Office of Tax Analysis 

U.S. Treasury Department 

Washington, D.C. 20220 

Issued: July, 1976 

Taxation of Western Enterprise 

in Selected European Socialist Countries 

Paul Jonas 

University of New Mexico 

OTA Paper 13 May, 1976 
TABLE OF CONTENTS 

Page 

I . Introduction ......................... 1 

I1. Growth Potential ....................... 3 

A . The Distribution of Employment .............. 3 

B . Interpretation of the Diagrams .............. 6 

I11. Joint Ventures in the Socialist Countries .......... 7 

A . Definition and Purpose of a Joint Venture ........ 7 

B . Opening the Doors to the West .............. 7 

C . Summary ......................... 8 

IV . The Case of Yugoslavia .................... 9 

A . General ......................... 9 

B . Ownership ........................ 9 

C . Restrictions on Foreign Investments ........... 11 

D . Taxation of Joint Ventures ................ 12 

1. Gross Income. Net Income. and Profit ......... 12 

2. Distribution of Profits ............... 13 

3 . Withholding Tax Affecting the Foreign Partner .... 14 

4 . Tax Incentives .................... 14 

5. Differential Taxation Between Republics ....... 15 

6 . Summary ....................... 15 

V . The Case of Romania ..................... 16 

A . General ......................... 16 

B . Ownership ........................ 16 

C . Taxation of Joint Ventures ................ 17 

1. Determination of Gross Income. Net Income. and Profits 17 
page 

2. Tax Rates and Tax Holidays ............ 19 

3 . Distribution of Profit .............. 19 

4. Avoidance of Double Taxation ........... 20 

VI. The Case of Hungary ................... 21 

A . General ....................... 21 

B. Ownership ...................... 22 

C. Taxation of Joint Ventures .............. 23 

1. The Determination of Gross Income. Net Income. 

andprofits ................... 23 

2 . Tax Rates and Tax Holidays ............ 24 

3. Avoidance of Double Taxation ........... 26 

D. Financial Operation ................. 26 

VI1. The Case of Bulgaria ................... 27 

A. General ....................... 27 

B . Regulations on Foreign Economic Cooperation ..... 28 

C. Summary ....................... 29 

VI11. The Case of Czechoslovakia ................ 30 

A. General ....................... 30 

B. Summary of Western Cooperation with Czechoslovakia . . 31 

IX. Conclusion ........................ 32 

A. Accounting Procedures ................ 32 

B. Business Taxes .................... 33 

C. Transfers ...................... 34 

D. The Future ...................... 36 
I. INTRODUCTION 

It is often argued that joint ventures in socialist countries 

represent a sudden new frontier for Western business firms. The present 

study suggests, however, that this "new opportunity" should be examined 

more critically and placed in a dynamic context. Western as well as 

Soviet-bloc enterprises (Yugoslavia, due to her special case, is not part 

of the latter group) have been through various stages of thought in 

regard to economic transactions with political adversaries: 

(1) Cold War: National security concerns are dominant. One 

should not provide any tangible benefit to a political 

enemy which seeks your destruction. Thus the Western 

countries establish embargoes and Soviet-bloc states follow 

autarkic policies. 

(2) -Thaw: If the assumed economic gains exceed the estimated

benefits of the adversary, then some limited economic transactions, subject to export controls, could be considered. 

(3) De'tente: The most important goal is the relaxation of 

political tensions; therefore, economic gains are secondary, 

In this stage, a limited number of Soviet-bloc countries invite 

Western equity capital investments to demonstrate the end of 

confrontation and also to seek abolition of discriminatory 

tariffs, changes in export control policy, and other benefits. 
-2-

(4) Normalcy: Business firms, both Western and Soviet-bloc, 

seek profits and profitability within the system under 

which they operate, and political considerations do not 

play a significant role. 

This project selects a single issue within the present détente and 

attempts to answer the question. "What are the fiscal rules in 

selected European Socialist countries that will apply to foreign corporat ions ?" 

The following areas will be investigated for Yugoslavia, Romania, 

Hungary, Bulgaria, and Czechoslovakia: 

(1) The nature of limitations on the formation of foreign 

associations in various sectors; 

(2) The types of business organizations (for example, corporate, 

partnership, branch office) in which foreigners may participate; 

(3) !The concept of taxable income, including the treatment 

of depreciation allowances; 

(4) Types and rates of tax "normally" levied on corporate 

income and potential tax holidays. 
-3-

11. GROWTH POTENTIAL! 

A. The Distribution of Employment. To demonstrate the growth 

potential of the selected socialist countries of Yugoslavia, Romania, 

Hungary, Bulgaria, and Czechoslovakia, we will use the so-called 

"snowflake diagrams," developed by the International Labour Organization.-1/ 

Snowflake diagrams demonstrate the distribution of employment across 

the major sectors of an economy and can be used for the analysis and 

prediction of growth potentials. The sectors selected are: Agriculture, 

Manufacturing with Mining, Construction, Transportation, Commerce, and 

Services. The diagrams are constructed on a six-axis graph with the 

percentage share of each sector plotted on one axis. Immature lessdeveloped economies are elongated upward along the agricultural axis. 

As the economy matures, the diagrams become more rounded; and, when the 

economy reaches the developed industrial stage, the snowflake "melts" as 

employment shifts heavily to the manufacturing and then to the services 

sectors (Table 1 and Figure 1). 

It is proposed by the constructors of this model that in boom times 

an ample reserve of agriculturally employed labor is one of the basic 

ingredients of economic growth. The corollary of this proposition is, 

however, that the country should be ready to utilize current technological 

knowledge, to link her economy to the international market, and to keep 

population growth controlled. One way to achieve these goals is to 

establish joint ventures with developed industrialized countries. By 

this method, access to technology, secure capital formation, and knowledge of export and import markets are more readily available. 
-4-

TABLE 1 

Data of Snowflake Diagrams 

(Figures are percentages of total 

work force employed in each sector) 

Bulgaria 

Romania 

Czechoslovakia 

Yugoslavia 

Hungary 

45 -

MM -

svs -cam -

Tran Const 

64 16 11 3 3 3 

70 13 8 3 2 4 

31 35 13 8 6 7 

57 18 14 4 3 4 

36 30 16 7 6 5 

Abbreviations: Ag -- Agriculture 

MM -- Manufacturing with Mining 

Svs -- Services 

Com --Commerce 

Tran --Transportation 

Const--Construction 
-5-

Figure 1 : Snowflake Diagrams 

1 Tran 

Czechoslovakia 

Yugoslavia 

,MM I--MM /' svs ' 

-1 

svs J n,' 

Const corn,/ 

kan 

\Const com ,/ 

Tran 

Ramania 

Data Source: International Population Statistics Reports Series 

-P-90.nos. 13, 14, 16, 18, 22. Bureau of the Census, U.S. 

