Corporate Tax 2020

Last Updated January 15, 2020

Bulgaria

Law and Practice

Author



Tabakov, Tabakova & Partners has a tax team consisting of six experienced members, four of whom are lawyers and two are economists. The team has a very strong tax litigation practice, dealing with a huge number of tax litigation cases every year. The team is renowned for its extensive knowledge of international taxation, and for providing tailored tax solutions for both corporations and individuals. The firm is a member of the Parlex Group.

Businesses generally adopt a corporate form. There are five alternative forms of corporate structures available under Bulgarian law: the limited partnership, the unlimited partnership, the limited liability company, the joint stock company and the limited partnership with shares. They differ in many aspects, such as the liability of the members (unlimited versus limited), the number of members (single member versus multiple members), and the type of participation of the members (personal versus capital or combined). Despite their differences from a corporate law perspective, all corporate structures available under Bulgarian law are taxed as separate legal entities and in accordance with the same rules.

Bulgarian tax law is not familiar with the concept of transparent entities, where the entities’ income is considered the income of its owners, per se. With regard to transparent entities under civil law, the tax legislation introduces a fiction that treats them as non-transparent for tax purposes.

Consortiums in the form of civil partnerships are commonly used for public procurement tender purposes. They are characterised as a light form of business co-operation and are preferred either with the goal to meet some tender criteria, or for multidisciplinary projects requiring broader expertise.

Any legal entity incorporated under Bulgarian law is a Bulgarian resident and must have its seat in Bulgaria, so Bulgarian law uses a legal seat (place of incorporation) test and not a real seat (place of management) test. Bulgaria’s double tax treaties work with three tie-breakers with respect to dual resident persons other than individuals. The most commonly used are the place of effective management and the law of incorporation test. The third tie-breaker is the mutual agreement procedure. In terms of the MLI, Bulgaria is likely to reserve the right not to apply the entirety of Article 4 to its covered tax agreements.

Generally, all incorporated businesses pay corporate tax at the rate of 10%. However, certain incorporated businesses are levied with alternative taxes (eg, gambling and shipping). Special investment purpose joint stock companies (investing in real estate or in the securitisation of receivables) and collective investment schemes that are publicly traded in Bulgaria, as well as national and certain alternative investment funds, are exempt from corporate tax.

Individuals pay income tax at the rate of 10%. Sole proprietors pay income tax at the rate of 15%. Individuals and sole proprietors who are engaged in certain activities (as per a statutory list) pay patent tax determined by the respective municipalities, within the ranges laid down in the law.

Taxable income is calculated on the basis of the financial accounts. The accounting result is subject to adjustments for tax purposes, which take the form of:

  • positive or negative final adjustments (affecting the tax position once, in a single tax period);
  • reversible adjustments (affecting the tax position in more than one tax period in such a way that an income/expense is taxed/deducted for tax purposes in a tax period different than the one in which the income/expense is included in the financial accounts); and
  • specific adjustments.

Examples include the following:

  • positive final adjustment – non-deductible expenses, such as non-business-related expenses, expenses characterised as hidden profit distributions, etc;
  • negative final adjustment – non-taxable income, such as domestic and EU and EEA inbound intercorporate dividends, etc;
  • reversible adjustments – income and expenses from subsequent valuations (revaluations and impairments), provisions, etc; and
  • specific adjustments – gains/losses on publicly traded shares, etc.

Profits are taxed on accrual basis.

Bulgaria does not have a patent box regime.

Depreciation of technological equipment is recognised for tax purposes. Bulgarian law also provides for a taxpayer’s right to deduct the costs of an intangible asset at once instead of it depreciating over time, subject to certain conditions laid down in the law.

Special incentives are available to special enterprises and co-operatives hiring people with disabilities, as well as to social and health insurance funds.

There are also certain generally available incentives (subject to conditions) for businesses hiring unemployed persons or giving scholarships, for entities carrying out manufacturing activities in municipalities with higher than the national average unemployment rate, and for registered farmers.

Losses can be carried forward only. There is a five-year limitation period for the carrying forward of losses. Generally, capital losses are deductible.

As a general rule, only business-related expenses are deductible in the computation of taxable corporate income.

Secondly, Bulgaria has transfer pricing rules that apply to both intra-group and third-party financing, whether cross-border or not. The relevant provisions capture any borrowing or lending which is not at arm’s length. The excess interest is not deductible.

