Risks and obligations associated with keeping the payroll records of non-resident employees

Keeping the payroll records of employees who are not tax residents in the Czech Republic may pose complications for the employer‘s payroll department, as specific rules and obligations apply to these employees. This issue is already in the crosshairs of the tax authorities, and, together with the abolition of the electronic registration of sales, it is expected that tax auditors will focus on this agenda closely.

Firstly, it is necessary to assess whether the employee is a tax non-resident for the given tax period in terms of Czech, foreign and international legislation. The Czech legislation is relatively brief in this respect, as it defines a tax non-resident as a taxpayer who is not a tax resident, i.e. does not have a place of residence in the Czech Republic for the given tax period and does not spend at least 183 days in the Czech Republic.

However, even if the taxpayer is a resident under Czech rules, they may be eventually classified as tax non-residents under an international double taxation treaty. This usually occurs when the foreign employee maintains residence in or economic or social ties (usually family) with his home country and therefore meets the conditions for tax residence in the respective country.

In these situations, the employee‘s residence must be decided based on the applicable international double taxation treaty. However, assessing tax residence on the basis of these treaties (which often differ from one another) requires detailed knowledge of the employee‘s personal situation, which is often not available to payroll departments; therefore, they are often unable to assess the employee‘s residence reliably.

The Declaration of the Taxpayer form allows the employee to notify the employer of their possible non-resident status. However, even if the employee does not do so (for example, because they are not aware of their own tax situation), the employer is still obliged to identify potential non-residence and keep payroll records accordingly.

As already mentioned, keeping payroll records of a non-resident employee involves an agenda that would not be relevant if the employee was a resident. In most cases, the non-resident employee is not entitled to any tax benefits other than the basic tax relief per taxpayer as part of the payroll administration.

In addition, the employer is also obliged to submit, together with the Annual Tax Reconciliation form, a summary of the aggregate data recorded on taxpayers‘ payroll sheets referred to in Section 2(3) of the Income Taxes Act (the document is generally known as Annex 2 to the Annual Tax Reconciliation), where the employer is obliged to provide the tax administration with relatively detailed information on specific employees who are tax non-residents. The tax authorities share information on non-tax residents within international cooperation; therefore, a foreign tax authority may inform the Czech tax administrator about employees who were not listed in Annex 2. Especially in the case of German tax residents with income from the Czech Republic, it is quite common that missing non-residents are identified.

If the employee is a tax non-resident who also works partially outside the Czech Republic (e.g. a cross-border worker who spends part of the working week physically in the Czech Republic but also works abroad for some portion of the week), it is possible for the employer, according to the Income Taxes Act, to only pay taxes on income with a source in the Czech Republic (in other words, the employer does not have to withhold taxes related to the working days spent abroad and does not have to submit a request to the tax administrator to cancel the obligation to withhold taxes in this respect, which the General Tax Directorate confirmed in the Coordination Committee meeting with the Chamber of Tax Advisors). This naturally involves the agenda of maintaining a workday calendar for individual employees, who should regularly report to the employer the details of their physical presence. If this is not done and the employer withholds the full amount of tax from the non-resident taxpayer, even for income related to work performed abroad, it is possible (and relatively frequent) that the local tax authority of the taxpayer will refuse to refund the tax upon filing the personal income tax return, arguing that the employer should not have paid the tax in the first place (hence, it can only be refunded to the employee through a retroactive adjustment of the employer‘s payroll records).

Keeping the payroll records of tax non-residents has historically been a relatively marginal issue, and payroll departments often lack the mechanisms necessary to identify them. As mentioned above, an inaccurate assessment of the employee‘s situation and the incorrect way of keeping the payroll records may have consequences for both the employee and the employer. Given the trends in the labour market (more frequent remote work, employment of foreigners due to labour shortages within the Czech Republic), it can be expected that the number of potential tax non-residents will likely increase in the future, and employers should therefore focus on this area before the tax administrator does so in the context of an audit.

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