Chapter 6. Investment promotion and facilitation in Croatia
This chapter provides an assessment of the evolving investment promotion and facilitation framework in Croatia. It discusses existing strategies and institutions governing investment promotion and facilitation as well as provides an overview of the use of investment incentives and special economic zones. It also highlights key reforms and remaining challenges to improve the business environment, including by streamlining administrative procedures.
As highlighted in the OECD Policy Framework for Investment, investment promotion and facilitation can be powerful means to attract investment and maximise its contribution to development, but their success depends on their design and progress in improving the quality of the overall investment climate. As such, countries worldwide decide to not only remove restrictions on foreign direct investment and provide high standards of protection to investors, discussed in earlier chapters, but also to proactively promote and facilitate investment, or certain types of investment, to maximise potential benefits to the host economy. Considering that Croatia has removed most formal barriers to FDI as shown in Chapter 4, the country could benefit from active investment promotion and facilitation policies to attempt to attract and retain investment and assist its strive towards more diversification and innovation.
As will be discussed in this chapter, Croatia has made important progress in several aspects of investment climate. Existing business polls suggest that, overall, investors assess favourably the general business climate conditions in the country. For example, according to a recent survey of foreign and domestic investors in Croatia undertaken by the American Chamber of Commerce in Croatia, 65% consider that the investment climate in the country improved in 2017 and nearly half believe that it has done so over the past five years.1 In addition, even despite political stability in recent years, there have been no large-scale divestments in the country. Still, unstable regulatory framework, long and complex administrative procedures, tax-related issues, together with a lack of long-term vision of the government, are highlighted as one of the greatest remaining challenges for doing business in Croatia by foreign and domestic business as well as international observers alike (e.g. Foreign Investor Council, 2017, Croatian Employers’ Association, 2016, European Commission, 2016-2018, PWC, 2015). These aspects are quoted to be as important of an obstacle to doing business in Croatia as the small size of the local economy.2
Against this background, the chapter provides an overview of the current approach to investment promotion and facilitation in Croatia and remaining challenges, evaluating in particular the overall institutional set-up and a strategy for investment promotion and facilitation as well as recent progress in the administrative simplification, the tax reform and the use of incentives for investment.
National strategy and the institutional set-up
Croatia has elements of national strategy for FDI attraction
The legal framework for investment promotion and facilitation in Croatia is governed primarily by the Act on Investment Promotion of 2015 as well as the Act on Strategic Investment Projects of 2013 that lay out the conditions and criteria for government’s support for investment projects (see Box 6.1). The Act on Investment Promotion sets the goals of Croatia’s investment and facilitation promotion policy, lists specific activities that can benefit from the state’s support as well as outlines the type of support available and the applicable requirement (see Box 6.1). It also specifies that investments need to relate to manufacturing and processing, development and innovation, business support activities and high value-added services to be eligible (Article 5), on top of satisfying other conditions relating to job creation, introduction of new equipment or contribution to regional development, among others.3
The Act on Strategic investment Projects serves a complementary role to the Act on Investment Promotion, defining what constitutes a “strategic investment project” in Croatia as well as providing information on the applicable selection criteria and procedures and the associated benefits. The main goal of the law is a provision of more expeditious administrative proceedings for strategic projects while the overall investment climate in the country gradually improves4 The law, first passed in 2015, was amended in March 2018, altering among others the threshold size of an investment that can qualify.5 It also explains the conditions of the disposal of state-owned assets, granting concessions and issuance of administrative permits. It applies to private, public and private-public investment alike. Most recently, in December 2018, both acts were amended, to reflect the abolishment of the Agency for Investment and Competitiveness (AIK), effective as of 1 January 2019, and the allocation of its responsibilities to the Ministry of Economy, Entrepreneurship and Crafts, discussed in more detail in the next section.
