monetary or non-monetary benefits should simultaneously be related to the status of the recipient of the benefit as a healthcare provider.
If the recipient of a monetary or non-monetary benefit from the holder is identified as a healthcare provider who is a natural person, and at the same time the received benefit constitutes a type of income for a natural person pursuant to Section 8 of the Income Tax Act, it is necessary to examine and assess whether the recipient is a taxpayer with limited tax liability (Section 2(e)) or a taxpayer with unlimited tax liability (Section 2(d)). This examination is of fundamental importance in connection with identifying the source of income, because if the recipient of the payment is a taxpayer with limited tax liability (a non-resident taxpayer in the Slovak Republic) and the source of income is outside the Slovak Republic, then withholding tax does not apply.
Each country has a specific procedure for determining the tax residency of individuals under its own domestic tax regulations, so in practice, a situation may arise where a person is considered a tax resident in two or more countries under domestic tax regulations, whether due to a reported permanent residence, temporary physical presence in the territory of the relevant country, or other reasons. If such a conflict of tax residency arises, the relevant provisions of a double taxation treaty, if concluded, apply; these provisions contain criteria for determining a person’s residency and are applied sequentially in the order in which they are listed in the relevant treaty, until only one country of residency for the person is determined. A person’s tax residency is assessed according to the domestic regulations of the state with which the person has a specific legal connection (residence, nationality, etc.).
3. Definition of the types of monetary and non-monetary payments subject to withholding tax, i.e., the scope of withholding tax
First and foremost, it is necessary to assess and determine whether the payment provided is subject to tax under the Income Tax Act pursuant to Section 2(b) of this Act. A specific feature in this area is that a gift provided by a patient to a healthcare provider is also subject to income tax.
At the same time, if a payment is provided to a healthcare provider in connection with a clinical trial, such payments are not subject to withholding tax. In such cases, taxation is carried out by calculating the tax base in the tax return, and the recipient of the consideration may in this case claim expenses demonstrably incurred in connection with the conduct of the clinical trial.
Also excluded from the application of withholding tax are payments that are tax-exempt. The taxpayer—i.e., the healthcare provider—must demonstrate that the conditions for tax exemption are met, as set forth in Section 9(2)(y) of the Income Tax Act.
For payments subject to withholding tax, it is important to subsequently assess the form of the payment provided, i.e., whether it is a monetary or non-monetary payment.
Monetary payments refer only to payments made in money, whether in cash, by deposit, or by transfer to an account; it must be money, not its equivalent.
Non-monetary benefits include all benefits that are not monetary benefits (i.e., for example, airline tickets, meal vouchers, gift certificates, in-kind benefits, etc.).
We hold the legal view that payments should be considered monetary and non-monetary payments if they are defined as “monetary and non-monetary payments” in Act No. 362/2011 Coll. on Medicines and Medical Devices and on Amendments to Certain Acts (hereinafter the “Medicines Act”).
This view can be derived from the direct link between the Income Tax Act and the Medicines Act (via the legislative reference “37ab” used by the legislator, which refers to the full text of the Medicines Act), as well as from the perspective of the purpose of the legal regulation of the taxation of monetary and non-monetary benefits, which was introduced into the Income Tax Act precisely by the wording of Article IV of the Medicines Act, which first introduced this concept into the Income Tax Act with effect from December 1, 2011.
However, the Financial Directorate of the Slovak Republic holds a different view, namely that monetary and non-monetary payments provided by holders to healthcare providers, for the purposes of the Income Tax Act, are understood to mean all and any payments, except for payments provided for clinical trials. This view significantly influenced, in particular, the application of withholding tax from 2015 to 2019.
We disagree with this view of the Financial Directorate of the Slovak Republic and hold the legal opinion that such a definition of payments subject to withholding tax does not follow from the wording of the legal regulation or the structure of the relevant legislation in all its versions, and furthermore, such an application would result in numerous absurd, discriminatory, and economically nonsensical situations. Furthermore, during the legislative process, the purpose of the legislation and the legislature’s intent to impose withholding tax on monetary and non-monetary payments with significance under the Act on Medicines (i.e., participation in professional events and related payments, gifts, or other benefits provided, for example, to physicians and healthcare professionals by marketing authorization holders).
There are, in fact, numerous benefits that the entities concerned provide (and have provided in the past), e.g., within the framework of normal business relations, where the application of withholding tax would directly result in a loss and thus an economic disadvantage for a normal transaction solely because the transaction takes place between entities in a certain position. An extensive interpretation of the Income Tax Act and the subsequent application of the legal norm by the tax authorities is capable of harming those subject to it, as it is significantly disadvantageous for certain transactions compared to the standard method of taxation through the determination of the tax base and the filing of a tax return. To date, several disputes have been filed against the Financial Directorate of the Slovak Republic in this regard, the subject of which is the question of the substantive definition of “monetary and non-monetary payments” for the purposes of applying or not applying withholding tax. We consider it important that the application of taxes, as well as customs duties and fees, imposed on various entities be fair, transparent, predictable, and lawful.
4. Source of Income and International Taxation
Another parameter under consideration that is decisive in relation to the application or non-application of withholding tax is the source of the provided payment, whereby the source of income (payment) may be either within the territory of the Slovak Republic or abroad. The source of income must be determined based on the actual economic provider of the payment that is subject to tax.
If the income originates from sources within the territory of the Slovak Republic, withholding tax is applied to recipients of the service who are taxpayers with both limited and unlimited tax liability (provided that the other conditions for applying withholding tax are met).
If the income originates from sources outside the Slovak Republic (from abroad), in such a case withholding tax applies only to recipients who are taxpayers with unlimited tax liability, i.e., only to tax residents of the Slovak Republic (provided that the other conditions for applying withholding tax are also met).
If a resident of one country earns income that originates in another country, it is necessary to apply the relevant double taxation treaty (DTT) to determine the correct taxation procedure (this applies generally, not only to withholding tax).
The current list of valid and effective double taxation treaties is publicly available on the website of the Ministry of Finance of the Slovak Republic. If there is no valid DTA in place between the countries concerned, the taxation procedure is applied solely in accordance with the domestic regulations of all the countries concerned, i.e., there is a high probability of multiple taxation of the same income.
If all the substantive conditions for the application of withholding tax are met, the procedure under the relevant provisions of Section 43 of the Income Tax Act applies to payments made by holders to healthcare providers, which is subsequently differentiated according to the form and source of such payments. If even one of the substantive conditions is not met, withholding tax is not applied and the income is taxed in another manner; alternatively, if it is not subject to tax or is exempt from tax, it is not taxed.
These answers represent the legal opinion of the law firm Hronček & Partners, s. r. o. and are not binding. Courts or other authorities empowered to apply the provisions of generally binding legal regulations in specific cases may take a different position on the matter. However, if you consider our legal opinion relevant and need expert legal advice on withholding tax, please contact us at info@legalfirm.sk
