Determining Tax Residency and Managing Financial Risks for Foreigners in Czechia

Do you know exactly when a foreign manager, investor, or business owner becomes a tax resident in the Czech Republic and what financial risks this entails? Unclear determination of tax domicile can lead to unlimited tax liability in both countries, penalties, and lengthy disputes. In this article, we provide specific criteria, practical examples, and a clear guide on how to safely navigate these complex situations under Czech law.

Do you need advice on this topic? Contact the Prague-based law firm ARROWS at office@arws.cz or by phone at +420 245 007 740. Your inquiry will be handled by "Mgr. Daniel Půlpán", an expert on the Czech legal system and tax residency.

How the Czech Tax Perspective Works: A Basic Guide for Foreigners

The Income Tax Act (ITA) defines two basic statuses for individuals: Czech tax resident and tax non-resident, which determine the scope of tax liability toward the Czech Republic.

A Czech tax resident has unlimited tax liability, meaning they are required to tax their worldwide income in the Czech Republic, regardless of the country in which it was earned.

A tax non-resident has only limited tax liability and therefore only taxes income derived from sources within the territory of the Czech Republic.

Correctly determining this status is crucial not only for income taxation but also because non-residents may have limited claims to tax deductions and credits unless they meet strict conditions (such as obtaining at least 90% of their worldwide income from Czech sources). If you are managing a larger portfolio, you might be interested to know that ARROWS offers comprehensive Tax Consultancy services.

Two Criteria for Establishing Individual Tax Residency in the Czech Republic

The status of a Czech tax resident for an individual arises if they meet one of the two basic criteria set by the Czech Income Tax Act:

1. Residence (Permanent Home): The person has a permanent home available in the Czech Republic where they intend to stay long-term. A permanent home is understood as accommodation that is not merely transitional.

2. Stay (The 183-Day Rule): The person usually resides in the Czech Republic, which is fulfilled if they spend at least 183 days in the Czech Republic during a calendar year (either continuously or in total).

It is important to distinguish between the tax law and civil law concepts. The term "permanent home" is defined by Czech tax law and requires permanent availability, not just formal ownership. Our Prague-based attorneys routinely perform legal analyses to help you correctly assess whether your property meets this critical definition and whether you are inadvertently creating unwanted tax residency. Do not hesitate to contact our law firm in Prague at office@arws.cz. 

The Risk of Retroactivity When Exceeding Stay Limits

According to the Guidelines of the General Financial Directorate (e.g., D-22 or D-59), situations where a change in tax domicile occurs during the tax period are addressed. If an individual acquires unlimited tax liability by meeting the criterion of usual residence (exceeding 183 days), this status applies retroactively for the entire tax period.

This mechanism poses a significant risk for high-capital investors. If a foreigner carries out a major transaction in January (e.g., selling foreign shares, dividends) and only later, in August, exceeds the 183-day stay limit in the Czech Republic, their January income automatically becomes subject to Czech taxation. 

The ARROWS law firm in Prague provides legal consultations that protect against penalties and audits while minimizing retroactive tax impacts under Czech legislation. Learn more about managing financial structures in our article on Trust Funds and Taxes. Feel free to reach out to us at office@arws.cz.

For a full overview of this service, visit our page HERE.

FAQ – Legal Tips for Determining Residence

1. Does residency change automatically after 183 days? 

The 183-day rule is more of an indicator. If it is determined that a person usually resides in the Czech Republic based on this rule, the resident status applies to the entire tax period, not just the period after the limit was exceeded. For an immediate solution to your situation, write to our Czech legal team at office@arws.cz.

 2. Can a non-resident with limited liability claim tax credits? 

Yes, but only if they meet the condition that at least 90% of their worldwide income comes from sources in the Czech Republic. This must be correctly documented in the tax return. Need legal assistance? Contact us at office@arws.cz. 

Dual Residency: When a Tax Conflict Arises

In an international context, it often happens that an individual meets the criteria for tax residency in two states simultaneously, which, if left unaddressed, would lead to the threat of double taxation on worldwide income.

This conflict is resolved by applying Double Taxation Treaties (DTT). The Czech Republic has nearly a hundred of these in force, and these international provisions take precedence over Czech national legislation.

Double Taxation Treaties (DTTs) define a set of hierarchical rules, known as tie-breaker rules, which serve to resolve dual residency and determine tax domicile in only one state for the purposes of the given treaty under international and Czech law.

