1 Overview of Legal and Regulatory Regime Governing Taxes

1.1. Corporate Taxation

The Law on Corporate Income Taxation ("LCIT")1 governsprovides the general corporate taxation framework for business operations in Bulgaria. LCIT establishes the following major corporate taxes, which are applicable to all business persons.

(i) Corporate Tax on Business Profit

For the financial year 2004 profit accumulated by local tax obligors is subject to corporate tax at the rate of 19,.5%. As of financial year 2005 the rate is reduced to 15%. Monthly advance instalments are due at the same rate. They are payable on the basis of 1/12th of the annual profit declared for the previous financial year, as adjusted with a coefficient set forth by the Law on State Budget for the relevant year. Such coefficient reflects changes in the economic environment for the respective year. Companies that have accounted for a loss, make quarterly advance instalments on the basis of their taxable profits for the current year.

Along with the basic corporate tax on profits, Bulgarian law has introduced several other alternative corporate taxes, which are final and deductible for profit taxation purposes. Such specific taxes include the following.

(ii) Tax on Funds Used for Out-of-pocket Expenses, Donations and Sponsorships

This final corporate tax of 20% is chargeable on funds spent for out-of-pocket expenses and entertainment; gifts , not bearing the trade name or mark of the tax obligor; donations and sponsorships, which are accounted for as expenses. Donations in favour of certain educational, health, charity or social organizations favor a lower rate of 15% final tax. Funds spent for these purposes are fully deductible from the tax base for profit tax purposes. The tax paid on such funds is also fully deductible from the tax base for profit tax purposes as well.

(iii) Tax on Social Expenses and Maintenance, Repairs and Operations of Automobiles, and certain Insurance Contributions

This corporate tax is at the rate of 20%, chargeable on social payments made by that the employers make, as well as for payments allocated on repairs and maintenance of automobiles. "Social expenses" are defined as any expenses booked in relation to the entity's activity, representing fringe benefits for the staff or managers, rendered in cash or in kind, including but not limited to food supplies, commercial and everyday attendance, transportation, entertainment services. Expenses for maintenance, repairs and operation of automobiles are also liable treated under this discussed framework, insofar as the activity performed with such automobiles is not occupational. Funds spent for these purposes are fully deductible from the tax base for profit tax purposes.

The expenses allocated for voluntary pension and health insurance and/or Life Insurance contributions, provided that they exceed certain amount, shall also be subject to a final tax of 20%.

Again the tax paid on such funds is fully deductible from the tax base for profit tax purposes.

(iv) Withholding Tax on Income from Passive and Portfolio Investments

Withholding tax of 15% is applicable to income from passive investments and portfolio investments, unless otherwise provided for in a double taxation treaty on avoidance of double taxation. Such income includes income originating from dividends, liquidation quota, rent, interest, fees for technical services, yields from the sale of fixed or financial assets and royalties for the use of intellectual property rights, management fees.

Only dividend income payable by Bulgarian entities to other Bulgarian entities incorporated as merchants is distributed free of withholding tax and is deductible from their tax base for profit tax purposes. Dividend income payable to any other recipients, including foreign recipients is subject to tax by way of withholding by the payer of 15% of the respective income. It is the liability of the local payer of such income to withhold and pay withheld amounts to the government.

A foreign beneficiary is under no technical obligation to make payment of taxes, except when the payer of income is not a tax obligor for corporate taxation purposes. A foreign beneficiary is also considered liable for such tax jointly and severally with the payer of income, upon the latter's failure to withhold and pay withheld tax.

Where there is a double tax treaty ("DTT") concluded between Bulgaria and the country of residence of the foreign beneficiary, the withholding tax rates stipulated in such treaty shall prevail with respect to the domestic withholding tax rate.

It should be emphasised however, that the eventual lowering or rate or respectively exemption from Bulgarian withholding tax provided under a DTT could be applied only if the beneficiary of such payments obtains from local tax authorities a positive statement on its status under the DTT prior to the income payment or the expiry of the deadline for payment of the withheld tax at the latest. For that purpose the foreign beneficiary of payments should file with the local tax authorities a form of a relief claim, comprising also part of which are a tax certificate issued by the respective foreign tax authorities, evidencing that it is a tax resident thereof and an affidavit stating that it has no permanent establishment in Bulgaria, to which the respective payment to be connected and that it is the actual beneficiary of such income. Clearance should be obtained within 30 days as of filing of the claim form as the lack of any response is considered a refusal for application of the treaty provisions.

