Ever since the announcement of the 2022 extra profit tax for Croatian companies a couple of months ago, a lot of uncertainty and controversy has been floating around in the media around it. Now, taking into account the latest information published on the subject, we decided to take a deeper look at this tax proposal.

The 2022 extra profit tax is claimed as a so-called “solidarity tax”, to be applied only during the year, a year of record inflation and energy prices. Ever since the EU first proposed additional tax measures on the entire EU level a couple of months ago, there has been speculation as to how this might be implemented. Now, months on, concrete details for the tax proposal in Croatia have been disclosed and it is currently in the consultation process. In short, companies will be affected under two conditions: that they have revenues of over HRK 300m in 2022, and that their operating profitability was higher than 20% than the average op. profitability in the period 2018-2021, meaning a 4-year average. If they fulfill these conditions, any extra profit over 20% of the average op. profitability will be taxed at 33% instead of the usual 18%. In this analysis, we look at what the tax amount is supposed to be for the companies that fulfill the requirements and all the implications of this tax proposal.

It should also be noted that the tax base that is submitted to the Croatian Tax Administration is different from the earnings before taxes (EBT) we use here, as it includes various govt. support measures, representation expenses, and tax deductions, among others. As companies do not disclose this tax base, we are left with using the aforementioned EBT as the best available approximation. For this analysis, we looked at the largest Croatian blue chip companies, as well as several additional companies (ZABA, HPB, INA, SPAN, Viktor Lenac, Maistra, Imperial Riviera, and Tankerska Next Generation).

The extra profit tax proposal was supposed to affect the companies that operate in the energy sector

When the tax was first proposed on the EU level a couple of months ago, the whole premise of the tax was that it would affect energy companies only. This would in general mean any company that achieves 75% or more of its revenues from energy-related activities. The reasoning behind this was that energy companies were achieving great profits during 2022, due to the movement in prices of commodities and electricity, while other sectors suffered. As such, the proposed tax was supposed to reduce the extra profitability of energy sector companies, and use the proceeds to help harder-hit companies in the other sectors. By any of these conditions, the extra profit tax in Croatia does not make sense.

The main argument, solidarity

The main argument that could be heard from the Croatian government as to why the tax proposal was made in such a way is solidarity. This would mean that companies that operated well in 2022 could “handle” the extra profit tax, while the proceeds would help the smaller and more strongly affected companies. The Government also mentioned that they already provided help to companies and households half a year ago and in September, and as such the companies should also be willing to help. The implications of this, however, do not make much sense.

First of all, unexpected taxes on companies which are also affected by the negative macroeconomic developments not only affect companies’ growth but investor confidence as well. Secondly, all companies are affected by the growth of commodity and energy prices, and for the most part, this development is outside of their control. Thirdly, it makes Croatian companies less competitive compared to their European and global peers. Fourth, and maybe most important, the conditions set are quite arbitrary and are sending a completely wrong message. If we take into account just the inflation, which was on average 1.2% during the 2018-2021 period, and is expected to be at an average of 10.4% in 2022 (based on our estimates for November and December), this would mean that just inflation equals 11.6%. In other words, it could be said that companies could in real terms only have an 8.4% higher EBT in 2022 compared to their 2018-2021 average if they want to avoid this tax.

This doesn’t make much sense as inflation is a quite broad indicator and as such it affects different sectors differently. Better indicators would include the industrial producer prices, which are on average 1.9% higher in the 2018-2021 period, and 37.5% higher during 2022 (based on our estimates for the last 2 months), or operating expenses growth experienced by the companies, especially in terms of material, energy, and staff expenses growth. Furthermore, the 4-year average also makes no sense if we take into account the importance of certain sectors to the Croatian economy.

Take the example of Croatian tourism to demonstrate this. If we look at its average EBT in the 2018-2021 period, we run into a huge problem. 2018 was a good year for Croatian tourism, 2019 was a “record” year, while 2020 was the worst year on record, and 2021, even though the companies somewhat recovered, was still 15-20% below 2019’s level. The 2022 tourism season recorded significant growth in revenue, increasing on average 20% above 2019’s level, but profitability suffered due to higher expenses. What kind of message would this tax send to one of the most important segments of the Croatian economy, if after years of operating below normal capacity, the companies are hit by a new tax?   

Comparison of earnings before taxes

To calculate this, we looked at the 4-year average EBT and added the 20% govt. cap on top of it, and then compared it to our 2022 EBT estimates.

2018-2021 Average EBT increased by 20% vs. 2022 EBT* (HRKm)

Source: Companies’ data, InterCapital Research Estimates

*Based on our estimates

As can be seen from the chart, the Company with the highest relative EBT growth compared to the average is Tankerska Next Generation, at over 8.6x, followed by HPB, with 3.9x, Brodogradilište Viktor Lenac, with over 2.5x, Imperial Riviera, with over 2.3x, Span, with almost 2.3x, INA, with over 2.2x, and Končar, with a growth of 121%. On the flip side, AD Plastik should record an EBT decline of app. 210%, Atlantic Grupa of 38%, HT of 15%, and Arena Hospitality Group of 13%.