Hierarchy and the Center of Vital Interests (CVI) Criterion

Tie-breaker rules are applied step-by-step in the following order:

1. Permanent Home: The state where the taxpayer has a permanent home available to them is determined.

2. Center of Vital Interests: If a permanent home is available in both states, the state where the taxpayer has closer personal and economic ties prevails.

2. Habitual Abode: If the CVI cannot be determined, the decision is based on the duration of the habitual abode.

3. Nationality: Nationality and, in extreme cases, a mutual agreement between tax administrations.

The Center of Vital Interests criterion is crucial for high net worth individuals (HNWI) and managers with global mobility. The Czech Financial Administration examines factual ties – where the taxpayer's family is located, where their main assets are situated, and where they conduct their primary business activities. Case law in the Czech Republic shows that it is necessary to bear a heavy burden of proof to demonstrate a CVI abroad.

Complexity of CVI and the Need for a Robust Defense

Although the DTT rules in the OECD Model Tax Convention are relatively clear, the assessment of the Center of Vital Interests is highly subjective and, in practice, requires in-depth knowledge of both local Czech legislation and international tax practice. Moving assets or family, which may seem like simple steps, actually involve hidden procedural details and risks that a layperson often overlooks.

In case of ambiguity or conflict with the Czech Financial Administration, there is a risk that states will be forced to initiate a lengthy and bureaucratic Mutual Agreement Procedure (MAP).

Thanks to the ARROWS International network built over ten years, our Prague-based law firm handles cases with international elements on a daily basis, ranging from the application of DTTs in the context of Spanish legislation to resolving German tax domicile. In this way, we can prevent protracted proceedings. 

It is therefore better to have legal opinions prepared by ARROWS, which take into account current case law and guarantee your tax certainty. Our Czech legal team is ready to assist you – write to us at office@arws.cz. 

Tax Resident Obligations: International Compliance and Capital Reporting

Obligations for wealthy individuals and investors do not end with the correct determination of tax residency. Czech tax residents with significant capital must fulfill specific reporting obligations in accordance with global standards.

Reporting Exempt Income for HNWIs

Individuals who are tax residents of the Czech Republic are obliged to notify the Tax Office of income that is exempt from tax (e.g., income from the sale of property or investments after the time test has passed) but whose value exceeds the statutory limit of CZK 5 million.

This reporting obligation applies to worldwide income and must be fulfilled by the deadline for filing the tax return. Failure to comply is penalized with high sanctions under Czech law.

The penalty for non-disclosure can reach up to 15% of the amount of the undisclosed income if the taxpayer fails to fulfill the obligation even within an additional grace period. ARROWS will ensure the preparation of documents required by law for correct reporting and the protection of your capital. For an immediate solution to your situation, write to us at office@arws.cz. 

International Reporting and Passive Entities

Czech tax residents are subject to global CRS (Common Reporting Standard) and FATCA standards. These agreements ensure the automatic exchange of information regarding financial accounts and assets held abroad.

Tax authorities in the Czech Republic are increasingly obtaining data on residents' foreign accounts, which significantly increases the risk of detecting undeclared income. Furthermore, corporate structures holding substantial assets or capital (e.g., holdings) may be classified as passive entities. This triggers additional specific reporting obligations for banks and financial institutions. 

Our law firm in Prague provides expert training for employees and management, including certification regarding global information exchange, and assists with compliance setup.

FAQ – Legal tips for reporting in the Czech Republic

1. What is considered a passive entity for CRS purposes? 

Typically, these are holding companies or funds whose income from passive activities (e.g., rent, dividends, interest) exceeds 50% of total income. Contact our Czech legal team at office@arws.cz for a tailored legal solution. 

2. What is the penalty for late filing of a tax return under Czech law? 

If the delay exceeds 5 working days, a penalty of 0.05% of the tax due is incurred for each day of delay, up to a maximum of 5% of the assessed tax. Do not hesitate to contact our Prague-based law firm – office@arws.cz.

Risk management for corporations: Secondment of managers and split residence

For corporations seconding top managers (CEO, CFO) to the Czech Republic, it is essential to correctly resolve their tax status to avoid additional tax assessments or the risk of creating a permanent establishment.

Relocation complications (Split Residence)

When a manager moves to the Czech Republic during the year, a "split tax residence" situation occurs. This division requires precise allocation of income and the application of tax credits to specific time periods, which is administratively very demanding under Czech legislation.