Other government documents also stress the importance of FDI attraction, in particular greenfield and export-oriented FDI, and outline different planned steps to ease the burdens on business and help promote and facilitate investment.6 For example, the Croatian Government Programme (2016-2020) underlines the government’s commitment to more effective investment attraction and further business climate improvements, for example through administrative simplification and tax reform. The Programme as well as the National Reform Programme 2017 and the Action Plan for Administrative Burden Reduction 2017 also outline different elements of planned business climate reforms and Croatia’s investment promotion and facilitation policy. Finally, at the time of writing this Review Croatia was developing a new National Development Strategy 2020-2030 that could provide a further building block in clarifying the role of FDI in the country’s economic development.7
The overall goals of investment promotion and facilitation in Croatia are set out by the Act on Investment Promotion (AIP) and the Act on Strategic Investment Projects (ASIP), the latter having been amended in March 2018. Specifically, AIP, sets outs the overall goal if investment promotion in Croatia in Article 4 and outlines the conditions under which investment can benefit from state support (in Article 5 and subsequent text):
Article 4
“(1) The objective, i.e. the purpose of investment promotion is promotion of the economic growth and fulfilling of the economic policy of the Republic of Croatia, the country’s integration in international trade and strengthening investment capability and competitiveness of Croatian enterprise.
(2) At the level of economic operators the objective and purpose of investment promotion is to build internationally competitive, transparent and attractive system of the aid to investments by legal or natural persons registered in the Republic of Croatia, who are profit tax payers engaged in an economic activity, participating in the trading of goods and services in the Republic of Croatia.
Article 5
(1) Investment promotion within the meaning of this Act constitutes a system of the aid to investments and the aid for timely performance of the necessary investment activities. It determines the method and time limits for completing all the necessary investment activities, aimed at a successful performance of the investment project in a fixed term, in the territory of the Republic of Croatia.
(2) The aid regulated by this Act pertains to investment projects and to fostering competitiveness in:
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manufacturing and processing activities
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development and innovation activities
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business support activities
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high value-added services.
(3) The aid regulated by this Act shall cover the projects referred to in paragraph 2 of this Article, which ensure environmentally friendly business activity and one or more of the following objectives:
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introduction of new equipment and modern technologies
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higher rate of employment and level of training the employees
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development of high value-added products and services
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increase in entrepreneurial competitiveness
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uniform regional development of the Republic of Croatia.”
Meanwhile, the Act on Strategic Investment Projects defines what constitutes a “strategic investment project” (in Article 5) and the criteria that need to be fulfilled.8 Namely, as per Article 5 of the Act, the project needs to take place in one of the listed activities (production and processing, development and innovation, business support activities, high value-added services, energy, infrastructure, agriculture or fisheries), complies with physical planning documents and satisfies one of the minimum capital investment thresholds, depending on their character. The Act on Strategic Investments was amended in March 2018, among others lowering the applicable thresholds and easing the financing requirements; as well as in December 2018, through the Act on cessation of the Act on the establishment of the Agency for Investment and Competitiveness, which abolished AIK and attributed the tasks performed by it to the Ministry of Economy, Entrepreneurship and Crafts, as discussed later.9
The specific steps required during the application process under either of the Acts are listed on the websites of HAMAG BICRO (www.investcroatia.hr) and the Agency for Investments and Competitiveness, AIK (www.aik-invest.hr).
Source: Act on Investment Promotion of 18 September 2015 and Act on Strategic Investments of 25 October 2013 (as amended in March and December 2018)
Various stakeholders consulted in the course of this Review, including government authorities, business and international organisations, stressed the need for a more comprehensive long-term strategy for investment promotion and facilitation in Croatia. They argued that the current policy framework is still largely confined to the provision of incentives and allocation of EU funds, governed by the Acts on Investment Promotion and Strategic Investment Projects. They added that the lack of a more comprehensive vision leads to disjointed actions and separate strategies across different Ministries and local bodies. Meanwhile, remaining investment climate issues, highlighted by investors and discussed in later sections of this chapter, pertain to a broad set of regulatory and administrative measures and require a coordinated whole-of-the-government approach. As such, it is not surprising that nearly half of respondents in the 2018 AmCham business survey (AmCham, 2018) identifies the lack of long-term government vision as a serious obstacle to doing business in Croatia. The Foreign Investors Council, a business association that bring together international companies that do business in Croatia, has also long been advocating a comprehensive, long-term vision going beyond the current policy elements.10 As such, the on-going elaboration of Croatia’s National Development Strategy until 2030 could serve as a building block in clarifying the role of private investment in the country’s economic development.
