Non-deductible expenses in Croatia: why you pay tax on more profit than you made

An owner looks at the profit and loss account, sees a profit of EUR 100,000 and expects tax on that amount. The profit tax return shows a base of EUR 125,000. The difference is not a bookkeeping error, but a consequence of accounting and tax rules not treating the same costs the same way.

We describe the rules as they stood at the time of writing. Rates and conditions change, so before a decision check the current Profit Tax Act or take advice.

Accounting profit and taxable profit

Accounting profit is the difference between income and expenses under accounting standards. Every real business cost goes into it in full.

The tax base starts from accounting profit and is then increased by expenses the law does not recognise and reduced by items the law allows to be deducted.

A non-deductible expense therefore does not disappear. You paid it and posted it, but you get no tax reduction for it. It really costs you more than the invoice says.

The most common non-deductible expenses

Entertainment. Hosting business partners, gifts, paid holidays or tickets. Half of these costs are not deductible. Promotional gifts of low value bearing the company name have separate, more favourable treatment.

Passenger cars. Half of the costs related to passenger vehicles (fuel, maintenance, insurance, rental, depreciation) is not recognised, unless use of the vehicle is charged to the employee as a benefit in kind. In addition, depreciation is recognised only up to a prescribed purchase value of the vehicle.

Fines. Traffic, tax, customs and other fines imposed by a competent authority are not recognised at all.

Costs of enforced collection of taxes and other public charges.

Default interest between related parties.

Donations above the prescribed limit. Donations for public benefit purposes are recognised up to a certain percentage of the previous year’s revenue. Above that, or if the recipient does not meet the conditions, the cost is not recognised.

Shortages above the permitted level. Shrinkage, spoilage and breakage are recognised up to the limits in a decision of the trade chamber or an internal act. Above that the shortage is non-deductible and also carries a VAT liability. More in the article on stock that does not match.

Write-downs of receivables that do not meet the conditions. Writing off an uncollected receivable is recognised only under prescribed conditions: a certain number of days past due and collection steps taken. Writing it off “because the customer will not pay anyway” is not enough.

Depreciation above permitted rates. If an asset is depreciated faster than the law allows, the difference is not recognised in that year.

Hidden profit distributions and private costs. Costs not related to the business but to the owner or their family: private travel, furnishing a flat, invoices unrelated to the activity. The risk is highest here, because income tax and contributions may be assessed in addition to profit tax.

Provisions the law does not recognise.

What it costs

Take a company with accounting profit of EUR 100,000 and these costs in the year:

	Cost	Non-deductible
Entertainment	20,000	10,000
Passenger cars	24,000	12,000
Fines	1,000	1,000
Private costs through the company	2,000	2,000
Total		25,000

The tax base is EUR 125,000 instead of EUR 100,000. At a rate of 18%, the tax is EUR 22,500 instead of EUR 18,000, so EUR 4,500 more. At the lower rate of 10%, which applies to companies with lower revenue, the difference is EUR 2,500.

It is more interesting to look at a single cost. A business dinner of EUR 200, at a rate of 18%, reduces tax by EUR 18, not by the EUR 36 that a fully deductible cost of the same amount would. To that, add the limits on deducting input VAT on entertainment and passenger cars.

Common mistakes

• Wrong classification. A marketing cost posted as entertainment loses half its recognition, and entertainment posted as marketing is a risk in an inspection.
• Cars without records. Without travel orders and usage records it is hard to prove a business purpose.
• Writing off receivables without a basis. Without reminders, a lawsuit or a claim filed in bankruptcy, the write-off is not recognised.
• Invoices unrelated to the activity. Every cost must have a business purpose that can be explained.
• Mixing private and business. The most expensive mistake, because fines and interest add up across several taxes.

What can be done

The aim is not to avoid costs the business needs, but to know what they really cost and not to pay tax where you do not have to.

1. Review the non-deductible expenses in your last return. How large they are and what they consist of.
2. Check the classification. Whether everything posted as entertainment really is entertainment.
3. Decide about the cars. For some vehicles charging a benefit in kind pays off, for some it does not. It can be calculated.
4. Tidy up collection of receivables. Reminders and lawsuits in good time, so that a write-off can be recognised when it comes.
5. Adopt internal acts. A decision on shrinkage and spoilage, rules on entertainment and company vehicles.
6. Separate private from business. Without exception.
7. Look during the year, not in April when the return is filed and nothing can be changed.

The other side: what reduces the base

Alongside items that increase the base, there are those that reduce it: tax losses carried forward from previous years, income that has already been taxed, and prescribed reliefs and incentives. We write about them in the article on tax reliefs for companies.

If you want to know what non-deductible expenses really cost you and which of them can be changed, we do that as part of tax and business advisory. Get in touch.