Double tax treaty

What it means

A double tax treaty is an international agreement between two states on which of them may tax a given income and to what extent. Slovakia has several dozen such treaties in force.

It settles two things: how the right to tax is divided between the source state and the state of residence, and the method for eliminating double taxation - a credit for tax paid abroad or exemption of the income.

A treaty creates no new taxes and no new duties. It can only limit or remove a state’s right to tax an income, never extend it beyond domestic law. If the Slovak Income Tax Act does not tax a given income, the treaty changes nothing, even where it would allow Slovakia to tax it as the source state.

How it works in practice

In practice it most often concerns withholding tax on dividends, interest and royalties, where the treaty rate is lower than the domestic one. The condition is a certificate of the recipient’s tax residence received before payment.

The other typical area is the permanent establishment: if activity in the other state crosses the threshold the treaty sets, a duty arises there to tax the profit and file a return.

A common case is a director or employee who works partly in Slovakia and partly in another state. Using the treaty we establish where they are tax resident and which state taxes their salary or remuneration. That decides whether the employer withholds advances in Slovakia and whether the person must also file a return in the other state.

What to watch out for

A treaty does not apply automatically - the benefit must be claimed and evidenced. Without a residence certificate the full rate is withheld and recovering it is slow. And a treaty does not replace transfer pricing rules: each state assesses related-party prices on its own.

The credit method never gives back more than would have been paid at home. If the foreign tax on the same income exceeds the Slovak tax, the excess is neither credited nor refunded as an overpayment and remains a pure cost. When agreeing remuneration or a price across borders it is sensible to work out the total tax in both states first.