Thirdly, Bulgarian law contains a hidden profit distribution rule. Hidden profit distributions include non-business-related, non-arm’s length expenses that are charged, paid or distributed in any form to an entity's members/shareholders or their affiliates. Interest expenses are specifically captured (unless the conditions of the loan are agreed in conformity with legal requirements) where at least three of the following conditions are fulfilled:

  • the loan exceeds the borrower’s equity on 31 December of the preceding year;
  • the repayment of the principal or the payment of interest is not limited by a fixed period;
  • the repayment of the principal or the payment of interest depends on the existence of or the amount of the borrower’s profits; or
  • the repayment of the principal depends on the satisfaction of claims of other creditors or on the payment of dividends.

Interest payments characterised as a hidden profit distribution are treated as a dividend in the hands of the recipient, but are not eligible for any of the exemptions that are otherwise available to dividends, and are therefore always taxed. In addition, such interest is non-deductible in the computation of the taxable corporate income of the payor.

Next, Bulgaria has a thin capitalisation rule. The relevant debt to equity ratio is 3:1. If exceeded, the rule limits the deduction of interest expenses exceeding 75% of an entity’s EBIT. Such non-deductible interest may be carried forward without limitation in time. Interest on financial leases and bank loans is carved out of the thin capitalisation rule, unless the transaction is between affiliates or the lease/loan is guaranteed/secured by an affiliate. The thin capitalisation rule does not apply to late interest and penalties, nor to interest which is otherwise non-deductible, nor to interest and other loan-related expenses capitalised in the value of assets in accordance with the applicable accounting law.

Lastly, a new interest limitation rule was introduced into Bulgarian law on 1 January 2019, in accordance with Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market. The interest limitation rule is not intended to substitute the thin capitalisation rule, but rather to complement it, and applies only to borrowing costs exceeding EUR3 million per calendar year. Borrowing costs below that threshold remain within the purview of the thin capitalisation rule.

The interest limitation rule applies to exceeding borrowing costs, which is to say to the amount whereby all deductible borrowing costs exceed all taxable interest and other economic equivalent income. Any borrowing costs in excess of 30% of the taxpayer's EBITDA are non-deductible. The interest limitation rule captures interest expenses on all forms of debt, other costs economically equivalent to interest and any other expenses incurred in connection with the raising of finance. The non-deductible costs carry forward is not limited in time.

There are no tax grouping rules in Bulgaria. Losses are utilised by each company individually.

Capital gains are generally taxable, except gains on publicly traded financial instruments, which are exempt but subject to strict conditions – ie, the exemption applies only to gains on instruments traded on a Bulgarian regulated market or on a market licensed and functioning in compliance with the requirements of Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014.

Capital gains are taxed at the rate of 10%, including, inter alia, gains on the alienation of shares.

Other taxes may be due depending on the transaction type. For example, a sale of shares would be net of taxes other than corporate tax. By contrast, the acquisition of real estate triggers the payment of a municipal transfer tax. VAT may be due as well.

Businesses are also liable to a 10% tax levied on certain business-related entertainment expenses, on social expenses provided in kind to employees and individuals hired under management and control agreements, and on certain expenses in kind related to business assets provided for personal use and/or associated with the use of staff by employees and persons hired under management and control contracts (hired persons), as well as by persons performing work in person. The tax on expenses is deductible for corporate tax purposes.

Gambling and shipping entities pay alternative taxes, as do publicly financed enterprises.

Bulgaria has a VAT system in place. The rate of VAT is 20%.

Incorporated businesses producing or importing certain products pay excise duties.

Usually, closely held businesses operate in a corporate form. The most commonly used corporate form is the limited liability company.

Generally, the corporate and individual rates are the same so, in principle, professionals are not incentivised to earn income at a corporate rather than individual rate. That being said, corporate structures are used occasionally by professionals to reduce social security and health insurance contributions. More often, such structures are employed to avoid the unlimited liability of the proprietor and to shield personal property.

There are no rules that prevent closely held corporations from accumulating earnings for investment purposes.

Capital gains on shares in closely held corporations derived by resident individuals are subject to 10% tax. The gain is determined as the sale price minus the documented cost of the acquisition thereof. The tax base is equal to all gains minus all losses derived from the sale of shares.

