Czech Sector Taxes: May not be as bad as Some Expect

Imposing Windfall Taxes Risks an ''Own-Goal''

There is speculation about the imposition of special sector taxes on both the Czech energy and banking sectors in light of their perceived current ''exceptional'' profits. While such taxes are possible, even probable, they are unlikely to be as onerous as some investors fear.

Given the widespread public ownership of the State utility CEZ, and to the lesser extent Czech banks, such as Komercni Banka and Moneta Money Bank, the Czech government will likely proceed with caution.

CEZ - Energy Tax Risks Hurting Those Most in Need of Help

The worst case scenario, explicitly outlined in the financial press, asserts that the Czech government will impose a hefty, even ''brutal'', tax on the profits of Czech energy utility CEZ, knock the share price, then later buy out/restructure minority shareholders ''on the cheap''.

However, if the purpose is to raise money for the State coffers in order to provide financial assistance to those affected by the surge in energy bills, such action is likely to prove both deeply unpopular and risks hurting precisely that segment of the population the government wishes to help.

There are currently approximately 145,000 Czech individuals with a direct investment in the shares of CEZ, representing 13% of CEZ's issued shares[1]. However, roughly 2/3rds of these Czech individuals have their shares in a so-called "nezarazeny ucet" (unclassified account), i.e. they do not have any contract with a broker, and received the shares in the coupon privatisation in mid 90s. Most of these shareholders are therefore now retired or approaching retirement: Precisely the segment of society the government must try to help in the current cost of living squeeze. It is difficult to see how financing State assistance by imposing a windfall tax, thereby knocking both the value of CEZ's share price and CEZ's future dividend paying capacity, will help the elderly Czechs manage the current cost of living crisis. Such action would be thoroughly pointless and leave many retired Czechs worse-off, not better-off, as a result.

Furthermore, the actual number of Czechs with savings in CEZ is substantially higher than indicated by those with a direct investment in CEZ. This is because numerous domestic collective investment and pension funds also have investments in CEZ. The CEZ Group is, after all, the largest quoted equity on the Prague Stock Exchange. Taking AKRO's funds as an example, CEZ currently represents the single biggest investment in 3 out of 4 of AKRO's mutual funds. Therefore AKRO's 40,000 unit-holders, again most from the voucher privatization of the mid-1990's, also stand to lose from any heavy-handed and misconceived ''help'' from the government.

Banks

To a large extent, the same argument applies to the banking sector. As an example, at the time of Komercni Banka's recent half-year results, there were 58,349 Czechs with a direct investment in Komercni Banka. Similarly, Moneta Money Bank has more than 20,000 Czechs on its share register. Again, these numbers exclude the tens of thousands of Czech citizens with indirect investments through their holdings in collective investment schemes or pensions.

What's the answer?

Of course, the government must act to help those most affected by the current cost of living squeeze. In any decent society, it's simply unacceptable to allow vulnerable citizens to go without basic needs, such as heating or food. However, care needs to be taken not to hurt those segments of society, such as the elderly, the government is trying to help.

It is this author's opinion that the government should use its controlling stake in CEZ to propose an additional ''special dividend'' from the company. This would be fairest way to raise additional funds. Whilst benefitting the government, it would also benefit private investors, pension funds and mutual funds alike. A win-win situation.

Similarly, before a bank sector tax is implemented, the government should review the potential of the already existing National Development Fund (NDF).

More generally, the current situation is also a reminder that the government also needs to re-double efforts to improve tax collection rates and tackle financial fraud: An area where the Czech Republic has been notoriously lax.

Concluding Comments

There isn't anything exceptional about the current situation: War, economic cycles and inflation have been recurrent themes over history. Alas, nothing the government does will completely mitigate the cost of living squeeze for the average citizen. However, that is not to say targeted help and targeted fund raising isn't required to help the most vulnerable. A special dividend from CEZ, better utilizing the existing bank financed National Development Fund, and improving tax collection rates needs to be part of the policy mix to raise those funds. In contrast, a ''brutal'' tax on key segments of the Czech economy may well end up causing more harm than good.

Jeremy Monk

Investment Director,

AKRO investiční společnost, a.s.

Prague. 29th August, 2022

E-mail: monk@akro.cz

Disclaimer

This article does not constitute investment advice or a recommendation to buy or sell any security.

[1] SHAREHOLDER STRUCTURE as at Dec 31, 2021: Czech Republic 69.8%, ČEZ, a. s. 0.2%, Other legal entities (e.g. collective investment/pension funds) 16.3%, Private individuals (Czech/Foreign) 13.7%.