Errors in income allocation and the determination of the tax base can lead to issues during tax audits and additional tax assessments for the seconded employee. This represents a significant risk and administrative burden for the employer. ARROWS will help you prepare or review contracts to ensure the tax status reflects reality and minimizes risk.

Protection of corporate capital and ARROWS insurance

Tax issues with an international element are far more complex in practice than they appear. Assessing criteria such as the Center of Vital Interests (CVI) and implementing Double Taxation Treaties (DTT) requires detailed expertise and knowledge of Czech and international case law.

The law firm ARROWS handles these matters daily, significantly saving clients time and minimizing the risk of errors. Our experience in providing long-term services for a portfolio that includes more than 150 joint-stock companies and 250 s.r.o. (LLCs) allows us to provide fast and efficient solutions. 

It is therefore safer for the client to have the matter professionally secured, as ARROWS is insured for damages up to CZK 500,000,000. We are an active partner for our clients and are happy to connect them when interesting investment or business opportunities arise in the Czech Republic.

Conclusion: Handle tax residency with confidence

Correct determination of tax residency is a fundamental pillar of international tax planning. Ignoring or incorrectly assessing criteria like a permanent home and center of vital interests leads to the risk of double taxation, fines, and protracted disputes with tax administrations, both in the Czech Republic and abroad.

To avoid errors, damages, or penalties, clients can safely leave the entire matter to ARROWS. We manage the entire process from initial legal consultations and drafting internal guidelines and legal opinions to obtaining necessary permits and representation in Czech courts and before administrative authorities.

Our attorneys in Prague protect your capital and minimize the risk of fines. Contact the ARROWS office at office@arws.cz to ensure international tax certainty.

FAQ – Most frequent legal questions regarding tax residency for foreigners in the Czech Republic

1. What is the difference between a tax resident and a non-resident in the Czech Republic?

A Czech tax resident (individual) has unlimited tax liability and is taxed on their worldwide income, while a non-resident is taxed only on income from sources within the Czech Republic (limited tax liability). Correct determination of tax domicile is essential for tax optimization. If you are dealing with a similar issue, contact us at office@arws.cz. 

2. How does the Czech Financial Administration prove my center of vital interests?

The Czech tax authorities assess the taxpayer's closest personal and economic ties. Specifically, they investigate where the family (spouse, children) is located, where the main assets are held, and where business activities are primarily conducted. Our Prague-based attorneys can assist you in meeting the burden of proof. Contact us at office@arws.cz.

3. What is a certificate of tax domicile and when do I need it?

A certificate issued by the Czech Financial Administration proves that you are a resident of the Czech Republic for the purposes of applying Double Taxation Treaties abroad. It is required to apply reduced withholding tax rates with foreign income payers. We provide complete representation before registries and regulators to obtain it. Contact us at office@arws.cz. 

4. What is the procedure if I move to the Czech Republic during the year?

This creates what is known as "split residence." If residency is determined based on habitual presence (183 days), the status is applied retroactively to the entire year, which requires careful allocation of income according to the guidelines of the General Financial Directorate. If you are facing a similar situation, contact us at office@arws.cz.

5. Do I have to report exempt income earned abroad?

Yes. As a Czech tax resident, you must notify the Czech Financial Administration of any exempt income that exceeds CZK 5 million, regardless of where it was earned. Failure to report can lead to a penalty of up to 15% of the income. Do you need legal assistance? Contact us at office@arws.cz.

6. How can ARROWS help us with international tax compliance (CRS/FATCA)?

We provide legal advice on determining the status of entities (active vs. passive) for CRS/FATCA purposes and ensure the preparation of documentation to avoid regulatory risks during the global exchange of information. Do not hesitate to contact our Prague-based law firm at office@arws.cz.

Don't want to handle this problem alone? More than 2,000 clients trust ARROWS law firm, and we have been awarded Law Firm of the Year 2024 in the Czech Republic. See HERE for our references; it would be our honor to help you resolve your issue. Inquiries are free of charge.

Disclaimer: The information contained in this article is for general informational purposes only and serves as a basic orientation to the issue. Although we ensure maximum accuracy of the content, Czech legislation and its interpretation evolve over time. To verify the current wording of regulations and their application to your specific situation, it is essential to contact ARROWS law firm in Prague directly (office@arws.cz). We bear no responsibility for any damages or complications arising from the independent use of information from this article without our prior individual legal consultation and professional assessment. Every case requires a tailor-made solution, so please do not hesitate to contact us.

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