The institutional framework for investment promotion and facilitation is evolving
Besides the lack of a clear national strategy for investment attraction to-date, Croatia also has an evolving institutional set-up for investment promotion and facilitation. While it appears that some of the recent reforms have been motivated by the desire to streamline the activities of the agencies active in the field, it remains to be seen whether they can achieve intended results. For example, while the Ministry of Economy, Entrepreneurship and Crafts is in charge of outlining broad strategic orientations of such a policy, until very recently, according to the Act of Investment Promotion, two national-level investment promotion agencies (IPAs) were responsible for implementing this policy at the national level– the Agency for Investments and Competitiveness (AIK, Agencija za investicije i konkurentnost, see Box 6.2) and the Croatian Agency for Small and Medium-sized Enterprises, Innovations and Investments (HAMAG-BICRO, see Box 6.3). Other agencies at both central and sub-national level are involved in investment promotion and facilitation. For example, the Croatian Bank for Reconstruction and Development (HBOR) also provides financial support for firms, in particular to support reconstruction and development of Croatian economy, exports growth, infrastructure development, environmental protection as well as provision of export insurance for firms. Both HBOR and HAMAG BICRO manage and disburse EU Structural Funds that can support domestic business development. Until recently, there also existed separate agencies responsible for investment attraction into certain sectors, although some were recently abolished (e.g. the Centre for Monitoring Business Activities in the Energy Sector).11 Finally, several actors at the sub-national level are also involved in investment promotion and facilitation in Croatia.12
AIK was established in 2012 and organised as an autonomous public agency, reporting to the Ministry of Economy, Entrepreneurship and Crafts (MEEC), until its abolishment as of 1 January 2019. It has undergone three significant institutional reforms in the course of its lifespan, including a merger with the public-private partnership (PPP) unit in 2015. According to its staff, the agency has also been subject to previous threats of dismantling, which resulted in some staff leaving the organisation at different points of time (in general, the turnover of staff has been high, reaching on average nearly 50% in the last five years). According the to the cessation act, after the agency’s abolishment, all its staff and functions are taken over by MEEC (Article 4) and a follow-up regulation is going to clarify the structure of a new department in the Ministry.
In the past, AIK used to be publically financed with all the resources coming from MEEC, which is a common arrangement among OECD IPAs (on average, 98% of IPAs’ investment promotion budgets come from the state). AIK used to also have a Board of Directors, which is the case in over two thirds of OECD IPAs; yet, its Board, was composed entirely of public sector representatives and chaired by MEEC. The OECD IPAs often use Boards as means of bringing in outside expertise and oversight (as such an average OECD IPA Board has 38% private sector participation). In that sense, the lack of private sector participation in the Board and a full reliance on MEEC for financial resources made AIK in its previous form already heavily dependent on the Ministry.
AIK also used to have limited financial resources compared to OECD IPAs. While a median OECD IPA had a total budget of EUR 11 million and an FDI promotion budget of EUR 4.6 million in 2016, AIK’s total budget was EUR 1.58 million and EUR 0.9 million for FDI promotion that year. Moreover, while AIK’s total budget has increased since its establishment in 2012, the financial resources devoted to FDI promotion appear to have stayed constant, according to the agency’s responses to the survey. Meanwhile, the size of IPA’s budget is found to be associated with higher total inward FDI stock per capita and the number of foreign affiliates established in the country, conditional on the countries’ size and level of development (Volpe Martincus and Sztajerowska, forthcoming). It remains yet to be seen if the absorption of AIK into the Ministry may be associated with a larger, or more stable, budget.
Likely as a result of limited financial resources, AIK did not have certain elements typical of IPAs in other OECD countries. For example, while a customer management relationship (CRM) system is used by 94% of OECD IPAs, and it is considered a critical tool for gathering information about and interacting with clients as well as managing resource and staff in the IPA world, AIK reported not have such a system (even if it had an internal programme allowing tracking of every investment and enquiry as well as assistance provided, according to its staff). Also, the agency had no foreign offices abroad while an average OECD IPA has 34 foreign offices (19 of which undertake investment promotion functions). This may have limited its ability to generate prospective investment leads and maximise the number of realised investments, in particular in sectors where Croatia is not a well-known location. Similarly, while almost three quarters of OECD IPAs staff have experience in the private sector, 42% of AIK’s staff had such a profile. Finally, many activities usually performed by IPAs, in particular in investment facilitation and policy advocacy, were not undertaken by AIK (see Figure 6.4).
As discussed later in this chapter, if AIK’s integration into the Ministry translates into easier access to resources and policy-makers, it might help broaden the portfolio of services offered by former AIK and bolster its operations. Yet, it also involves a number of risks, related to potential disruption, loss of autonomy and brain drain, among others, that, if not managed appropriately, can have detrimental effects.