Department of Commerce, U.S. Government Printtng Office, 

Washington 25, D.C., 1960-1965. 
-6-

B. Interpretation of the Diagrams. Given the snowflake diagrams 

of the selected socialist countries in Figure 1, the following conclusions 

can be drawn. 

1. All five countries have relatively high levels of agricultural employment. This sector is often characterized by disguised unemployment 

and relatively low incomes. Western enterprise, therefore, can expect a 

readily available, relatively cheap labor force. 

2. The countries which offer the largest labor pool appear to be 

Bulgaria, Romania, and, to a lesser degree, Yugoslavia. At this time, 

Bulgaria is not interested in joint ventures with Western enterprise. 

Thus, Romania and Yugoslavia, who actively seek foreign, equity-type 

investment, show the greatest potential for raw labor inputs. 

3. Hungary and Czeclioslovakia show more concentration in their respective 

industrial sectors and services. Thus, the labor pool in these countries 

is composed of more sophisticated workers who will require higher wages 

and benefits, but lower training costs should be incurred. However, 

Czechoslovakia is not now interested in joint ventures with U.S. firms, 

4. The following rule-of-thumb can be summarized for Western enterprise 

seeking joint ventures with the selected socialist countries. In a 

production process characterized by a relatively low capital-labor ratio, 

Yugoslavia and Romania offer the best opportunities. (If regulations 

change, then Bulgaria should be included here as well.) However, if the 

production is characterized by a relatively high capital/labor ratio, then 

Hungary and, potentially, Czechoslovakia appear more attractive. 
-7-

111. JOINT VENTURES IN THE SOCIALIST COUNTRIES 

A. Definition and Purpose of a Joint Venture. The joint venture 

is a business association of comparatively long duration set up by tws or 

more parties in order to run an enterprise subject to sharing of control, 

risk, and profit. The concept of the joint venture is not new in the 

European socialist countries. Such ventures have been created between 

Socialist and less-developed countries, and some socialist enterprises 

also act as investors in joint undertakings in "fraternal" socialist 

countries. These facts refute the often-heard allegation that one of the 

reasons for the hesitancy of some centrally-planned economies to enter into 

joint ventures is that the legal framework has yet to be defined. 

The joint venture, as often stated, reconciles two interests. The 

foreign investor aims for the most effective protection for his property; 

moreover, he desires to enter a new market, to reach third markets through 

a new base, and to transfer production to a place where the costs of 

construction, labor, and so forth, are lower than in his own country. From 

the standpoint of the capital-importing host country, it is expected that 

the Western investor will furnish both tangible assets, such as machinery 

and materials,and intangibles, such as patents and skills. 

B. Opening the Doors to the West. Price-directed, worker-selfmanaged, market-socialist Yugoslavia was the first socialist country-21 

to invite Western capital equity to incorporate in a joint undertaking.-31 

Everybody waited for the reactions of the other European socialist countries 

and these, with the obvious exception of Albania,&' were not unfavorable. 
6/ 

-8-

The German Democratic Republic and Czechoslovakia were among the first 

eleven foreign partners to conclude token joint venture contracts with 

Yugoslavia. The other countries of the COMECON group took the stand of 

expectation and exploration. The maverick of the Soviet bloc, Romania, 

was next to open the doors to Western Enterprise,l’ with Hungary following 

thereafter .-

C. Summary. The value of the joint venture depends on the degree 

to which it meets each partner’s requirements. In the Western countries, 

as with all business associations, the joint venture is created to carry 

on a business that will generate profits. The usual objective of a firm 

in a centrally-planned framework is to maximize output or the volume of 

trade or services. These various objectives could conflict but they can 

also coincide. There is no general theory which can be offered, and every 

joint venture should be evaluated separately. 
-9-

IV. THE CASE OF YUGOSLAVIA 

A. General. On the basis of the Constitution and the laws, Yugoslav 

enterprises are autonomous self-managed organizations. They have full 

legal capacity, and are entitled to freely assess all factors involved 

in entering into business arrangements. The manager is not appointed by 

the central authorities but is selected on the basis of competition. In 

the case of a joint enterprise, the partners may agree that the foreign 

partner appoint an authorized person in his employ who would establish 

labor relationships with the enterprise. The title and capacity of this 

person is co-director, and he is not subject to formal approval by the 

workers' council. 

Basically Yugoslav enterprises conform to market forces in accordance 

with the unique Yugoslav market-socialist system. The Yugoslav national 

economic plans are not legal, binding obligations; they are mainly guidelines, similar to the French plans. The enterprises are entitled to draw 

up their own development and investment plans. 

The enterprises themselves distribute realized income and allocate 

it to various funds and to personal income (wages and salaries). Therefore, 

in Yugoslavia, there is very little check on increasing wages, since the 

workers' councils decide wages. 

B. Ownership. Under ordinary conditions common to western economies, 

equity investment constitutes ownership. But if one of the investors is 

from a Western country, and the joint business venture is in a socialist 

country, is this capitalist the partial owner of a socialist firm? This 
- 10 -

is a touchy question. It does indeed seem contradictory that countries 

which, in accordance with the prescription of socialist theories, expropriated their own capitalists, would now invite the cooperation of 

Western enterpreneurs to pocket the Marxian "surplus value", that is, 

the profits. Yugoslav theorists were much concerned to provide an 

acceptable solution for this puzzle. 

The Yugoslav solution is elegant and may provide a blueprint for 

all those nations which badly need foreign capital in order to solve some 

of their economic ills but, at the same time, are hesitant to invite 

foreign capital into their economy. Yugoslav theoreticians propose that 

at the very moment the foreign capital crosses the border of a country, 

it becomes socially owned. It is claimed that investment coming from 

Western investors is not associated with capitalist assets in the socialist 

country, since the capitalists are not co-owners of the joint undertakings. 