(v) Incentives Investors may enjoy a preferable corporate tax status if they invest in the acquisition of certain tangible and intangible assets (including equipment, transmission appliances, electricity carriers, communication devices) in regions with unemployment rates, exceeding by 50% the national average rate for the last 2 years for the relevant municipality with 50%. The tax preference is a tax deferral of the due corporate tax with the amount of 10% of the value of the acquired assets referred above. The tax deferral is accounted as reserves and may be applied for the following 5 tax years. Since such deferral may be treated as state aid, the latest amendments of the LCIT, effective as of 1 January 2005, provide that the requirements of the Law on State Aid2 for the granting of state aid for regional development and a number of conditions outlined in detail in the LCIT, should be met in cases where investors wish to benefit from said preference. If the amount of the tax preference exceeds a specific threshold pointed in the LCIT, the authorisation of the Commission for Protection of Competition should be obtained as part of the measures for compliance with state aid legislation.

Companies creating new job positions in regions with the unemployment levels referred to mentioned above may enjoy a tax preference consisting of deductibility from their financial results before tax adjustment of the amounts of obligatory social insurance instalments paid on the account of employers with regard to the new employees. The preference is used only once in the year of hiring of the new employees, provided that the conditions for granting state aid for employment stipulated by the Law on State Aid are satisfied.

Donations of up to 10% of the financial result before tax adjustments its transformation for tax purposes are deductible from upon determination of due profit tax base, if such donations are made from the reserve funds or undistributed profits from previous years in favour of the Energy Efficiency Fund, established under the Law on Energy Efficiency3,as well as certain educational, or health, charity or social organisations.

(vi) Carry-forward of Losses

Commercial companies may carry-forward losses for up to for a 5years term.

(vii) Depreciation Allowance

The depreciation allowance on various categories of assets for corporate taxation purposes is set forth in the LCIT. The annual depreciation rates (amortisation quota) recognised by the tax law are as follows:

Annual Depreciation Rates

(%)

(a) Solid buildings, including buildings booked as investment estates, facilities, transmission appliances, electricity carriers, communication devices

4

(b) Machines, manufacturing equipment, apparatus

30

(c) Transportation vehicles (automobiles excluded), road and airstrip surfacing

10

(d) Computers, peripheral devices, software and right to use software

50

(e) Automobiles and certain depreciable assets

25

(f) All other depreciable assets

15

(g) Longterm intangible assets, for which legal restrictions for use exist

(up to)
25

For tax purposes, a tax depreciation plan has to be prepared, in line with the above referred categories and maximum depreciation rates.

Consequently for the fixed assets in the energy sector the depreciation rate for the first category of assets, i.e. 4% per annum, shall apply.

(viii) Thin Capitalization Rule

For profit tax purposes the maximum amount of interest expenses (netted off with income from interest decreased after taking into account with the income from interest income) under loans by commercial companies, shareholders and other parties (as well as under financing leasing transactions and bank loans if between related parties), shall not exceed 75% of the accounting profit (which profit , which is calculated without inclusion of any interest income or expenses). Upon occurrence of an accounted loss, the entire amount of compensated interest expense (interest expenses minus interest income) shall increase the financial result of the company upon its adjustment for corporate tax purposes upon its transformation before taxation for tax purposes4. Consequently the deductible interest expense (netted off with interest income) will be limited up to 75% of the company's EBIT (earnings before interest and tax).

No thin capitalization regulation shall apply when for the respective fiscal year the debt to equity ratio is 2 to 1.

The expenses for interest payments, booked by a local tax obligor, which exceed said thin capitalization rule shall increase its financial result prior to its adjustment its transformation made for the purposes of taxation pursuant to the LCIT. However, such an increase shall be deductible (up t a certain amount) from the taxable profits for the subsequent three fiscal years but up to a certain amount.

