Center for Environmental Public Advocacy
Friends of the Earth - Slovakia
February 2002


According to the Friends of the Earth, the selective approach of the government toward the provision of state aid to foreign investors is in breach of the relevant EU directives and regulations on competition policy and, as such, violates the acquis and presents a serious impediment to the provisional closure of Chapter 6 “Competition Policy”. The EU representatives came to the same conclusion on various occasions. However, Slovak government officials repeatedly voiced their intention to preserve these measures as long as possible, even after accession to the EU.

Content I. Introduction II. Tax relief schemes and investment incentives Tax reliefs: "We shall keep till the last moment” Recommendations Investment incentives: State aid to regions, or subsidies for large investors? Recommendations III. Other forms of preferential treatment “Significant investments”: private of public interests? Recommendations Support to industrial parks: circumvention of state aid rules Recommendations IV. Transparency – specific problem of government favours Recommendations V. Summary conclusions Recommendations for negotiations on the Chapter “Competition Policy” Attached document: The State Aid Office as a Tool for Draining Public Funds I. INTRODUCTION "We will probably solve the issue of tax holidays by calculating the outstanding amount of pledged tax reliefs, which will practically determine the amount of the state aid to be provided to these companies in various forms.” Deputy Prime Minister Maria Kadlecikova on what the government intends to do when tax holidays are abolished Slovak TV 1, 21st February 2002 The “Strategy of Support to the Inflow of Foreign Investments to the Slovak Republic” [1] was the first strategic document adopted by the cabinet of Mikulas Dzurinda after it had taken office. The strategy defined various forms of direct and indirect measures (subsidies) designed to attract foreign investments, which were expected to induce a broad range of positive effects, particularly in the economically backward regions of Slovakia. According to the strategy, the purpose of these measures was to ensure regional revival and development, facilitate technological upgrading, introduce production of sophisticated products with higher value added, reduce the trade deficit, provide access to foreign markets, boost exports, make the economy of Slovakia more competitive, create new opportunities for the secondary development of small and medium enterprises, revitalise the economy by foreign direct investments in regions (through increased purchasing power, inception of new entrepreneurial activities, increased tax revenues, etc.) and last, but not least, to curb soaring unemployment. However, the way in which the legislation on investment incentives was subsequently created and implemented proves that these measures were not primarily intended to stimulate regional development or reduce unemployment. In fact, these measures have given rise to new forms of direct and indirect state aid granted to private enterprises without any public control or involvement in the process of decision making. Although the undefined notion of “public interest” is oftentimes referred to in connection with government support to foreign investments, the documents that serve as the basis for granting incentives are not publicised and the process of decision-making is not transparent, which raises doubt about the need for and purpose of this kind of state aid. The size of investment is typically taken as the main and, frequently, the only criterion based on which the government decides to support a foreign investor. The quality of the investment, its contribution to regional development and employment, and impact on the business environment, are taken (at best) as criteria of secondary significance, if at all considered. Apart from aggravating the existing market distortions and favouring large export-oriented international corporations at the expense of smaller local undertakings, these support measures absorb considerable public funds that could otherwise be used to finance properly targeted employment schemes in the economically and socially less-favoured regions of Slovakia. Notwithstanding the above, there are no mechanisms in place that would enable the government to objectively assess the impact of aided projects and the efficiency of public spending. At the Invest Forum held in New York in February 2001, Slovak Deputy Prime Minister for Economy Ivan Miklos admitted that the government was not making any cost/benefit analyses of state aid to foreign investors. And those cases, where partial analyses have been made, indicate that the original expectations will, for the most part, never materialise. [2] According to the Friends of the Earth, the selective approach of the government toward the provision of state aid to foreign investors is in breach of the relevant EU directives and regulations on competition policy and, as such, violates the acquis and presents a serious impediment to the provisional closure of Chapter 6 “Competition Policy”. The EU representatives came to the same conclusion on various occasions. However, Slovak government officials repeatedly voiced their intention to preserve these measures as long as possible, even after accession to the EU. The Friends of the Earth are of the opinion that – in the interest of creating a sound economic environment and equitable conditions for regional