This solution is derived from the concept of Roman law, namely 

from the term instituta pactum reservati domini. This doctrine is 

practiced in trade as a sort of security for the seller that the 

buyer will fulfill the contract. A car remains in the ownership of 

the dealer until all the payments are made, but it is operated and 

used by the buyer. Similarly, the foreign investor can use the whole 

part of his share, but he does not own it. While he retains title 

to his invested assets, this does not violate Article 8 of the 
- 11 -

Federal Constitution which lays down the principle that "no one has the 

ownership to the social means of production and that the means of production and other means of social work....are social property." The word 

11 ownership" was also carefully left out in the entire foreign investment 

legislation.-71 

The rights of the foreign investor, in spite of the fact that he 

does not own any assets in the Yugoslav economy, seem quite secure. The 

regulations provide that he may share in the profits from the joint 

venture "as long as he participates in it with his own assets" and also 

that he has the right to the return of the particular items invested in 

the joint venture. The foreign investor, therefore, subject to the 

contract, could retrieve his entire equity regardless of its form (cash, 

tangibles, intangibles); practice has demonstrated and confirmed this 

option. Therefore, a piece of machinery which has a lifetime of ten years 

can have an interesting metamorphosis. Used by a foreign investor as

equity in a Yugoslav investment, it becomes socially-owned property, but 

if the investor returns home after five years the machine, in a new 

reincarnation, again becomes private property. 

C. Restrictions on Foreign Investments, Host governments often 

impose limits and restrictions on foreign investments, and regulations 

are often made which exclude foreign capital from certain areas of 

activity. The Yugoslav approach is the following: banking, insurance, 

inland transportation, internal commerce, public utilities, and social 

services are areas or sectors in which all foreign investment is excluded. 
- 12 -

An exception can be made by the Federal Executive Council if it decides 

that a particular investment will expedite the development of a certain 

sector. So far, the Council has not used its powers in this respect although potential foreign investors have been interested in entering 

complex projects involving inland transportation. Some sectors, such as 

manufacturing, processing, the extractive industries, agriculture, 

tourism, and research, are open for foreign participation and for registration with the government. 

A special territorially-determined area of foreign investment is a 

free custom zone. In Yugoslavia, nine such zones have been registered: 

Beograd, Novi Sad, Rijeka, Koper, Split, Zadar, Ploce, Bar, and Pula. 

Article 2 of the respective decree enumerates activities using foreign 

equipment that may be jointly run within these zones: storage of goods, 

perfection of foreign goods, usual handling of goods such as classifying 

and packaging, and erection and financing of other facilities. Amendments to include activities such as industrial manufacture coupled with 

custom-free import of foreign-invested equipment have been proposed.-81 

D. Taxation of Joint Ventures. 

1. Gross Income, Net Income, and Profit. Joint venture contracts 

in Yugoslavia have adopted the same systems of income reporting, computation of profits, and accountancy as all domestic enterprises, Accordingly, 

gross income is the total receipts accrued from invoiced sales of product 

and services. Net income, or simple income, is gross income minus the 

cost of material and services and depreciation of fixed assets (domestic 

and foreign), 
- 13 -

Material costs and services include raw and other materials used, 

services of third parties, rent, advertising and promotion, costs of 

participation in fairs, maintenance of fixed assets, purchase of protective devices and clothing for workers, transportation for workers, 

and emoluments of apprentices./ The Western reader may be astonished not 

to find labor costs in this enumeration, Under worker self-management, 

labor costs are not considered expenditures since they are received by 

the "owners" of the enterprise. 

Before becoming distributable profit, net income is reduced by 

various contributions. The foreign partner, in general, does not escape 

any contribution that affects his Yugoslav counterpart, unless previously 

negotiated by contract. The income of the enterprise is not taxed; 

rather, the worker's personal income (wages and salaries) is taxed. 

Legal 10/ and contractual g/reserves are additional obligations. In some 

cases,part of the net income must be allocated to the enterprise funds 

prior to distribution to the parties; this should be clarified in the 

contract. The remaining net income is the distributable profit. 

2. Distribution of Profits. On distribution of profit, the 

law is flexible. The foreign partner can take his share out in accordance 

with his percentage of equity in total assets, whereas the domestic 

partner can use his share in two ways: (1) for salary/wage bonuses; 

(2) for allocation to the enterprise's funds. The law does not require 

that the shares in net distribytable profits be proportionate to each 

partner's contribution but, in practice, & contracts concluded so far 

demonstrate that the equity ratio was the sole criterion. 
- 14 -

With regard to losses, the contracts provide that either the parties 

will share in the losses in proportion to their investments or the losses 

will be offset against the income. In either case, the losses reduce 

the tax base. 

3. Withholding Tax Affecting the Foreign Partner. Once the 

foreign partner's share of distributable profit has been decided, a 

special withholding tax of 35 percent is levied, after which that share 

is transferable. This tax is applicable only on the foreigner's share 

of profit, and is executed by monthly estimated payments during the 

calendar year, unless the recipient enterprise draws its balance sheets 

quarterly, Both partners are held liable for any failure to pay the tax. 

Royalty payments are also subject to a municipal withholding tax at 

rates set locally up to a maximum rate of 30 percent on the gross royalty 

reduced by a fixed percentage for expenses. (Domestically, the, tax applies 

only on royalty payments to individuals.) 