(ix) Annual Tax Return

Corporate tax obligors are under an obligation to file with the respective regional tax office an annual tax return for corporate tax purposes by until March 31 of the following year. The annual financial statement of the company, as well as the auditor's report should accompany the tax return.

1.2. VAT Taxation

(i) Rates

There are two tax rates of VAT in Bulgaria, namely 20% for the general category of taxable transactions and 0% for export transactions. Pursuant to the Law on Value Added Tax5 sale of electricity and thermal power energy is a VAT taxable supply, where VAT is charged at the rate of 20%. VAT-taxable are all transactions for title transfer of goods or services, except for a limited category of exempt transactions, among which are also the privatization sales.

VAT may be charged only by entities that have registered for VAT purposes. VAT is also charged upon import, by the customs authorities, on the value of imported goods. Tax base for VAT charge in the case of import is the sum of contract value of imported goods plus the customs duties and fees due with respect to import and excise duty, if any.

(ii) Incentives

Upon import in some cases a special VAT accrual method may apply, where instead of the customs authorities, a VAT-registered person may accrue VAT, provided it has obtained a permission to apply the special VAT accrual method issued by the Minister of Finances, and it imports special goods enumerated in a list approved by the Minister of Finances. In order for a person to be entitled to apply the special VAT accrual method, it has to meet the following requirements: (i) it should realise an investment project approved by the Minister of Finances, with a duration of the project of up to two years and an, amount of the investments in excess of greater than BGN 10 million, which investment is to be made within two years, for a period not exceeding two years and which leads to the opening of more than 50 new working positions; (ii) it should be registered for VAT purposes; (iii) it should have no due and payable tax obligations and obligations towards the mandatory social and health security; and (iv) it should have obtained a permission issued by the Minister of Finance and (v) the conditions precedent for the granting of state aid for regional development should have been are met.

Upon application of the special VAT accrual method, the importer is entitled to clear the imported goods without effective payment or securitisation of payment of the VAT due and is entitled to a VAT credit with a shorter refund period of 10 days.

(iii) VAT Registration and Deregistration

Business entities have the obligation to register for VAT purposes upon reaching the statutory registration threshold of BGN 50,000 turnover from taxable transactions (exclusive of exports) accumulated for a period of 12 consecutive months. Export-oriented business entities have the option for voluntary VAT registration on the grounds of turnover including export transactions of BGN 50000, accumulated for a period of 12 consecutive months. Regardless of the taxable turnover, a local entity is also entitled to register for VAT purposes for a period of 3 years on the grounds of registered and fully paid in capital of the company of at least BGN 500000. A foreign entity without any permanent establishment in the country (such as: a representative office, a branch, an office, a shop, construction site, quarry, etc.) but performing taxable transactions is entitled to register through a special authorized representative if the general VAT registration requirements are met.

Deregistration obligation occurs if the total taxable turnover of the registered person for the last 18 months goes under the threshold of BGN 50000.

All VAT registered persons have the obligation to open a VAT account, which is a specific bank account, opened with the approval of and maintained under the supervision of tax authorities. It is to be credited and debited with VAT amounts only and could not be used for payment of any other tax liabilities. It is obligatory for use whenever the recipient of goods or services is a VAT registered person and the VAT due under the transaction exceeds BGN 1,000.

(iv) VAT Refund

Only VAT registered persons are entitled to a tax refund for VAT paid on goods or services received or imported. Refundable tax is initially subject to setoff against outstanding public obligations of the tax payer and then undergoes a three-month deduction procedure. Following expiry of such three-month period any remainder of refundable tax, after examination for any other setoffs, is payable within 45 days. As a consequence, it generally takes the general term for refund results in 135 days to obtain such a refund.

Export-orientated companies favor a shorter refund period of 45 days, if their exporting transactions exceed 30% of total turnover for the preceding 12month period.

VAT paid on assets acquired or accounted as part of the capital before the date of registration may be claimed for refund by VAT registered persons provided these assets are available and described in the registration inventory at the time of registration. This privilege may be exercised in any subsequent tax period after VAT registration.