Gains on publicly traded shares are exempt, but only where the shares are traded on a Bulgarian regulated market or on a market licensed and functioning in compliance with the requirements of Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014. Importantly, there is no difference in the treatment, depending on speculative intent, holding period, amount of the gain, or the purpose of the participation (private or business). The exemption is available to Bulgarian residents as well as EU and EEA residents.

Interest, dividends and royalties are levied with withholding taxes. Dividends are taxed at 5%, while interest and royalties are taxed at 10%.

Outbound dividends to EU and EEA companies are exempt. Interest and royalties paid to associated EU and EEA companies (or permanent establishments thereof) are exempt, subject to conditions.

There is also a special exemption that applies to interest on bonds or other debt instruments issued by resident entities, the state and the municipalities, which are traded on a regulated market in an EU or EEA Member State, and to interest on certain loans extended by EU or EEA resident entities to a resident entity, provided that the bonds or the other debt securities are traded on a regulated market in an EU or EEA Member State.

Interest on loans extended to the state or the municipalities is also exempt.

There are no published official statistics, but the primary tax treaty countries used for equity and debt investments appear to be the Netherlands, Austria and Germany.

Bulgarian tax authorities are quite concerned with treaty shopping practices. Claims for treaty relief are vetted strictly by the tax authorities.

Tax treaty benefits are available only in the aftermath of a special administrative procedure, which ends with a tax ruling either allowing or disallowing the claim for treaty relief.

Bulgarian tax authorities tend to rely heavily on the beneficial ownership test to curb treaty shopping practices. In terms of the MLI, Bulgaria is likely to opt for the Simplified Limitation on Benefits Provision to apply to its tax treaties, except to the one with the USA, which already contains such a provision.

Associated entities, including entities belonging to one and the same group, should deal with each other at arm’s length. The burden of proof in such situations is reversed and shifts to the taxpayer, which is to say that a resident entity dealing with associated entities must demonstrate to the tax authorities that the transaction is at arm’s length.

If associated entities do business under terms that differ from those between independent entities and hence affect the tax base, the tax authorities are entitled to determine the tax base and assess tax on the basis of such terms as would have been agreed upon between independent entities.

Bulgaria adopted rules on transfer pricing documentation in the aftermath of BEPS Action 13 (Transfer Pricing Documentation and Country-by-Country Reporting), which follow OECD’s recommendations, as well as those in the Code of Conduct on transfer pricing documentation for associated enterprises in the European Union.

In accordance with Council Directive (EU) 2017/1852 of 10 October 2017 on tax dispute resolution mechanisms in the European Union, Bulgaria adopted rules on the resolution of disputes related to tax treaties or other similar international treaties.

Local tax authorities do not challenge the use of related party limited risk distribution arrangements for the sale of goods or provision of services locally, as long as the contracts are entered on arm’s length terms and are not used for the artificial avoidance of permanent establishments.

Bulgarian law works with the same five methods as the OECD Transfer Pricing Guidelines (TPG):

  • comparable uncontrolled price method (CUP);
  • resale price method (RPM);
  • cost plus method (CP);
  • transactional net margin method (TNMM); and
  • profit split method (PS).

However, the OECD TPG may not be used in interpreting and applying domestic transfer pricing rules. The Bulgarian tax administration has issued its own domestic TPG, which are considered to be in line with the 2010 OECD TPG, but not with its more recent versions.

Compensating adjustments are allowed under Bulgarian law. The adjustments may be upward or downward.

Mutual agreement procedures (MAPs) are currently very rarely used in practice, because they usually stretch over time and until recently lacked a domestic legal and procedural framework.

Local branches of non-local corporations (with respect to the profits attributable to the branches) are taxed in the same way as local subsidiaries of non-local corporations.

Capital gains of non-residents on the sale of stock in local corporations are taxed by a 10% withholding tax. However, this tax captures only direct gains. Indirect gains (ie, gains on the shares of a foreign holding company that owns the stock of a local corporation directly) are not taxed as they are not considered to be sourced in Bulgaria.

Generally, tax treaties eliminate the Bulgarian tax on direct gains. There are, however, exceptions, where treaties:

  • do not eliminate the tax (eg, the tax treaty with Cyprus allows source country taxation of gains on the sale of stock, except for publicly traded stocks);
  • introduce special requirements (eg, the tax treaty with Austria requires a minimum 20% interest in order to restrict the source country’s taxing rights with respect to the gain); or
  • contain provisions dealing with real estate-rich companies (eg, the tax treaty with Switzerland reserves a right for the source state to levy a tax on the alienation of shares in real estate-rich companies – ie, shares that derive, directly or indirectly, 50% or more of their value from real estate properties situated in the source state).