4. Tax Incentives. The Yugoslav federal legislation grants a 

concessionary reduction of the 35 percent tax in proportion to the percentage of profit that the foreign investor ploughs back. The reduction 

may be as much as 90 percent. As the reinvestment rises, the reduction 

increases. The foreigner enjoys the same concession on the percentage of 

profit he deposits in a bank, if it is longer than ten years. If the 

deposit is for at least five years, the concession is half; however, the 

tax concessions are not applied if the withdrawal period is less than five 

years. Interest on the deposit of the foreigner's profit is not taxable. 
- 15 -

5. Differential Taxation Between Republics. Sweeping changes 

in the field of taxation are expected, as all the republics, both 

developed and undeveloped, are now entitled to tax foreign investors 

according to their statutes. The tax may not exceed 35 percent but may 

be lower. Foreign investors should be aware of local regulations. For 

example, while the levy on the foreigner's profit from joint investment 

is 35 percent in Serbia and Slovenia, it is reduced to 20 percent in 

Bosnia-Herzegovina, and to 14 percent in Macedonia.- 12I 

6. -. There are two categories of required payments 

affecting joint ventures in Yugoslavia: (1) required contributions, and 

(2) the profit tax payable by the foreign partner. The foreign partner's 

share of some of the contributions may be negotiated in the contract, such 

as legal reserves and social insurance contributions. Then the foreigner 

pays the 35 percent withholding tax on his share of the profits. 
- 16 -

V. THE CASE OF ROMANIA 

A. General. Romania, the maverick of the Soviet bloc, conducts 

her foreign relations more or less independently of the Soviet Union 

and the rest of the COMECON countries; at the same time, she maintains 

a tight grip on her domestic economy, which is one of the strictest 

centrally-planned systems in East Europe. Romania's trade with 

COMECON and "other socialist countries" has been decreasing, while trade 

with Common Market and less developed countries has been increasing. 

(For example, trade with the United States in 1974 approached $200 million 

compared with $116 million in 1973.) At the same time Romania follows 

the "Preobrazhensky-type super-industrialization" concept of forced 

industrializationwhich dominated Soviet economic policies during the 

Stalinist period. Each economic plan stresses a high rate of industrial 

expansion. 

B. OwnershiE. Decree No. 425 of November 2, 1972 on Tax and Profits 

of Joint Companies Constituted in the Socialist Republic of Romania, 

permits foreign ownership of as much as 49 percent of the equity in Romanian 

joint ventures. This represents a fundamental change in the earlier 

Romanian position, which demanded "exclusive ownership of all joint economic 

units established in Romania." The 1972 Decree was an attempt to introduce new methods designed to alleviate the chronic deficit in Romania's 

trade balance, especially vis-L-vis the Western industrialized nations. 

It was hoped that joint ventures with Western companies would improve this 

situation. 
- 17 -

C. Taxation of Joint Ventures. 

1. Determination of Gross Income, Nef Income, and Profits. 

The accounts of the joint venture are not kept in the local currency 

but in the so-called "agreed currency". (Some minor exceptions to this 

rule are enumerated in Article 21.) The "agreed currency", although not 

stated explicitly, is usually the currency of the foreign partner. If 

the foreign partner's country lacks convertible currency, then the accounts are kept in a selected hard currency. 

The association is separated from the actual prices of the local 

markets, for the internal pricing system of Romania is divorced from the 

world market pricing system. Local currency expenses, such as the wages 

of local employees and domestic supplies, are paid by the Romanian authorities in lei and billed to the joint venture in hard currency. How I__ 

are costs arising from the usage of domestic resources determined? The 

unit price of the domestic inputs should be negotiated in the contract in 

terms of the hard currency selected. The bill will come from the state 

authorities and not from the vendor. The contract price is usually lower 

than the price for labor, raw materials, and so forth, in the investor's 

home country, but not as low as the costs of 

Romanian firm. Romanian authorities rightly 

to sponsor the operation of a joint venture 

Romanian population whicli would be required 

low price level on input prices. 

these inputs faced by a 

feel that it would be unfair 

from the sacrifices of the 

to maintain an artificially 

The same principles apply to sales by the joint companies to domestic 

enterprises. The price will not be paid in -lei by the buyer but will be 
- 18 -

reimbursed by the Romanian authorities in the selected hard currency 

on the basis of the negotiated output unit price. 

The calculation of net income would be simplified if the company's 

operations were exclusively domestic. Then, the company's net income 

would be determined on the basis of the negotiated prices for local 

inputs and sales of output. No part of the net income could be transferred abroad; it could be reinvested in the joint venture or in another 

association. However, significant transactions of the joint venture 

may be international, for which prices are determined exogenously by 

the international market. The Romanian stand is thLt, while for domestic 

purposes a distorted price system is a must to achieve various objectives, the international exchange of goods and services even among 

socialist countries cannot ignore objective laws and one cannot superimpose an artificial price structure. Thus the net income for such international transactions is divided in accordance with the equity between 

the domestic and foreign partners; after taxes, the share of the foreign 

investor can be repatriated. 

Net income is also reduced by depreciation allowances and legally 

required reserves. Depreciation is dealt with in Article 27, which states 

that the rates of depreciation should, generally, be established in the 

Contract of Association but that they may not be lower than the standard 

rates laid down by Romanian laws. A deduction of 5 percent of annual 

profit may be taken each year for amounts set aside in a tax free reserve 

fund until the reserve reaches 25 percent of invested capital. 
- 19 -

2. Tax Rates and Tax Holidays, A 30 percent tax is levied 

on the joint venture's annual net income. However, profits reinvested 

for at least five years in the same or other joint ventures are taxed 

at a reduced rate of 24 percent. Moreover, new companies may be granted 

a tax holiday or full exemption for the first profitable year of operation and taxation at half the ordinary rate (that is, 15 percent if 

distributed, 12 percent if reinvested) for the following two years, 

3. Distribution of Profit. The net profit after tax can be 

(1) appropriated to form voluntary reserves; 

(ii)ploughed back to finance fresh investments; 

(iii)paid out to the shareholders as dividends; 

(iv) any combination of (i), (ii), and (iii). 

The share of each appropriation may be determined by an enterprise policy 

formulated in the Contract of the Association or it can be determined 

by the General Assembly of the shareholders. 

As regards repatriation of dividends by the foreign partner, the 

situation is not totally clear. The likely situation is that the amount 

that can be remitted abroad will be limited to the foreign investor's share 

of hard currency in the international account, in accordance with the 

proportion of the foreign partner's equity. For example, assume that 

the net profit is $100, of which 40 percent originates from domestic 

operations and 60 percent originates from international operations. 

Further, suppose. that the foreign partner's investment is 40 percent of 

total assets. Then, if no appropriations are made from the international 
- 20 -

account to voluntary reserves or reinvestments, the foreigner could 

presumably remit 40 percent of the $60, that is, $24. 

Dividends remitted abroad are subject to a 10 percent withholding 

tax. 