development – these distorting measures should be eliminated as soon as possible. One of the purposes of this document is to draw appropriate attention to the existing problems before the finishing line of negotiations on the competition policy chapter is reached. It is undoubtedly in the best public interest of both the Slovak Republic and the European Union to ensure that these negotiations do not replicate the previous non-transparent negotiations on other pre-accession chapters where the public had no possibility to participate, but rather to stir a broad discussion on the issues highlighted in this document. Only an open and democratic process can yield satisfactory output which – particularly in this case – may have a considerably positive impact on the efficiency of public spending and the quality of economic development. II. TAX RELIEF SCHEMES AND INVESTMENT INCENTIVES Tax reliefs: "We shall keep till the last moment” The corporate income tax relief schemes [3] constitute one of the most problematic issues under the Competition Policy chapter. These tax reliefs (also known as “tax credits” or “tax holidays”) are currently regulated by §35-35a of Act No. 366/1999 on Income Tax, as well as by Government Regulation No. 145/1993 [4] on Conditions for Relieving Taxpayers of Income Tax Liability and Regulation No. 192/1998 on Conditions for Relieving Newly Registered Tax Persons of Corporate Income Tax. The basic criterion that makes private companies entitled to claim tax holidays under these regulations is the size of the capital stake controlled by a foreign investor. The Income Tax Act introduces one additional condition – minimum amount of equity capital. Neither criterion reflects the effects that the investment has for the region or society as a whole. Such criteria of eligibility fall short of stimulating investment in less favoured regions and increasing employment in the areas affected by major layoffs, which effectively frustrates the declared purpose of tax reliefs. Moreover, the conditions of eligibility, as laid down in the Income Tax Act, bring no relief to the disadvantaged groups of entrepreneurs and fail to stimulate the development of such types of production and entrepreneurial activities that have manifestly beneficial effects on the society (for example activities that reduce energy consumption or excessive extraction of raw materials, programmes based on renewable energy resources, recycling schemes, and the like). The granting of tax holidays is subject to no approvals. Those who comply with the criteria defined in the law are automatically entitled. In reality, only companies with foreign capital participation are able to demonstrate compliance, the only exception being §35a (which, from January 2001, broadened the scope of entities entitled to tax holidays). After the last amendment, adopted in November 2001 to address the concerns raised by the European Commission, any tax credit granted under §35a is subject to the State Aid Act provisions. In other words, each application for the granting of tax holidays must be reviewed and approved by the State Aid Office (SAO). Nevertheless, given the weak position of the SAO, its inadequate staffing, political dependence and, above all, the history of circumventions by the SAO of the State Aid Act, the amendment is not likely to change things for better in reality. Apart from the SAO, no body of public administration and no representative of the general public may influence how this indirect state subsidy is used. The amendment had no impact on §35. The application of the thus defined conditions of eligibility for tax relief is discriminatory against small and medium enterprises in Slovakia and distorts the still underdeveloped and seriously deformed business environment. Moreover, the provisions of §35 of Act No. 366/1999 are at gross variance with Act No. 231/1999 on State Aid, which requires that government subsidies be approved and their size determined in advance. Under these circumstances, the beneficial effects of tax reliefs remain questionable. Unless the incentives are properly directed and regionally focused to stimulate activities in public interest, the economy of Slovakia is bound suffer from the effects of continued distortions. Quite obviously, selective application of such ‘incentives’ will further deepen the existing disparities between individual regions of Slovakia and marginalize small and medium sized enterprises to a larger degree than ever before. The tax reliefs, as defined in §35 and §35a of the Income Tax Act and the related Government Regulations, are non-systemic measures that distort economic competition and favour certain economic operators, particularly large export-oriented companies with foreign capital participation which – unlike the majority of smaller domestic operators – are viable even without such support. The Slovak branch of the Friends of the Earth International has repeatedly called the attention of the Slovak government to the problems connected with the enactment and implementation of this non-systemic measure. In its position on the Income Tax Act amendment, the Friends of the Earth stated: “The Friends of the Earth express anxiety over certain non-systemic measures that distort the market environment, treat foreign economic operators more favourably than the Slovak ones, and have no positive effects on competition. Such measures are contemplated by the proposed amendment to §35a. The Friends of the Earth asks the members of parliament to delete