Source: OECD-IDB Survey of Investment Promotion Agencies
Until end 2018, the formal division of labour between HAMAG-BICRO and AIK was based on the size of firms assisted: while HAMAG-BICRO was expected to focus on SMEs, AIK was responsible for servicing large firms In addition, AIK also serviced firms that wished to be considered for strategic investment projects, either of private or public-private in nature13, and managed private-public partnerships in Croatia. Besides that division by a type of clients, the official objectives of both institutions were the same: to promote Croatia as a desirable investment destination, proactively attract and assist in implementation of investment projects and facilitate development of the Croatian economy. Even if AIK staff’s considers that AIK was the national IPA in a traditional sense, de iure competencies were divided among both agencies, according to the Act on Investment Promotion, and they both provided similar information and services to investors. Such an institutional solution was atypical and not found elsewhere among the 32 OECD countries that participated in the OECD-Inter American Development Bank (IDB) Survey of Investment Promotion Agencies (Box 6.3), none of which reported to have more than one national IPA (OECD, 2018a).
Croatian Agency for SMEs, Innovations and Investments (HAMAG-BICRO) was founded with the aim of supporting the development of small and medium-sized enterprises, improving the innovation process and encouraging investments. It was created in 2014 through a merger of the Croatian Agency for Small Businesses and Investments (HAMAG INVEST) and the Business Innovation Agency of the Republic of Croatia (BICRO). The Agency’s activities include the promotion of establishment and development of small business entities, financing operation and development of small business entities by loans and guarantees issuing for approved loans by creditors as well as promotion of investments in small business. The Agency is an independent institution under the supervision of the Ministry of Economy, Entrepreneurship and Crafts. Agency services for investors are:
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Distributing information about the advantages of the investment environment in Croatia
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Providing information about investment opportunities in Croatia
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Providing support to foreign investors regarding their investment activities
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Providing foreign investors with information about legislation, incentives, locations and potential suppliers
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Providing assistance with applications for investment incentives
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Facilitating communication between foreign investors and national and local authorities
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Aftercare services for foreign investors already operating in Croatia
In order to create better conditions for investments in 20 counties One Stop service centres were created as part of the EU funded project “ICPR – Development of Investment Climate”. The role of One Stop service centres is to provide all the necessary information at one place to potential investors and support them while obtaining necessary permits. The One Stop service centre initiative includes all relevant institutions at the county level—the main coordinator at the county level is the regional development agency.
The following information is available on the Web site of the regional development agencies:
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business zones available in the county
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potential partners and suppliers in a given county
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traditional sectors in the county
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as well as services provided by the county to investors
Source: Government of Croatia
In this context, as part of a wider government reform aiming to streamline central state bodies14, the Agency for Investments and Competitiveness (AIK) was abolished, effective as of 1 January 2019.15 According to the Law on Cessation of the Law on the Establishment of the Agency for Investments and Competitiveness, all the agency’s responsibilities and staff were absorbed by the Ministry of Economy, Entrepreneurship, and Crafts and all services earlier provided by AIK are going to be provided by the Ministry.16 A separate regulation is to outline the new organisation of the Ministry and the structure of the new department, and provide further information on its functioning.17
It is yet unclear how this institutional arrangement will impact the level of coordination of investment promotion and facilitation activities in Croatia, or specific services provided to investors. According to the act that has abolished the agency, and as confirmed by the government,18 all activities and functions of AIK are planned to be absorbed by the Ministry and the other bodies active on investment promotion are expected to function as before. The government also highlights that the absorption of the agency into the Ministry of Economy, Entrepreneurship, and Crafts can give it more political clout, and facilitate its investment facilitation and policy-advocacy functions. Yet, at this stage, it is an open question if the reform can lead to streamlining of investment promotion and facilitation activities at the central government level in Croatia, and whether it will result in an improvement, or a deterioration, in the overall investors’ experience. At the sub-national level, the coordination of different efforts to attract and facilitate investment is also an on-going challenge, and will need to be further addressed by the government as complementary measure to the arrangement at the central level.