4. Avoidance of Double Taxation, Romania has concluded 

income tax treaties to avoid double taxation with the Federal Republic 

of Germany and with the United States. The U.S.-Romania treaty was 

signed on December 4, 1973. It entered into force in January, 1976; 

but applies retroactively to January 1, 1974. 
- 21 -

VI. THE CASE OF HUNGARY 

A. General. The study of Hungarian economic policy in the 1960s 

shows how changes in economic mechanisms and policy concepts can be made 

in a market economy that is open, planned, and noncapitalist. A new 

economic model--the New Economic Mechanism (NEM)--went into operation in 

January, 1968. It is based on the following principles. 

(a) In a relatively developed industrial society with an extensive domestic and international division of labor, the most 

efficient form of organization of economic activity is the 

market exchange system, regardless of the form of ownership, 

(b) Because the means of production are pub1icIy owned, the operation of the market can be regulated in such a way as to eliminate those disturbances which occasionally disrupt economic 

processes in a private enterprise system. 

(c) The basic instrument and control for the socialist market 

economy is the macroplan. The plan has the same economic aims 

and objectives as the Government, and it indicates the 

instruments at the Government's disposal. The market and the 

price system provide signals for the planners which warn them 

that investigations and interventions are necessary to "guide" 

the economy in the desired direction. Therefore, the plan 

acts as a correcting mechanism. 

(d) The success indicator for efficiency is profit, a measure of 

success and an automatic regulator of income distribution. 
- 22 -

(e) Competition is necessary; indeed it is an indispensable part 

of the mechanism for adjusting to a market equilibrium, 

(f) Such an economy needs a relatively free price system. It 

cannot function properly without the automatic adjustment 

carried out in response to constant changes in relative prices. 

(g) Decision-making should be decentralized. A limited number of 

macrodecisions should be made by central authorities while 

microdecisions taken by the economic units aim to achieve the 

goals more efficiently. 

The New Economic Mechanism stresses the concept of cooperation with 

Western enterprise. Industrial cooperation with the firms of the developed 

industrial nations is considered one of the most important aspects of 

economic development because, as stated, "we must find substitutes for 

imports at any price." 

B. Ownership. In 1970, Hungary announced the principle of partnership between foreign and local firms, including enterprises from the 

Western industrialized nations. The conditions were elaborated in 

October 1972 in a short decree which leaves many issues to be filled in 

by regulations. Specific agreements for joint ventures can be obtained 

rather easily, and should be incorporated in the contract.-131 

Joint ventures in Hungary, with respect to ownership, normally 

take the form of joint stock or limited liability companies. The limit 

to foreign equity pgrticipation is not spelled out in the Decree, but 

it is normally 49.9 percent (which can be relaxed, especially if several 

Western firms would like to participate in the undertaking). 
- 23 -

It is an interesting provision of the Decree that the foreign 

partner may apply to the Hungarian National Bank for a guarantee to 

secure the right of its ownership against any damages which may result 

from direct or indirect acts of the Hungarian state or of the Hungarian 

counterpart. 

If the venture is in commercial or service activity, then only 

the concurrence of the Ministry of Finance is needed for a contract 

(which is called a "memorandum of the association"). If the venture 

holds industrial assets and engages in industrial production, then the 

approval of the Council of Ministers is necessary. In Yugoslavia and 

Romania,authorities seek primarily industrial joint ventures engaged in 

sophisticated production processes using forms of superior technology. To date, joint ventures in Hungary are concentrated in services, 

trade, or assembly of kits. 

C. Taxation of Joint Ventures. 

1. The Determination of Gross Income, Net Income, and Profits. 

Decree No. 28 of 1972, issued in accordance with section 31 of LawDecree 19 of 1970, defines the financial conditions of establishing, 

functioning, and terminating joint ventures. In accordance with 

Hungarian financial law, joint ventures are considered to be Hungarian 

enterprises; to a large extent the rules and procedures governing their 

money circulation, order of accounting, formation of funds, definition 

of profits, and taxation are the same as those governing local enterprises. Related questions may be regulated in the contract. 
- 24 -

Gross income is defined in Hungarian book-keeping as the value of 

all goods and services sold in the internal and international operations, 

The gross book-keeping profit (net income) is the difference between 

gross income and the aggregate of the fixed and variable costs of the 

joint venture. 

The measure of profitability is often used in Hungary to establish 

the success of business enterprises. If gross income is Y and gross 

profits is S, then profitability P is measured by the ratio: P = S/Y. 

For Hungarian enterprises, the gross book-keeping profit is increased by the increment of the wage fund, but joint ventures are exempt 

from wage increment levies. The gross book-keeping profit is diminished 

by depreciation deductions and by the sums set aside for the risk fund. 

The rate of contribution to the risk fund should be outlined in the contract of the association; the fund is increased until it equals 10 percent 

of the capital of the association. After deduction of the risk fund, 

the association may create a so-called employee's participation fund out 

of gross profits. However, the amount of this fund shall not exceed 

15 percent of total wages and salaries. 

The regulations do not prescribe any further mandatory formation 

of additional reserves or funds, and the remainder of the gross profits 

represents the so-called profit-sharing funds (net profits subject to 

taxation). 

2. Tax Rates and Tax Holidays. The profit-sharing fund, 

which can be considered as net profits, is taxed at 40 percent or 60 

percent--40 percent if the rate of profit (measured as the ratio of gross 
- 25 -

bookkeeping profit to the association's net assets) is 20 percent or less 

and 60 percent if the profit ratio is over 20 percent. The tax paid on 

profits reinvested in the joint venture may be refunded on special application to the Ministry of Finance; the rules on this are not clear, 

however, and should be clarified in the contract. 

There are also social security contributions for which the employer's 

share is about 17 percent of the wage bill and an 8 percent payroll tax. 

There do not seem to be any tax holiday exemptions from profits 

tax. 

The after tax balance is divided according to the equity participation of the investors. The foreign investor's share may be remitted 

abroad without any withholding tax. 

In the case of Hungarian firms the profit-sharing fund after taxes 

is often augmented by grants from ministrjes (such as contributions to 

low-cost meals provided for personnel, allowances granted to workers 

going through personal difficulties, subsidies to cover expenditures on 

day nurseries and other child-care services); premiums granted to enterprises which have achieved particularly impressive records; and special 

tax incentives to exporters. 