Taking these numbers at face value, however, just shows us how unfair this tax would be. Take the examples of Tankerska Next Generation, Atlantska Plovidba, and HPB to demonstrate this. Tankerska Next Generation and Atlantska Plovidba do not pay the usual income tax but have a special shipping tax. This tax is calculated differently, based on the tonnage of their ships, and is paid even in years of negative profitability. These losses can be carried forward and reduce the taxes in the following years. However, the government stated that no tax shields (of which these losses are a part) could be applied to the extra profit tax, and given that no specific information was given for the shipping industry, we’ll treat them the same as normal companies. Tankerska Next Generation would not even be on the list of eligible companies if they didn’t record over HRK 300m in revenue in 9M 2022 (for the first time since 2018, when ironically, its revenue amounted to exactly HRK 300m) due to the shipping industry supply/demand dynamics.

Furthermore, hospitality companies have a low average 4-year EBT exclusively due to the COVID-19 period of 2020/2021. In 2020 inbound countries’ economies experienced lockdowns, while in 2021 return to previous levels of activities was only partial, and as such companies did not achieve pre-pandemic levels of income, even with the State support that was given. As such, it would not be fair to punish these companies as COVID-19-related results were exclusively a result of the external environment. For Valamar, it would be fair to compare the 2022 EBT result to 2019 or to the 2018 and 2019 average EBT. When we do that, we see that their expected 2022 EBT is 6% lower so they would not fall under this tax. Meanwhile, Imperial is a completely different company in 2022 than it was in 2018. It was created in its current form at the end of June 2019, after the Makarska Hotels were merged with the Rab hotel company Imperial, and were integrated into the Valamar Riviera group. Together with the AZ fund, Valamar bought most shares of the Rab and Makarska hotel companies from the State. Also, two capital increases were made, the first one in 2019 and the 2nd in 2021. As such, the growth of Imperial Riviera’s EBT in 2022 came as a result of continued growth in assets and investment. This is a normal growth path for tourism companies, and a normal way of doing business should not be punished by additional taxes.

What’s even more astounding is the case of HPB, which as we can recall, bought Sberbank’s Croatia subsidiary for HRK 1 in April, and as such received negative goodwill of HRK 1bn. As this goodwill is added to the net profit in the P&L during the year it made, this would mean that the Company’s profitability increased significantly. In fact, in 9M 2022, if HPB did not purchase Sberbank, it would record a decline in profitability. If the tax gets implemented as is, HPB will have to pay HRK 294m in taxes for 2022, which is higher than its net profit by 20-30% based on our estimates.

The only 3 companies you could realistically say the extra profit tax can be applied to due to their growth would only be Span, INA, and Končar. But even this would be a stretch. For Span, one of the only tech and growth companies listed on the ZSE, it is expected that in its current phase of development it will grow significantly. Likewise, Končar, which also recorded solid growth during the year, did so despite the higher energy expenses and commodity prices, not because of them. This only leaves INA, which we find to be the only company out of all the observed companies that the extra tax if applied, should be applied to. They recorded significant growth in revenue and profitability, and this came directly as a result of higher energy commodity prices, for the most part. On the flip side, AD Plastik, which was heavily affected by semiconductor shortages in the automotive industry in 2021, while at the same time, its operations in Russia were disrupted after the Russian invasion of Ukraine, should by the logic of this tax, receive significant government support.

Estimated tax cost to the observed companies

So having all of this in mind, if applied at current conditions, how much would the tax cost the observed companies?

33% additional tax effect on observed companies* (HRKm)

Source: Companies’ data, InterCapital Research Estimates

*Companies that wouldn’t be affected by the tax are excluded

By far, the largest tax amount will have to be paid by INA, and by our estimates, this will amount to app. HRK 839m. Next up, we have HPB, with HRK 294m, and ZABA, with HRK 110m. At the same time, there are several companies, even some of the largest, that would not have to pay the tax under current conditions.

The largest amount that would have to be paid by INA, is again the only one that could be justified under this scheme. HPB’s high tax is only due to the negative goodwill, while ZABA’s growth in profitability is expected, as it is the largest bank in Croatia, and the current demand for loans is still high despite the increase in interest rates. Taxing Končar and Adris could be somewhat justified due to their growth, although if we take into account that over 50% of Adris is in the tourism segment, this is also questionable. On the flip side, HT would not be eligible for the aforementioned tax, due to their 2018 EBT being significantly higher (HRK 1.29bn) compared to the years following it (HRK 900m in 2019, HRK 713m in 2020, and HRK 743m in 2021), and as such, the average on which the 20% increase is applied is higher. As we expect that HT will achieve an EBT of app. HRK 927m in 2022, because of 2018 increasing the average, they would not have to pay the tax. Atlantic Grupa and Podravka would also avoid the new tax under this scheme, as both companies were more strongly affected by higher costs during the year, leading to a reduction in profitability.

Finally, what does this mean for investors?

Extra profit tax per share* (HRK)

Source: Companies’ data, InterCapital Research Estimates

*Companies that wouldn’t be affected by the tax are excluded

To put things into perspective, on a per-share basis, HPB’s extra tax of HRK 145/share would mean that at the current price, it amounts to 18.6% of the share price.

All in all, what can be taken away from this whole tax proposal is that there are many holes in it, no matter how you look at it. Even if you discard all the above-mentioned arguments, and only look at two things: first of all, the government made many strides in the previous years to reduce the tax burden and thus attract investments into Croatian companies. As such, introducing this tax would go against everything that was achieved so far. And secondly, not only would the companies be paying this tax, but so would the investors, as lower profit would mean less money for investments, dividends, and overall growth. Fundamentally, just this implication is sending the completely wrong message to anyone who would potentially invest in Croatia, and as such, in its current form and under its current conditions, the extra profit tax is completely unfair and illogical.