The recent reform could be used to rethink Croatia’s investment promotion and facilitation
In Croatia, the abolishment of AIK appears to have been motivated by reasons other than improving the quality of the institutional set-up for investment promotion, i.e. centralisation of state bodies.19 Still, the authorities should attempt to use it as an opportunity to rethink the institutional set up for investment promotion and facilitation. In general, governments routinely create new or reform old IPAs in search of the right institutional and organisational set-up (Figure 6.1). On average, each IPA has been reformed at least once in the past ten years (Volpe Martincus and Sztajerowska, forthcoming). Reforms often involve modifications to the organisational structure but also changes in the legal status, a reporting ministry and composition of mandates, including via mergers and demergers with other bodies. Given the frequency of changes, governments need to ensure that they have clearly identified strategic objectives behind the reforms and learn from the past performance to ensure tangible improvements.
In this context, as part of its reflection on future activities and structure of the new department in charge of investment promotion and facilitation in MEEC, the Ministry could learn from AIK’s experience to identify which changes can help improve the portfolio of services offered, which practices should be retained, and what risks may need to be managed during transition. To assist in that process, the following section thus presents results of the benchmarking of AIK to 32 OECD IPAs as part of the OECD-IDB Survey of Investment Promotion Agencies (see Box 6.4), focusing on key strategic factors relevant to the on-going reform, pertaining mostly to the choice of functions, prioritisation strategy, services offered to firms, and the allocation of financial resources to the responsible body.20
Source: OECD-IDB Survey of Investment Promotion Agencies (2017)
The main goal of an IPA is inward FDI attraction but IPAs often undertake other functions as well (an average IPA in OECD performs 5.7 different functions). Overall, IPAs of larger countries and advanced economies tend to be more specialized, i.e. have fewer mandates and focused on core internationalisation support (including in export- and innovation-oriented activities), with other specialised government agencies undertaking the remaining functions. Among OECD IPAs, the most common set of mandates, besides inward FDI promotion, is promotion of exports, innovation promotion and regional development (performed by half or more of IPAs, see Figure 6.2). AIK did not have these activities as part of its official mandate, even though, according to its staff and website, it has de facto supported regional development in certain ways.21 Still, export promotion and innovation promotion was missing from the agency’s mix of functions. This is somewhat surprising, considering that, beyond the allocation of export guarantees to firms by HBOR, there is no separate export promotion agency operating in Croatia.22 In turn, AIK had other secondary mandates less typically found among OECD IPAs, such as the management of private investment projects and public-private partnerships (PPPs) under the Act on Strategic Investments (the latter since 2015), and promotion of certain high-value activities in the tourism sector, as defined in the Act on Investment Promotion, more typically found in developing countries.23 As such, the Ministry of Economy, Entrepreneurship and Crafts could consider what role it wishes for the new department to play in these most common secondary IPA functions, i.e. export-, innovation and regional development promotion, and which activities may need to be undertaken by other government bodies.
The OECD and the IDB have partnered to design a comprehensive survey of IPAs. The questionnaire provides detailed data that reflect the multiple recent policy developments as well as rich and comparable information on the work of IPAs in different countries. The survey was displayed and shared with IPA representatives from OECD and Latin America and Caribbean (LAC) countries in the form of an online questionnaire that was divided into nine parts:
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Basic profile;
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Budget;
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Personnel;
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Offices (home and abroad);
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Activities;
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Prioritisation;
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Monitoring and evaluation;
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Institutional interactions; and
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IPA perceptions on FDI.
National IPAs from 32 of the 35 OECD countries participated in the OECD- IDB survey, representing a 94% response rate. The participating agencies are those from the following countries: Australia, Austria, Canada, Chile, Czech Republic, Denmark, Finland, France, Estonia, Germany, Greece, Hungary, Iceland, Ireland, Israel, Korea, Latvia, Japan, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Slovenia, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. IPA respondents completed the questionnaire between May and September 2017. The data gathered through the survey served as a basis for a preparation of a mapping report of IPAs in OECD countries, as well as benchmarking with other regions (e.g. LAC and Middle East and North African countries).