When discussing the contract with the Hungarian firm and authorities, 

the question of possible miscellaneous contributions to the profitsharing fund from outside sources based on the principle of equal treatment can be raised. This is particularly important with respect to the 

tax preferences on profit from export activities. These preferences
- 26 -

extended to 158 enterprises in 1972, and yielded a reduction of about 

10 percent in the total profit taxes of those enterprises. The preference amounts to 2.7 forints per export dollar earned.- 14I 

Joint ventures in Hungary can probably expect better conditions 

for their international operations in the near future. Hungary has 

applied for GATT membership, and this would involve a significant reduction of domestic tariffs. 

3. Avoidance of Double Taxation. There is a possibility that 

some problems of taxation will be alleviated by tax treaties subject to 

the principle of reciprocity. According to Section 11 of Decree No. 28 

of 1972 of the Minister of Finance, "while implementing international 

agreements on double taxation, the standpoint of the Minister of Finance 

is decisive in the question of reciprocity." Hungary has some such 

agreements concluded prior to 1950, with Austria (Act XL of 1925), 

Italy (Act XXIV of 1928), Sweden (Act XXV of 1937), the Netherlands 

(Act V of 1940), and Switzerland (Act VI of 1949). A new treaty with 

Austria is under discussion. 

D. Financial Operation. The hard currency of the joint enterprise 

should be recomputed to local currency at the exchange rate or exchange 

coefficient agreed upon by the representatives of the foreign company 

and the officials of the host country. This should be subject to readjustments, and disputes should be settled by arbitration before an international forum, such as the Chamber of Commerce in Zurich. Hungarians, 

until now, have always accepted the position of the International Chamber 

of Commerce on disagreements between the partners. 
- 27 -

VII. THE CASE OF BULGARIA 

A. General. Bulgaria's aim is to bring her economy more and more 

in line with the Soviet pattern, and her state plans are formulated 

according to the philosophy of cooperation with the Soviet Union. The 

Soviet Union is reluctant to allow on her soil equity-type joint ventures between domestic enterprises and Western corporations, and this 

stand is also taken by Bulgaria. 

Bulgaria's per capita GNP is the lowest among the European socialist 

nations, but it is growing fast. Yearly increases, measured in real 

terms, are around 9 per cent, and are greatest in the industrial sector. 

An area of disappointment for Bulgarian planners is agriculture. Labor 

shortages and out-of-date equipment in the agricultural sector are 

responsible for poor performance. This explains the interest of Bulgarian 

policy-makers in technologically sophisticated Western agricultural 

machinery, Other interests are mainly telecommunication equipment, pharmaceuticals, non-electrical machinery, and mechanical appliances. Lately, 

Bulgaria is interested in obtaining electronic, oil extraction, and 

ship-building equipment. 

Bulgaria's recently signed free trade agreement with Finland, 

eliminating trade barriers between the two countries, is reportedly the 

first of its kind between a centrally-planned and a price-directed economy. 

A barrier to U.S. and Bulgarian trade is Bulgaria's inability to receive 

U.S. Government credits until an agreement has been reached on defaulted 

bonds issued by the Kingdom of Bulgaria and presently held by U.S. 

citizens. 
- 28 -

Bulgaria is interested in foreign cooperation on "turnkey" projects. 

Such a project might involve a Western firm supplying, for example, a 

tractor plant, which it turns over to Bulgarian authorities ready for 

operation. Purchase of the plant and equipment may be backed by government-guaranteed Western credit, and the Western firm may agree under a 

long-term marketing agreement to purchase tractors, engines, or parts 

from the completed Bulgarian firm, paying in hard currency which the 

Bulgarian firm uses to pay for the plant, plus interest. 

At the end of 1974, the Bulgarian government adopted new legislation 

on "economic, industrial and technical cooperation with foreign juridical 

and physical persons." This legislation does not permit direct Western 

equity investment in the Bulgarian economy, but it has established the 

conditions for Western companies wishing to invest in the Bulgarian economy. It is sometimes claimed that this legislation, in practical terms, 

allows Western corporations to draw benefits similar to those of the joint 

ventures. 

B, Wgulations on Foreign Economic Cooperation. On June 12, 1974, 

the Bulgarian State Council issued a brief decree, No. 1196, on economic, 

production, and technological cooperation with foreign firms and individuals 

(Darzhaven Vestnik, No. 46, June 14, 1974), which specified that the 

Council of Ministers should issue detailed regulations on its implementation. 

These regulations have now been published (Darzhaven Vestnik, No. 73, 

September 20, 1974), and give a clearer idea of the range of joint activities envisaged within the framework of expanding economic relations. The 
- 29 -

decree begins by stating that "economic, production, and technological 

cooperation between Bulgarian economic organizations and foreign firms 

and individuals is being encouraged." To this end, "favorable planning, 

financial credit, customs, and other conditions are being created," and 

fulfillment of the obligations assumed by Bulgarian enterprises is 

guaranteed. 

Both the decree and the regulations state that a foreign firm or 

individual, by sending specialists, may participate in measures undertaken 

by a Bulgarian economic organization to increase labor productivity, 

improve organization of production, introduce new technologies, or sell 

its products on the international market. 

C. Summary. Bulgarian joint ventures are limited and intended 

primarily to help Bulgarian firms export their products, through technical 

assistance or "turnkey" projects for which she usually compensates the 

Western firm with actual produce. 

Ukaz No. 85 of August 31, 1974, by virtue of an unfinished sentence, 

seems to suggest that provision might be made in the future for establishment of corporate joint ventures producing on Bulgarian soil, but this 

seems unlikely until the time that such ventures are established in the USSR. 

One cannot expect Bulgarian policy-makers to follow the Romanian or 

Hungarian patterns. 

With respect to corporation income, Bulgarian taxes follow the Soviet 

model strictly, and no taxes are levied at present on the income of 

foreign enterprise operating cooperatively in Bulgaria. 
- 30 -

VIII. THE CASE OF CZECHOSLOVAKIA 

A. General. Before the August 1968 invasion of Czechoslovakia by 

the Soviet Union, the policy of the Czechoslovak government, as described 

by the economic architect of the Prague Spring, was "to take advantage 

of offers to cooperate with Western firms in order to modernize plants 

and to introduce new and more effective production and, in addition, with 

the help of the Western partner, to penetrate markets that our country 

has abandoned on its own accord or that have been closed to us over the 

1115/ past twenty years. -

After the Soviet invasion, the goal of the country can be summarized 

as the "full restoration of the socialist character of the society and 

economy. This means, as various symposia have demonstrated,g' that the 

key problem is the question of socialist ownership and its defense "against 

bourgeois ideologists and revisionists." 