the entire §35a from the bill. Similar tax incentives have become a target of criticism of various domestic and foreign institutions for they are not efficient, create uneven conditions for foreign and domestic operators and distort competition on the market.” [5] In its Evaluation of Economic and Social Measures, the Central European Institute for Economic and Social Reforms (INEKO) was similarly critical of the measures adopted by the government in May 2000: “The measure was not viewed positively. There was a general consensus that the creation of a standard business environment would have been more efficient than the adoption of incentives designed to pamper foreign investors. Government was criticised for creating uneven conditions for foreign and domestic investors and for distorting economic competition.” [6] Also international financial institutions remained sceptical about the tax holiday scheme. For example, the International Monetary Fund issued a statement on 5 September 2000 (at the initiative of the Friends of the Earth), which reads as follows: “ It is not the Fund’s policy to oppose the use of all tax incentives under all circumstances. It is the Fund’s view, however, that tax incentives are frequently not the most cost-effective instrument for promoting FDI... Furthermore, if not carefully designed and administered, tax incentives could often provide a fertile ground for abuse, corruption, and rent-seeking activities—as has been observed in many countries. ...the Fund maintains flexibility and judges the appropriateness of employing tax incentives in any country on a case-by-case basis. In the case of Slovak Republic, a recent FAD technical assistance mission did recommend, largely on evasion concerns, the removal of tax holidays introduced earlier this year (§35 of Act No. 366/1999), in view of the tax administration’s weak capacity to effectively enforce them.“ [7] Also the European Commission permanently raises questions about the controversial tax holidays for investors. According to the Commission opinion of 7 March 2001, “§35 distorts competition and influences trade between the EU and Slovakia”. Also the Regular Report on Slovakia’s progress towards accession for the year 2001 states: "Although the investment incentives law was recently amended to ensure its compatibility with the acquis, similar incentives (such as in particular under Article 35(a) of the Income Tax Law) are neither in line, nor monitored by the State Aid Office.” [8] It is important to note that tax holidays involve substantial sums of money which – oftentimes at variance with the state aid regulations – reduce the revenues of the state budget. According to the information provided by the Central Tax Directorate, during the 1999 taxation period, the corporate income tax relief under Government Regulation No 192/1998 for Volkswagen Slovakia a.s. amounted to SKK 1,318,235,600 (appr. € 31.2 million). [9] In the tax year 2000 alone, seven companies enjoyed tax reliefs under §35 of the Income Tax Act in the aggregate amount of SKK 916,685,390 (appr. € 21 million). In the same year, 45 companies benefited from Government Regulations No 145/1993 and 192/1998 and their total tax relief reached SKK 1,687,543,623 (appr. € 38.6 million). [10] Even these figures do not represent the total sum of tax reliefs granted in conflict with the state aid rules. The audit of the State Aid Office, conducted by the Audit Section of the Slovak Government Office in May and June 2001, concluded that in 8 out of 10 randomly selected transactions worth SKK 11.5 billion (appr. € 263 million), the SAO approved state aid in conflict with the State Aid Act (231/1999). [11] The publication of information about state aid is another problem area. In response to the request by the Friends of the Earth, the Central Tax Directorate provided only aggregated figures, without divulging the list of entities that claimed tax holidays pursuant to §35 and §35a of the Income Tax Act and Government Regulations No 145/1993 and 192/1998, nor the amount of individual reliefs, citing tax secrecy as the reason. Interestingly enough, the information on other tax incentives (e.g. for VSZ a.s. Kosice, VSZ Ocel a.s. Kosice, etc.) was published in both the Commercial Journal and the SAO Regular Report on State Aid. Recommendations In connection with the upcoming negotiations between Slovakia and the EU on the provisional closure of Chapter 6 “Competition Policy”, we propose the government of Slovakia to forthwith rescind §35 and §35a of Act No 366/1999 on Income Tax, including Government Regulations No 145/1993 and 192/1998. The government should immediately terminate the granting of tax reliefs conferred under the aforementioned regulations. According to the available information, the contracts signed with individual private corporations contain a clause wherein the government commits itself to compensate these corporations for abolished tax reliefs should the legislature repeal the laws and regulations on tax incentives. The government will thus have to find a way to get around this contractual commitment toward private corporations, which, if delivered, could have a devastating impact on the society as a whole. Any state aid provided to these corporations from now on must be in strict compliance with the relevant EU standards, and any decisions taken in this respect must be transparent and open for public scrutiny. In the light of the aforementioned, we propose that the competent EU authorities make the closure of Chapter 