Source: OECD (2018a)
In terms of the sectoral focus, all agencies of the 32 OECD countries surveyed prioritise certain countries and sectors in their activities and some additionally prioritise certain investment projects and investors (Figure 6.3). Some OECD IPAs also devote relatively large shares of staff to priority sectors (50% on average) and more than half of agencies have dedicated organisational units. In case of Croatia, the Act on Investment Promotion lists a broad set of activities that provide a basis for the IPA’s focus, i.e. manufacturing and processing, development and innovation activities, business support activities and high value-added services.24 In addition, the agency provided tailored information on eight specific sectors listed on its website, i.e. tourism, information and communication technologies (ICT), automotive, food, pharmaceutical, logistics, machinery and equipment manufacturing and textile industries. On the other hand, it excluded investments by SMEs, which are attended to by HAMAG-BICRO, as well as some investments in the energy and infrastructure sectors that were attended to by other organisations. In addition, unlike the majority of OECD IPAs (see Figure 6.3), the agency reported not to prioritise and specific investment projects or investors and did not have any specific staff or organisational unit devoted to that purpose. Meanwhile, economic studies find that sector- and other forms of targeting by IPAs is positively correlated with inward FDI, ceteris paribus (Harding and Javorcik, 2011 and Volpe Martincus and Sztajerowska, forthcoming). The OECD (2015a) also highlights that coordinated sector- and market-specific investment promotion campaigns tend to bring better results than generic marketing efforts. In the context of the importance of targeting to IPAs’ work, the Ministry could consider how it wishes to approach the targeting strategy in investment promotion and facilitation efforts.
Source: OECD-IDB survey of Investment Promotion Agencies (2017)
During the interviews conducted in the process of this Review, the MEEC expressed scepticism about the need to focus the agency’s work on specific sectors or countries. Meanwhile, the former IPA itself mentioned that sectoral focus could help it recruit staff and organise internally and the Foreign Investors Council stresses the need for a more unified strategy, including regarding sectors to be supported. The Ministry of Foreign and European Affairs (MOFEA) also stressed that a common understanding of the priority activities could help coordinate efforts across different government bodies. In this context, some further thought could be given to the department’s future targeting strategy and the government sectoral strategy more generally. This could be linked to the development of a broader FDI attraction strategy, as discussed earlier.
Source: OECD-IDB survey of Investment Promotion Agencies (2017)
In terms of the total number of activities, AIK performed 33 different actions, which is slightly below the OECD average (38). In addition, there were notable differences between the type of services provided by AIK and those routinely offered by OECD IPAs. Overall, while AIK performed many of the image building- and investment generation activities performed by the OECD IPAs, there was a perceivable gap on investment facilitation activities and aftercare services (Figure 6.4). It is worth highlighting that AIK had a well-designed website, providing a wealth of information of relevance to investors (in English and Croat): e.g. on business climate and investment conditions in Croatia, sectoral guides, guidance on the applicable regulations and administrative steps to implement an project, a catalogue of available investment projects as well as investment incentives- and a local salary calculators, among others – which can usefully be re-deployed by the Ministry in its new capacity.25 The digital investments project map is also an example of an interesting online service offered by the agency: the tool provided an overview of the various investment opportunities in different counties and sectors in Croatia, together with the project description and other relevant information such as planned capacities, estimated value, transaction model, project status, and dedicated contacts.26
Yet, even though AIK provided all the relevant information pertaining to establishment of a new investment project in Croatia on its website, it did not generally provide installation assistance to investors (e.g. help with licenses and permits, utilities, legal issues, construction and land permits, see Figure 6.4). In addition, it did not provide any capacity building or matchmaking services to local firms nor assistance in recruiting local talent or providing training to local staff, which is still considered as an important barrier by foreign firms in Croatia. This landscape may be partially related to the fact that other agencies undertake some of these functions, HAMAG-BICRO or Croatia’s One Stop Shop (HITRO.HR). Still, to the extent that burdensome administrative procedures and finding local partners and staff remain an issue for Croatia, the government could consider endowing the new department with capacities to provide a fuller portfolio of investment facilitation and aftercare services to firms, and ensuring close cooperation with other bodies in this area. Progress in this area may be particularly relevant in Croatia considering the government’s efforts to reduce administrative burdens on firms and an interest in “upgrading” the type of FDI it attracts.27 Most OECD IPAs devote significant resources to facilitation and aftercare services (OECD, 2018a) and offer a wider range of aftercare services to firms, including dedicated account managers (OECD, 2018a). Such an approach requires, however, the ability to focus on some firms more than others, which highlights the importance of a targeting strategy, mentioned earlier, as well as resources to pay staff.28
Adequate resources for the new department are, hence, one of important factors to consider. AIK explained in the context of this Review that the fact that it did not charge firms for assistance explained the gap in the services it offered relative to OECD agencies. Yet, none of the OECD IPAs charge firms for investment promotion and facilitation activities (unlike for export promotion services) and rely nearly entirely on state budgets (on average, 98% of OECD IPA’s investment promotion budget comes from the public sector). As such, the size of the state budgetary allocation plays an important role in allowing an IPA to adequately perform its functions.29 Meanwhile, AIK had a budget for investment promotion (of EUR 0.9 million) significantly below the levels found in other OECD IPAs (one fifth of the average budget of an OECD IPA), most likely influencing its capacity to perform certain activities and access to modern management tools found in OECD IPAs (see Box 6.2.).30 As such, the government should consider if the planned budgetary allocation to the newly created department can allow it to appropriately serve its function and, ideally, develop new services and improve its functioning.