There are no change of control provisions that could apply to trigger tax or duty charges.

No formulas are used to determine the income of foreign-owned local affiliates who are selling goods or providing services. Contracts should be entered into on arm’s length terms.

Payments by local affiliates for management and administrative expenses incurred by non-local affiliates are deductible if they are business-related and at arm’s length.

Please see 2.5 Imposed Limits on Deduction of Interest regarding the deductibility of interest payments. In general, Bulgaria levies withholding tax on outbound interest payments. Please see 4.1 Withholding Taxes for more details.

Resident corporations are taxed on their worldwide income, so the foreign income of resident corporations is taxed.

In terms of foreign income, resident corporations can avail themselves of the methods for the avoidance of double taxation provided for in Bulgaria’s double tax treaties. If there is no tax treaty in place with the respective source jurisdiction, resident entities are entitled to a foreign tax credit for foreign taxes levied on foreign-sourced dividends, royalties, technical service fees and rental payments.

Foreign income is taxed and, therefore, associated expenses are deductible, subject to the general deductibility standards.

Dividends from foreign subsidiaries of local corporations are taxed. Nevertheless, all inbound EU and EEA inter-corporate dividends are fully exempt. However, Bulgarian law includes a provision tackling financial hybrid mismatches, in which case the exemption does not apply to received dividends distributions.

Intangibles developed by local corporations can be used by non-local subsidiaries in their business without incurring local corporate tax, provided that the use is at arm’s length and for bona fide commercial reasons.

Bulgaria’s CFC rules came into effect on 1 January 2019. They were introduced in the aftermath of Council Directive (EU) 2016/1164 of 12 July 2016 laying down rules against tax avoidance practices that directly affect the functioning of the internal market.

Local corporations are taxed on the undistributed income of their foreign subsidiaries or permanent establishments. The taxable income is calculated in accordance with the general rules.

The applicability of Bulgaria’s CFC rules is subject to a two-pronged test. The first one (control) tests whether the local corporation controls the foreign entity, either alone or together with its affiliates. The relevant threshold is set at 50% of the voting rights, interest or profits of the foreign entity, and may be either direct or indirect. The second one (low taxation) tests whether the actual corporate tax paid by the entity or permanent establishment is lower than the difference between the corporate tax that would have been paid under Bulgarian law and the actual corporate tax paid by the entity or permanent establishment on its profits.

As a carve out, Bulgarian CFC’s rules do not apply where the foreign entity carries on substantive economic activity supported by staff, equipment, assets and premises, as evidenced by the relevant facts and circumstances.

The rule provides for certain double taxation avoidance measures, which guarantee that double taxation will be avoided once the foreign income is distributed in fact or where the CFC is taxed on the profits that have been included in the base for taxation in Bulgaria.

There are no specific substance requirements pursuant to Bulgarian law. However, the Bulgarian tax authorities interpret the beneficial ownership test as including a substance requirement where a non-local affiliate is supplying a service to a Bulgarian resident and is looking to avail itself of a benefit available under a tax treaty. In line with that, according to Bulgarian law a conduit company is, inter alia, a company that lacks sufficient assets, equity or personnel equivalent to its business.

Gains on the sale of shares in non-local affiliates are taxed, unless (as a general rule) the shares are traded on a Bulgarian regulated market or on a market licensed and functioning in compliance with the requirements of Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014.

Bulgaria has a general anti-avoidance rule, as well as specific anti-avoidance rules.

According to the general rule, the tax authorities are entitled to adjust the tax base if they identify a transaction or a series of transactions, whether between affiliates or between independent parties, that has been concluded under terms that are not at arm’s length resulting in tax avoidance.

Specific anti-avoidance rules target certain transactions that are considered to result in tax avoidance, per se (such as interest-free loans, false services), as well as domestic and cross-border (EU) reorganisations targeted to achieve only tax benefits or where such reorganisations are devoid of economic rationale or represent a disguised sale of shares.

Bulgarian law does not set forth a routine audit cycle. Nevertheless, practice shows that an active business may expect to be audited every five years, unless characterised as a very low risk one.