6 “Competition Policy” conditional upon immediate compliance with these requirements and dismiss any request for transitional periods that could enable the Slovak government to circumvent the acquis on competition and state aid. Investment incentives: State aid to regions, or subsidies for large investors? Act No. 565/2001 on Investment Incentives, passed by parliament on 4th December 2001 with effect from 1st January 2002, is another piece of legislation that aggravates existing distortions in the Slovak business environment. This Act enables the Ministry of Economy to award, in addition to the 10-year tax holidays available to a broader range of enterprises, also public subsidies aimed at supporting the creation of new jobs and retraining schemes. These so-called “investment incentives” require clearance by the SAO and approval by the cabinet; once cleared and approved, the Ministry of Economy issues final decision. Again, the main criterion here is quantity rather than quality, which discriminates against small and medium sized enterprises because only large foreign investors are typically able to make the necessary investment. Also in this case, there are no clear criteria that would direct this type of support to less favoured areas. When approving investment incentives, the cabinet is only expected to “take into account mainly the national-economic significance of the investment and the effects of investment incentives on competition on the relevant market of the Slovak Republic”. [12] However, the Act does not define the notion of “national-economic interest” (and thus leaves it at the discretion of state officials) and provides for no remedial mechanisms in situations where the state officials circumvent or ignore this vaguely defined condition. Moreover, the Act does not specify any criteria based on which the significance of investments should be assessed. These government subsidies – renamed into “investment incentives” (i.e. tax holidays, contributions for creation of jobs and retraining programmes) – are defined in the Act as “state aid for regional development”. In reality, however, these incentives represent just another vehicle for funnelling state aid into private corporations regardless of the region and sector they operate in. Already before the adoption of the Act, the Friends of the Earth pointed at the problems which these investment incentives are bound to cause: "If enacted as proposed, the Act on Investment Incentives will further exacerbate existing market distortions in Slovakia and broaden the space for inefficient and voluntarist expenditures of public funds for purposes that may contravene public interest”. However, neither these arguments nor proposals for specific solutions have been accepted. Hence, the Act on Investment Incentives (565/2001) discriminates against small and medium entrepreneurs, who are simply unable to comply with the minimum investment threshold. It also creates opportunities for non-transparent and biased decisions motivated by other priorities than the best interest of the society. Recommendations We propose that the Slovak government amends the Act on Investment Incentives by changing the criteria for decision-making on this form of state aid in order to make sure that support is only directed to those regions where the rate of unemployment stands above the national average. The minimum investment requirement should be cancelled in order to make these incentives accessible also to small and medium enterprises. At the same time, the amendment should ensure higher transparency of and public control over decisions on investment incentives. We suggest that the Commission permanently monitors and evaluates the application of the funds granted under Act No. 565/2001 on Investment Incentives, particularly with a view to their impact on regional development and employment. Since the Slovak government officials announced their intention to devise another type of state aid should the existing support schemes for foreign investors be abolished, we suggest that the Commission keeps an eye on all new schemes of state aid and monitors individual decisions of Slovak authorities, which might attempt to compensate investors for the abolished incentives, and – in the event of a conflict with the state aid rules – revise the provisional closure of the chapter on competition policy. III. OTHER FORMS OF PREFERENTIAL TREATMENT “Significant investments”: private of public interests? The Commission does not seem to have noticed Act No. 175/1999 on Significant Investments, which enables the government to grant considerable advantages to a group of selected investors without being obliged to consult ex ante the authorities responsible for securing equal opportunities for all entities. Moreover, the Act contains no definition of public interests and priorities. According to Act No. 175/1999, if the government decides that a particular project is a “significant investment”, it may expropriate the land on which the project is to be built. In Slovakia, land is expropriated at prices regulated by a decree of the Finance Ministry, which are typically several times lower than the market prices. This means that any investor in a project classified as “significant investment” may save dozens of millions Slovak crowns or more, depending on the size of expropriated land, not to speak about the benefit of simplified land-acquisition procedure. The only criteria that must be met for a project to earn the status of “significant investment” are: (1) investment of at least SKK 1 billion (appr. € 23.7 million), (2) unspecified national economic significance of the production or employment generated by the project, and (3) decision of the cabinet that the project is in public interest. Apart from the size of investment, which can be called in doubt as a measure of significance, none of the above criteria is clearly defined. Moreover, there are no restrictions in place for projects falling into the so-called “sensitive sectors” [13] according to the EU classification. The table below shows that most benefiting projects fall into this category (particularly projects in the motor industry). Such criteria give undue advantage to the group of large (and mostly foreign) investors. At the same time, decision-making on these advantages is non-transparent and based on rather vague criteria. Advantages are not expressed in monetary terms, which makes any monitoring and control practically impossible. This approach aggravates the existing market distortions not only in Slovakia, but also in the entire Central European region. The status of “significant investment” has so far been awarded to the following projects: Company / Name of project VOLKSWAGEN Slovakia, a.s. Bratislava / Expansion of car manufacture and sub-group productions, including related and ancillary structures AUTO Martin, a.s. Martin / Construction of an industrial par for car manufacture in the Záhorie region Plastic Omnium Auto Exteriors, s.r.o. Bratislava / Manufacture of outer parts for automobiles and their assembly, branch of Lozorno Plastic Omnium Fuel Systems, s.r.o. Bratislava / Manufacture and assembly of fuel systems for cars, branch of Lozorno (including road link to highway) VUMA, a.s. Nove Mesto nad Vahom / New production hall of BRANSON Whirlpool Slovakia, a.s. / Expansion of production facilities and spare parts manufacture in the city of Poprad GOLDEN WIRE, s.r.o. Banovce nad Bebravou / Production of the Bekaert steel wires SLOVALCO, a.s. Ziar nad Hronom / Expansion of aluminium production and processing Although Slovakia has a good law on free access to information and these “significant investments” have been formally pronounced as being in public interest, public officials are reluctant to divulge any documents based on which the cabinet took its decisions. For example, in the case of the SLOVALCO “significant investment”, the Ministry of economy refused to make the underlying documents available. Since the Ministry refused to provide this information also in the appellate proceedings, a lawsuit demanding the release of documents on the “significant investment” of SLOVALCO was filed with the Supreme Court in May 2001. The court has not yet issued its verdict. Recommendations In connection with the upcoming negotiations between Slovakia and the EU on the provisional closure of Chapter 6 on competition policy, we suggest that the government of Slovakia forthwith rescinds Act No. 175/1999. We suggest that the competent EU authorities make the closure of Chapter 6 on competition policy conditional upon immediate compliance with this requirement and dismiss any request for transitional periods in this regard. Support to industrial parks: circumvention of state aid rules Support to the development of industrial parks, available under Act No. 193/2001, is another indirect form of government subsidies to the private sector with significant budgetary ramifications. The law defines municipalities – the founders of industrial parks – as the formal beneficiaries of aid. However, this form of support does not fall under the provisions of the State Aid Act (No. 213/1999), nor is it subject to assessment and approval by the State Aid Office, even though the ultimate benefits go to private operators of industrial parks or enterprises within industrial parks. This fact was also known to the Ministry of Economy, which prepared the bill and submitted it to the parliament. When summoned by the parliamentary Committee for Economy, Privatisation and Business to substantiate the bill on 9 May 2001, a representative of the Ministry of Economy reasoned that subsidies for the establishment of industrial parks could not be provided directly to private enterprises because it would be a state aid and “if they fall under the state aid regime, such subsidies would not be viable”. He also said that rather than subsidising operations within industrial parks, the purpose of the aid was to support the site development and construction of infrastructures. Otherwise, it could be classified as state aid, which “will give rise to problems”. Similarly as the Act on Investment Incentives, this law does not obligate the government to decide on the basis of clear criteria. What is most likely to happen is that these aid funds will end up in the industrial parks around Bratislava and other metropolitan areas perceived by investors as attractive (e.g. the Zahorie industrial park) rather than in less-favoured regions that suffer from high unemployment. In addition, the Act on Support to Industrial Parks Development does not contain sufficient tools of control that can be used to ensure that the granted aid is actually used for the intended purpose. This act is thus just another in the series of various government subsidies that creates opportunities for corruption and makes the spending of public funds inefficient. So far, the most controversial cases of government aid to industrial parks include the IGP industrial park at Vrable and the industrial park for automobile