Tax credit method

What it means

The tax credit method is a way of avoiding double taxation in which a Slovak resident includes foreign income in their tax base, works out the Slovak tax and deducts the tax paid abroad from it. The credit is capped at the Slovak tax attributable to the foreign income.

If the foreign tax was lower than the Slovak tax, the difference is paid in Slovakia. If it was higher, the excess is not refunded in Slovakia. The income is thus taxed at least at the Slovak level, but not twice.

Under double tax treaties the method is most often applied to capital income such as interest, dividends or royalties from abroad, and to some business income. The alternative is the exemption method.

How it works in practice

We deal with it most often for income from foreign investments. A foreign broker withholds withholding tax on dividends, and in Slovakia the income is declared and the credit claimed. The evidence is the broker’s statement showing the gross amount and the tax withheld.

Foreign withholding tax can be higher than the treaty allows if the investor did not provide a certificate of tax residence or the relevant form. Only tax up to the treaty rate can be credited, and the rest must be reclaimed from the foreign authority.

For companies with foreign income, the credit is claimed in the corporate return. Evidence of the foreign tax paid must be kept, because without it the tax office will not allow the credit and the income will be taxed twice.

What to watch out for

The most common mistake is declaring only the net amount after foreign tax and not claiming the credit or, conversely, deducting all the foreign tax with no cap. Both give the wrong tax, one to the taxpayer’s detriment, the other in their favour with the risk of an assessment.

The second risk is missing evidence. Foreign statements are often only in a foreign language and do not clearly show the tax. At an audit the tax office may ask for an official document or a translation, so they should be kept with the return.