1.3. Taxes and Fees Payable at Municipal Level

The most significant municipal taxes and fees include the Real Estate Tax, the Tax on Donations and the Waste Disposal Fee.

(i) Real Estate Tax

Pursuant to Bulgarian Law on Local Taxes and Fees6, the companies owning a real estate, including a building, yard, a plot, shall be liable for payment of Real Estate Tax. The owners of a construction, built on state-owned or municipality-owned plot or yard are also considered tax obligors for the plot, respectively the yard as well. Such tax is due regardless of whether the respective real estate is in use or not.

The Real Estate Tax is due on an annual basis and is fixed at the rate of 0.15%. For non-residential estates owned by companies, the tax base for charging the Real Estate Tax is their balance value. However, for constructions built-up on state-owned land, the tax base will be the tax evaluation prepared by tax authorities.

The Real Estate Tax is payable to the municipal budget where the estate is located in four equal instalments, each falling due, as follows: (i) from February 1 until March 31, (ii) until June 30, (iii) until September 30 and (iv) until November 30 of the year for which the tax is due. If paid in full by March 31, the taxpayer is entitled to the benefit of a 5% discount of the due amount of tax.

(ii) Specific Exemption

No Real Estate Tax shall be due or payable for constructions that have been certified pursuant to the Law on Energy Efficiency with A or B certificate for a period of 10 or 5 years, respectively, depending on the category of the certificate. The Law on Energy Efficiency provides for adoption of a regulation on the certification of buildings, which will outline in detail the terms and conditions for granting such certificates. Any state-owned or municipality-owned construction in operation with total area of over 1000 sq. m. is subject to such certification of its energy characteristics.

(iii) Tax on Donations

Gratuitous transfer of property, as well as waivers of debts is subject to a tax on donations at the rate of 5%, except when the transfer is based on a law or a deed of the Council of Ministers for gratuitous transfer of property to investors in priority investment projects. Other exemptions from such tax are the acquisition of property pursuant to the Law on Privatisation and Post-Privatisation Control7 and the in-kind contributions to the capital of a commercial company.

Such tax is payable by the transferee, unless otherwise agreed between the parties to the donation. The tax base for the charge of such tax is the evaluation of the property, determined pursuant to certain criteria. Except when real estates are concerned, in which case the tax is payable prior to the transfer, All such the donations are to be reported and the tax thereon paid within 2 months as of receipt of the donation (other than in the case of real estate donations in which case the tax due is payable prior to the transfer).

(iv) Waste Disposal Fee Owners of real estates are also liable to an annual Waste Disposal Fee. It is determined for each city by the respective municipal council, dependent on the quantity of waste, the number of users or as a percentage. Effective as of January 1, 2004, the municipality should notify the owners for the amount of Waste Disposal Fee due and the terms for its payment.

Double Tax Treaty, concluded between the Republic of Bulgaria and Italy governing the rates of withholding tax applicable:

Dividends
%

Interest
%

Royalties
%

Capital Gains
%

10

0

5

0

Footnotes

1 Promulgated in State Gazette, Issue No. 115 of 5 December 1997, as subsequently amended.

2 Promulgated in State Gazette, Issue No. 28 of 19 March 2002.

3 Promulgated in State Gazette, Issue No. 18 of 5 March 2004, as subsequently amended.

4 Pursuant to the LCIT generally the financial result of a company (accounted loss or profit) is subject to transformation (adjustment)ed before prior to calculation of due corporate taxation by way of its increasing (adding back certain expenses) and decreasing (deducting certain items of income) with certain amounts, representing various types of income or expenses stipulated in detail by the LCIT. Such transformed (adjusted) financial result represents the taxable base, which is levied with corporate tax rate.

5 Promulgated in State Gazette No. 153 of 23 December 1998, as subsequently amended.

6 Promulgated in State Gazette, Issue No. 117 of 10 December 1997, as subsequently amended.

7 Promulgated in State Gazette, Issue No. 28 of 19 March 2002, as subsequently amended.

Nadejda Krastanova is an associate of the Company Commercial Law Dept. of Studio Legale Sutti in Milan.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.