production near Lozorno. In fact, the aid granted for the development of the IGP industrial park Vrable was the first decision taken according to Act No. 193/2001 on Support to Industrial Parks Development. The Ministry of Economy granted the city of Vrable SKK 28.8 million (appr. € 676,000) to complete the development of the IGP industrial park, wherein, at that time, several manufacturers of automobile components opened their operations. However, according to the documents submitted to the cabinet and according to the statutory representative of the city of Vrable, the industrial park was not established by the city, but by a private limited liability company – Industrie und Geverbepark Vrable s.r.o. (IGP). This company operates the park and benefits from the grant. In other words, the government gave a grant to the city of Vrable which – with the knowledge and consent of the Ministry of Economy and the cabinet – transferred the grant to a third person, i.e. private company. Such a conduct can be considered a breach of the state aid rules with the aim of circumventing the application of more stringent and clear criteria for the state aid authorization. Another case involves the provision of a government grant to support the construction of an industrial park for in the area of Lozorno for a number of sub-contractors delivering components to Volkswagen Slovakia a.s. According to the available government documents, the cabinet supported the development of technical infrastructure (water pipeline and sewerage, roads, rail links, gas distribution network and power mains) for the Lozorno industrial park in the year 2000 and 2001 through a grant of SKK 563 million (appr. € 12.9 million). A portion of this amount went to public utility companies and organisations in the form of purpose-specific subsidies for the construction of mains and networks for the industrial park. Since the State Aid Act was already effective at the time, the grant was provided in breach of §15 of the State Aid Act, which contains stringent restrictions on the provision of state aid to the automobile industry. Quite obviously, in both of these cases the government circumvented the rules for the provision of state aid and there are grounds to believe that one of the main reasons for the ignorance of the State Aid Act was that the grant went to the sensitive sector of automobile production. Had they been considered in conformity with the State Aid Act, the grants would most likely not have been approved. Recommendations We suggest that Act No. 193/2001 on Support to Industrial Park Development be amended in a manner that ensures that any support provided to the developers of industrial parks is considered as state aid in conformity with the State Aid Act. By the same token, whenever the government grants funds to state companies, public utilities or other organisations for the development of technical infrastructure, which is intended to serve mainly private enterprises or become a part of their assets upon completion, such support should be considered state aid and, therefore, subject to the rules applicable to the provision of state aid. We suggest that the Commission pays close attention to the aforementioned Act and its practical application and demands legislative changes that prevent the application of this Act as a tool for bypassing the state aid rules. IV. TRANSPARENCY – SPECIFIC PROBLEM OF GOVERNMENT FAVOURS As indicated above, transparency is a specific issue when it comes to taking decisions on the granting of state aid or other indirect forms of government subsidies that evade the regime of state aid. Although the State Aid Office publishes annual reports on the approved state aid, these reports do not reflect all support funds provided by the government to private enterprises. This applies, for example, to the tax reliefs granted pursuant to §35 and §35a of Act No. 366/1999 on Income Tax [14] and Government Regulations No. 145/1993 and 192/1998. The State Aid Office keeps not records of these tax reliefs, whereas tax offices refuse to publicise this information with reference tax secrecy. Another problem is that the cabinet and Ministry refuse to publicise the documents based on which decisions are taken to classify projects as “significant investments” pursuant to Act No. 175/1999. On one hand, the government awards certain investors the status of being significant and thus makes them eligible for various benefits that are not available to other economic operators. On the other hand, the public is denied access to the underlying documents and has no opportunity to challenge such decisions. Obviously, if a “significant investment” is in the public interest and the law provides for a possibility to expropriate land in public interest, any decision in this regard must be transparent and publicly controllable. Nevertheless, the government claims that such information is confidential and constitutes commercial secret. According to the Friends of the Earth, the transparency of decisions on any type of state aid must be paramount to private interests, particularly if such a private interest is claimed to involve an investment in public interest. Recommendations We suggest that the Slovak government makes publicly available, without any delay, all the documents it has used in the past to take decisions on “significant investments” within the meaning of Act No. 175/1999 and publicises a list of state support granted pursuant to §35 and §35a of Act No. 366/1999 on Income Tax and Government