In this atmosphere, complicated by other international problems such 

as the question'ofCzechoslovak gold reserves held by the United States, 

it is highly unlikely that joint ventures in Czechoslovakia can be established with Western firms. Yet, the country has a serious handicap in 

the investment sector which has existed for a number of years and which 

the Finance Minister calls "our Achilles heel"..z/ Czechoslovakia is 

deeply in need of Western investments. A new "Law on Procedures for the 

Concluding of Agreements on Economic Cooperation with Countries Abroad" 

(No. 85/1972, published in Sbirka Zakonu) was promulgated. However, in 

spite of its promising title, it seems designed to restrict cooperation 

with the West and favors autarky in the field of technological development. 
- 31 -

B. Summary of Western Cooperation with Czechoslovakia. "Doing 

business with Czechoslovakia" is extremely difficult for Western firms, 

although relations with the industrialized countries and even the problems of joint ventures are occasionally discussed in Czechoslovakia.-181 

Czechoslovakia will probably be the last country in the Soviet bloc to 

permit joint ventures on her soil. 

The reasons for this are political. Czechoslovak leaders are now 

eager to prove that their country is not "Western-oriented"; they are 

sensitive to such criticism since, among the European socialist states, 

Czechoslovakia has the most sophisticated labor force, the most developed 

economy, and the most internationally oriented population (the German 

Democratic Republic notwithstanding). 
- 32 -

IX. CONCLUSION 

The only socialist countries which have issued legislation or decrees 

to allow equity-style joint business ventures with Western companies on 

their soil are Yugoslavia, Romania, and Hungary. The remainder of the 

European socialist states, which with the exception of Albania are part 

of the Soviet bloc, follow the example of the USSR, which does not 

recognize Western capital investments in her economy. 

The following outline summarizes the regulations related directly 

or indirectly to taxation: 

A. Accounting Procedures 

1. Yugoslavia. 

a. Joint ventures in Yugoslavia are based on the concept of 

I1free contractual regulations"; therefore, all accounting 

rules should be included in the contract. 

b. The Yugoslav partner is required to maintain separate 

accounts. 

c. The calendar year is taken as the time unit reflected 

in the balance sheet, 

2. Romania. 

a. The accounting system should be outlined in the contract. 

b. Romanian personnel are paid in domestic currency, and 

this should be purchased on the basis of a separately 

determined exchange rate from the Romanian National Bank. 

C. All hard currency payments of the joint business venture 

must be generated from funds of the business venture or 

financed by loans coming from abroad. 
- 33 -

3. Hungary. 

a. 

b. 

C. 

d. 

The accounting system should be outlined in the contract 

and approved by the Ministry of Finance. 

A "risk fund" should be set aside in accordance with the 

contract of the joint venture; annual losses can be charged 

against this fund. 

Operations which use foreign currencies and raise credits 

are guided by the same rules as domestic organizations. 

Wages and contracts with local personnel should be in 

accordance with Hungarian statutory rules and approved 

by the Ministry of Finance. 

B. Business Taxes. 

1. Yugoslavia. 

a. The domestic partner is obligated to pay the tax and the 

foreign investor should provide his share which is ordinarily 35 percent of profits, but is reduced on reinvested 

prof its. 

b. There is a variation in the rate of taxation between 

Republics; in the undeveloped parts of the country the 

rates are considerably lower. 

C. If the Western partner keeps at least 20 percent of his 

profit in a local bank, he may be exempted from tax on 

interest earned on these deposits. 

d. Royalty income is taxed at graduated rates of 10 to 25 

percent on net royalties. 
- 34 -

e. Personal service income taxes, including social security 

taxes, may be as high as 70 percent. 

2. Romania. 

a. Romania taxes the joint venture's annual profits at a 

rate of 30 percent. 

b. An additional 10 percent withholding tax is levied on 

distributions to nonresidents. 

c. If profits are reinvested for a period of five years, 

then profit taxes are reduced from 30 to 24 percent, 

d. Tax exemptions may be granted from the Council of Ministers 

for the first year and tax reductions (up to 50 percent) 

for the following two years. 

3. Hungary. 

a. Profit taxes are imposed at 40 percent or 60 percent, 

The rate is 40 percent if the profits are up to 20 

percent of the net assets and 60 percent if the profits 

exceed 20 percent of net assets. 

b. If profits are reinvested, the taxes on those profits may 

be reimbursed. 

c. Pension contributions and social security payments are 

the same as for domestic firms, 17 percent. 

C, Transfers . 1. Yugoslavia. 

a. The foreign partner is free to transfer his share of net 

profits abroad, provided that the enterprise has the 

foreign exchange at its disposal. 
- 35 -

b. The foreign partner is permitted, under some circumstances, 

to withdraw all or part of his investment. 

c. The source for foreign currency for repatriation is the 

retention quota, which is 20 percent of export proceeds 

for all industries and 45 percent of revenue generated 

from tourism. In addition, an allowance of convertible currency allocated to joint ventures amounts to 33 percent 

of its export proceeds. For remittance of investment, these 

sources are amended by an annual allowance of 5 percent 

of depreciation. 

2. Romania. 

a. The foreign partner is free to transfer his share of net 

profits abroad from the enterprise foreign exchange fund. 

b. Such transferred profits are subjected to a 10 percent 

dividend withholding tax, (Interest payments abroad are 

taxed 15 percent and royalties 20 percent; however, these 

rates are reduced in some cases by the United StatesRomania income tax treaty.) 

C. The portion of the profit which goes to the reserve fund 

cannot be transferred abroad. 

3. Hungary. 

a. Net profits are transferable, and capital repatriation in 

convertible currency, after payment of taxes, is secured. 

b. The foreign partner can withdraw tax-free his share of the 

association in accordance with the rules stipulated in the 

contract of the association. 
- 36 -

c. Foreign personnel are limited to transferring abroad 

50 percent of wages or salaries. 

D. The Future. The practical implication of this study is that, 

if a long-run investment is considered in the Socialist countries, then 

Western investors should seek stable concessions, such as adequate 

depreciation deductions, in their contracts. Business contracts in 

these countries are still flexible and special concessions can be achieved 

by quid pro quo bargaining. 