Bulgaria introduced a CFC rule (Action 3) and an Interest Limitation Rule (Action 4). Bulgaria also has CbC legislation in place, with an activated information exchange network (Action 13). A Hybrid Mismatch Rule (Action 2), rules regarding mandatory automatic exchange of information in the field of taxation in relation to reportable cross-border arrangements (Action 12), rules on transfer pricing documentation (Action 13) and effective dispute resolution rules (Action 14) will come into effect on 1 January 2020.

Bulgaria has been found not to have any harmful tax regimes in place (Action 5).

Bulgaria is a signatory to the MLI, but has not yet ratified it (Action 15).

The general governmental attitude to BEPS is positive, and Bulgaria is very serious in abiding by its international commitments. However, Bulgaria appears not to be proactive but is rather following the general OECD/EU decisions. In line with the object and purpose of the whole BEPS project, the Bulgarian government aims to achieve more fair and effective tax rules.

International tax does not have a high public profile in Bulgaria. BEPS-related measures remain quite abstract to the general public. International tax has made headlines in the Bulgarian mass media only once in the last couple of years, in the aftermath of the Panama papers leak.

In line with fair competition practices, Bulgaria has one of the lowest corporate tax rates in the EU, which has been driven by the need to make the country more attractive to foreign investors.

Balancing efforts could include improving the efficiency and neutrality of the Bulgarian tax system, as well as the structure of the tax framework, which is becoming overcomplicated.

Given that tax is only one of the factors taken into account when investing abroad, Bulgaria could also work on the overall investment and business climate.

The CFC rule could have a detrimental economic impact as it could potentially result in an increase of the overall tax burden of local corporations and hence drive investments away from Bulgaria.

The provisions of Council Directive (EU) 2017/952 of 29 May 2017 amending Directive (EU) 2016/1164 as regards hybrid mismatches with third countries should be transposed into Bulgarian law by 31 December 2019, in part dealing with reverse hybrid mismatches by 31 December 2021. Hence, as of 1 January 2020, Bulgarian law should include provisions neutralising the effects of hybrid mismatches and mismatches with a taxpayer that is resident in more than one jurisdiction.

Bulgaria operates a worldwide taxation regime.

Bulgaria operates a worldwide taxation regime.

The proposed double taxation convention limitation of benefit or anti-avoidance rules are likely to have effect on inbound investors in Bulgaria as they will limit access to tax treaty benefits. The only double taxation treaty that currently has a limitation of benefit clause is the one with the USA.

Transfer pricing is one of the top priorities of the Bulgarian tax authorities. However, proposed changes are not expected to change things drastically, at least not immediately, as it will take time to implement the relevant rules and train the tax administration to enforce them. Meanwhile, businesses are likely to respond and adapt to the new tax environment.

Arguably, CbC is a measure that would only have effect over time, with the cumulation of reports, as it will only then give tax authorities sufficient resources to evaluate the risk posed to the Bulgarian tax system. Nevertheless, the measure seems to be the best one available.

Bulgaria has not yet introduced any changes in relation to the taxation of transactions effected or profits generated by digital economy businesses operating largely from outside Bulgaria.

Bulgaria will follow the general EU/OECD decision regarding the taxation of the digital economy.

Bulgaria levies a withholding tax on IP royalties sourced in the country – ie, paid by Bulgarian residents or permanent establishments within the country. The relevant rules do not distinguish between owners of IP in tax havens and in countries that benefit from a double tax treaty. That being said, IP owners in tax havens will always be subject to the 10% domestic tax rate (while IP owners in tax treaty countries may avail themselves of lower treaty rates), and their Bulgarian counterparty will bear the burden of proof regarding the arm’s length nature of the IP royalties.

There are no further general comments about the BEPS process.

Tabakov, Tabakova & Partners

18 Ami Bue Str., entr. 3
Bulgaria
Sofia 1606

+359 2 963 02 66(86)

+359 2 963 02 76

office@tabakovi.bg www.ttplaw.bg
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Law and Practice

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Tabakov, Tabakova & Partners has a tax team consisting of six experienced members, four of whom are lawyers and two are economists. The team has a very strong tax litigation practice, dealing with a huge number of tax litigation cases every year. The team is renowned for its extensive knowledge of international taxation, and for providing tailored tax solutions for both corporations and individuals. The firm is a member of the Parlex Group.

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