Regulations No. 145/1993 and 192/1998 throughout the existence of these regulations. We suggest that the European Commission makes the closure of the chapter on competition policy conditional upon the adoption by Slovakia of such legislative and procedural changes that increase the transparency of and public control over all decision-making processes related to the provision of state aid and other advantages to economic operators. V. SUMMARY CONCLUSIONS The measures aimed at favouring foreign investors, adopted in Slovakia over the past four years, have become an object of criticism by a broad spectrum of domestic and foreign institutions. In the past, the Commission held that these measures were in conflict with the state aid rules and Protocol 2 to the Europe Agreement. According to the Commission, the tax holiday scheme under §35 and §35a of Act No. 366/1999 on Income Tax "does not respect specific requirements for the provision of state aid to sensitive sectors, such as steel industry, motor industry, shipbuilding and industry of synthetic fibres”. [15] The Commission applied similar logic when it objected the granting of tax reliefs pursuant to Government Regulation No. 192/1998 to Volkswagen Slovakia a.s. The government of Slovakia reacted (mainly through the Finance Minister) to these objections by several statements in the media claiming that these tax reliefes did not constitute state aid pursuant to Act No. 213/1999, but only a “tool of the government’s economic policy” [16] and used terminological manoeuvres to justify the bending of the rules for competition policy and state aid. In the position on the tax holidays granted to US Steel pursuant to §35 of the Income Tax Act, the European Commission states: "any aid provided to US Steel on this basis will constitute a breach of the Europe Agreement... ...unless the state aid for US Steel is in compliance with the rules applied by the Community, it will represent a serious impediment to the closure of Chapter 6 – Competition Policy. [17] " The objections of the Commission concerned, inter alia, state aid granted to VSZ Ocel a.s. and VSZ a.s. in the form of pardoned tax arrears and penalties on unpaid taxes and VAT between 1996 and 1999. This case is described in a greater detail in the attached documents. In reaction to the objections raised by the Commission, the Slovak Republic adopted a partial solution when, on 9.11.2001, the parliament amended §35a of Act No. 366/1999. However, §35 of Act No. 366/1999, as well as Government Regulations No. 145/1993 and 192/1998 remained intact and in full force. Since the tax offices provided -- on the basis of these regulations -- tax reliefs worth over SKK 2.6 billion (appr. € 59.5 million) in the year 2000 alone, the magnitude of the state aid is quite considerable. Various organisations in Slovakia submitted their comments to the draft legislation that introduced new forms of state aid, namely amendment to Act No. 366/1999 on Income Tax, Act No. 193/2001 on Support to Industrial Parks Development, and Act 565/2001 on Investment Incentives. For example, the Friends of the Earth urged both the government and parliament to increase transparency, public control and efficient allocation of state aid from the regional and social perspective. Neither the government nor the parliament took any of these suggestions into consideration. We wish to draw appropriate attention to the correlation between the chapter on competition policy and chapter on regional development. Uncontrollable subsidies to projects outside the less favoured regions will largely reduce the amount of public funds available to aid the most needy. This will generate pressure on increased assistance from the pre-accession and, subsequently, structural funds of the EU. There is a risk that if the Commission remains tolerant to the practices that circumvent state aid rules in Slovakia, it will pay the bill from the EU taxpayers’ money at the end of the day. Recommendations for negotiations on the Chapter “Competition Policy” We request that during the negotiations on Chapter 6 “Competition Policy” the European Commission and the Slovak Government take due account of the problems indicated above in order to remove the discrepancies existing between the legislation and practice in Slovakia on the one hand, and the EU rules and regulations for competition and state aid on the other. Apart from the suggestions outlined above, we request particularly the following: 1. To immediately rescind §35 and §35a of Act No 366/1999 on Income Tax, including Government Regulations No 145/1993 and 192/1998. The government should immediately terminate the granting of tax reliefs conferred under the aforementioned regulations. Any state aid provided to these corporations from now on must be in strict compliance with the relevant EU standards, and any decisions taken in this respect must be transparent and open for public scrutiny. 2. To disclose a complete list of state support granted pursuant to §35 and §35a of Act No. 366/1999 on Income Tax and Government Regulations No. 145/1993 and 192/1998 throughout the existence of these regulations. 