Equity-style business ventures are welcome in Romania and Hungary 

and may have prospects in Yugoslavia, but positive prospects for the 

same type of establishment in the command economies of the Soviet bloc 

may be overestimated. The non-equity type of association, which totally 

excludes the foreigner from direct ownership in the business association, 

is regarded by the majority of the Soviet-bloc countries as the most 

proper form of association with developed Western industrial countries, 
- 37 -

FOOTNOTES 

Thanks are due to the many persons and colleagues who participated 

to make this study possible. I am grateful also to the Office of Tax 

Analysis, U.S. Department of Treasury, for enabling me to undertake this 

venture and especially to Gary C. Hufbauer from the International Tax 

Staff of the Treasury for his patience, help and encouragement. 

I bear the sole responsibility for the views expressed. 

L/Vide, - for a description, "Melting Snowflakes", Economist, Vol. 235,

December 28, 1974, pp. 42. 

2/With respect to travel regulations, the centrally-planned COMECON 

countries exclude Yugoslavia from the socialist countries. 

/Official Gazette, No. 31/1967. The Federal Assembly of the

Socialist Federal Republic of Yugoslavia, July 1967. 

"Yugoslavia opens her door to Western 

monopolistic capital and subjects the Yugoslav economy to enslavement along

with twofold increase of exploitation of domestic workers." 

k/Radio Tirana broadcast: 

Radio Free 

Europe monitoring Radio Tirana on October 4, 1968, 3:30 p.m. 

?/The Grand National Assembly of the Socialist Republic of Romania 

passed a bill (Bill No. 1, Official Bulletin, March 17, 1971) on Foreign

Trade and Economic and Technico-Scientific Cooperation Activities. A 

subsequent bill dealing with questions of fiscal regulations and distribution of profits was passed by the State Council (Decree No. 425 on Tax 

and Profits of Joint Companies Constituted in the Socialist Republic of 

Romania, Official Bulletin, November 2, 1972). 

&/The Minister of Finance, Lajos Faluvggi, issued a decree on Economic 

Associations with Foreign Partners: Decree No. 28/1972, Official Gazette 

of the People's Republic of Hungary, No. 76, October 3, 1972. See also 

International Legal Materials (4) 989, (1973). 

LIThe Hungarian decree speaks about "the foreign partner's share" 

in paragraph 11/41; the Romanian decree speaks about the "share of the 

parties" in several places. 

8/Such proposals in the zones of Beograd, Rijeka, and Koper have 

been backed by the Assemblies of S.R. Croatia and S.R. Slovenia. They 

are still pending. 

Z'Law of Formation and Computation of Total Receipts and Income in 

the Basic Organizations of Associate Work, published in the Official 

Gazette of the SFR of Yugoslavia, No. 71/72, pp. 1427. 
- 38 -

E'Legal reservations affecting income include contributions for 

the use of urban ground; water rate; turnover tax; contribution for 

mandatory joint reserves of economic organizations paid to the commune 

or republic within which the enterprise is located. 

s/Contractual reservations affecting income include loan and 

interest payments; insurance premiums; bankers' commissions; membership 

fees to chambers, associations, etc. 

g/Vide, - A Law on Income Tax of the Organizations of Associated

Work, The Official Monitor of the S.R. of Serbia, No. 4/73, pp. 83; 

The Official Gazette of the S.R. Bosnia-Herzegovina, No. 36/72, pp. 1057, 

Z'Edward A. Hewett, "The Economics of East European Technology 

Imports from the West", The American Economic Review (May 1975), pp. 377-82; 

Paul Marer, Hungary's Industrial Cooperation with the West: Achievements, 

Problems and Perspectives (October 1975), prepared for the U.S. Chamber 

of Comerce. 3'1. Orszagh, "Analysis of the Operation of the Profit Tax 

Preferential Export Incentive System", Kylgazdasag, 17$1973, No. 11 

pp. 813-24. 

2'0ta Sik, Czechoslovakia : The Bureaucratic Economy (Vienna 1973) . pp. 1112. 

Id/Symposium an Socialist Ownership (Prague, October 17, 1974) 

l-//Rudolf Rohlicek, "The Investment Sector : Our Achilles Heel", 

Pravda (Bratislava, May 4, 1973). 

-18'1cEconomic Cooperation is the Great Interest to our Economy", 

Hospodardke Novlny (Economic Weekly), October 15, 1974. 
- 39 -

A LIST OF YUGOSLAV STATUTES 

RELEVANT TO TAXATION 

A. Income 

The Law on the Establishment and Computation of Total Receipts and Income 

in the Basic Organizations of Associated Work (Official Gazette 

of the SFRY No. 71/72). 

B. Taxation 

The Law on Profit Tax Payable by Foreign Persons Investing in a Domestic 

Economic Organization for Running Business in Common (Official 

Gazette of the SFRY Nos. 31/67 and 9/68). 

The Law on Profit Tax Concessions Favoring Foreign Persons Investing in a 

Domestic Organization for Running Business in Common (Official Gazette 

of the SR of Montenegro No. 23/69). 

The Law on Profit Tax Concessions Favoring Foreign Persons Investing in a 

Domestic Organization for Running Business in Common (Official Gazette 

of the SR of Macedonia No. 42/71). 

The Law Supplementing the Law on the Establishment of Interest Rates on 

the Funds in the Economy (Official Gazette of the SFRY No. 31/67). 

The Law Supplementing the Basic Law on the Contributions and Taxes 

Payable by Citizens (Official Gazette of the SFRY No. 31/67). 

The Decision Concerning Special Contributions, Income, Auditing and Profit 

Taxes Payable by the Foreign Contractors of Investments Works in 

Yugoslavia (Official Gazette of the SFRY No. 15/67). 

C. Bookkeeping and Auditinq 

The Law on the Bookkeeping in the Work Organizations (Official Gazette 

of the SFRY No. 48/68 and 56/69). 

The Law on the Revaluation of the Assets of the Organizations of Associated 

Work (Official Gazette of the SJ?RY No. 50/71). 

Directive on How to Materialize Revaluation of the Assets of the Organizations of Associated Work and to Report for the Sake of Social 

Records (Official Gazette of the SFRY No. 51/71).