3. We propose that the Slovak government amends the Act on Investment Incentives by changing the criteria for decision-making on this form of state aid in order to make sure that support is only directed to those regions where the rate of unemployment stands above the national average. The minimum investment requirement should be cancelled in order to make these incentives accessible also to small and medium enterprises. At the same time, the amendment should ensure higher transparency of and public control over decisions on investment incentives. We suggest that the Commission permanently monitors and evaluates the application of the funds granted under Act No. 565/2001 on Investment Incentives, particularly with a view to their impact on regional development and employment. 4. Based on our negative experiences with the operation of the State Aid Office we consider important that the Commission permanently monitors and evaluates the application of the funds granted under Act No. 565/2001 on Investment Incentives, particularly with a view to their impact on regional development and employment. 5. To rescind the Act No. 175/1999 and to make publicly available all the documents the government has used in the past to take decisions on “significant investments” within the meaning of thic act. 6. We suggest that the Commission pays close attention to the Act No. 193/2001 on Support to Industrial Park Development and its practical application and demands legislative changes that prevent the application of this Act as a tool for bypassing the state aid rules. We suggest that Act No. 193/2001 on Support to Industrial Park Development be amended in a manner that ensures that any support provided to the developers of industrial parks is considered as state aid in conformity with the State Aid Act. By the same token, whenever the government grants funds to state companies, public utilities or other organisations for the development of technical infrastructure, which is intended to serve mainly private enterprises or become a part of their assets upon completion, such support should be considered state aid and, therefore, subject to the rules applicable to the provision of state aid. 7. To investigate the practices of the SAO in relation to the State Aid Act, publish the results of investigation and draw specific consequences for any irregularities ascertained in regard to the approval, granting and reception of state aid by the SAO, government and beneficiaries, respectively. Since the government officials in Slovakia declared preparedness to replace the abolished support schemes with other forms of state aid for foreign investors, the European Commission should carefully scrutinise and monitor any new schemes and individual decisions taken by Slovak authorities in this regard and, where in conflict with the state aid rules, revise the provisional closure of the chapter on competition policy. (Other suggestions for systemic changes within the State Aid Office are outlined in the attached document “The State Aid Office as a Tool for Draining Public Funds”.) NOTES: [1] Cabinet approved the Strategy on 9 March 1999. [2] For example, according to a report released by the Hungarian Ministry of Economy in 2001, most industrial parks in Hungary are without R&D activities. The government’s programme of support to innovations, designed to stimulate research and development in industrial parks, assumed that – once investors got established in industrial parks -- they would develop their R&D lines of business, but nothing has happened. From among those who enjoy the benefits of industrial zones only few engage in research and development using the local intellectual potential. Two thirds of companies operating in industrial parks do not engage in R&D in any way. The report states that “the firms get established in industrial parks primarily due to the availability of cheap labour and invest little effort in developing sophisticated lines of production”. Source: Industrial Parks without Research and Development, Hospodarske noviny 11.7.2001 [3] §§17-21 of Act No. 369/1999 on Income Tax [4] Although Government Regulation No. 145/1993 was repealed by Act No. 374/1995, the tax persons established before the effective date of the Act, which were eligible for income tax relief pursuant to Government Regulation No. 145/1993, continue to be eligible for income tax relief under the conditions laid down in Government Regulation No. 145/1993. [5] The Friends of the Earth – Slovakia: Comments to the bill that amends Act No. 366/1999 on Income Tax, November 2000. [6] Source: http://www.ineko.sk. [7] Thomas C. Dawson, director of the IMF external relations department, letter to Ryan Hunter of the Friends of the Earth-Slovakia, dated 5 September 2000. [8] 2001 Regular Report on Slovakia’s Progress towards Accession, European Commission. [9] Response of the Central Tax Directorate of the SR dated 18.9.2000 to the request for information. [10] Response of the Central Tax Directorate dated 4.12.2001 to the request for information. [11] Protocol on the findings of a public administration audit focused on compliance with Act No. 231/1999 on State Aid, Office of the Slovak Government, Audit Section, June 2001. [12] §4(4) of Act No. 565/2001 on Investment Incentives [13] Under the State Aid Act, the ‘sensitive’ sectors include steel industry, motor industry, shipbuilding industry and synthetic fibres industry. These sectors are under close scrutiny of the Commission and the state aid is largely restricted. [14] According to §35a, approval by the SAO was not necessary before the last Income Tax Act amendment (November 2001). [15] Letter from European Commission to the Slovak mission to EU dated 7.3.2001 [16] "Brussels Caught Slovakia in the Act of Granting Tax Holidays”, Trend No. 17/2001, 25 April 2001 [17] Letter from European Commission to the Slovak mission to EU dated 26.2.2001