This being said, the experience of firms that used AIK’s services, and which were consulted for this Review, was in general positive, and many of them considered that the agency had accumulated the relevant staff, tools and know-how. In this context, the absorption of AIK into the Ministry poses challenges as well as opportunities. On the one hand, if it is associated with an endowment of the new body in adequate financial resources and a better access to policy-makers, it could potentially help develop the previously missing activities, notably in the area of investment promotion and policy advocacy.
On the other hand, the dismantling of AIK as a separate entity also brings a number of risks associated with a possible loss of autonomy (in contacting investors, performing tasks, or hiring workers, for example), disruption of services and a brain drain, in particular if changes involve adjustments in salaries. Reportedly as a result of the restructuring, a number of AIK staff quit their job to join the private sector.31 Skills shortages could become an important constraint on the effectiveness of the new entity and potentially impact investors’ experience. As such, these risks need to be adequately considered and addressed if the reform is to achieve its desired effect. Ideally, this should have been done prior to the abolishment of the previous agency but the government may still find ways to ensure a relatively orderly transition. The overall goal should be to rescue the best from AIK, which has been appreciated by investors and developed certain best practices, while equipping the new structure with tools that have previously been missing. The recent experience of the UK that also absorbed its IPA into a Ministry could potentially be helpful as the government advances with implementation to consider the various opportunities and risks.32
Note: White colour indicates that AIK does not perform the activity.
Source: OECD-IDB survey of Investment Promotion Agencies (2017)
Overall, the Croatian government faces a number of challenges in deciding about the future functioning and institutional set-up for investment promotion and facilitation in the country. These relate to the role, mandates and activities of the new department, its sectoral focus and prioritization strategy as well as the allocation of financial resources, among others, all of which can impact the new body’s organisation and operations. Mechanisms for institutional cooperation with other ministries, in particular with Ministry of Foreign and European Affairs, may also need to be rethought to ensure better coordination of activities and benefit from the MOFEA's network of embassies and consulates. At the sub-national level, ensuring better coordination among the different institutions can help achieve better communication with investors. Addressing these challenges may impact the effectiveness of Croatia’s investment promotion and facilitation policy in the future. Until further details are clarified and the organisation of the new body confirmed, it is uncertain whether the institutional change will improve or worsen the policy set-up for investment promotion and facilitation in Croatia. Finally, regardless of its final choices on strategic matters, it is equally important that the Ministry communicates clearly the objectives and activities of the new department to its staff, investors and the public. For example, adequate information should be provided on the website, which at the time of writing of this Review only provided an information about the abolishment of the agency, and information-dissemination events could be considered. Uncertainty may impact negatively potential human capital of the new department (i.e. former AIK’s staff) as well as investors affected by the transition.
Investment facilitation and administrative simplification efforts
For many years now, long and complex administrative procedures in Croatia have been highlighted as one of key barriers to doing business. As previously highlighted in Chapter 4, cross-country rankings, such as the World Bank’s Doing Business or WEF’s Global Competitiveness Report have regularly identified administrative burdens and the overall government efficiency as an obstacle to doing business in Croatia.33 For example, the burden of government regulation as well as the efficiency of settling legal disputes and of the legal framework for challenging regulations are the areas where Croatia scored the lowest in the 2018 Global Competitiveness Report, ranking 130th out of 161 economies (Figure 6.5). In Doing Business 2019, Croatia scores poorly in the area of dealing with construction permits (159 out of 190), starting a business (123) and paying taxes (89) (Figure 6.6). Several reports by the European Commission have stressed their detrimental effects on the Croatian economy (European Commission, 2014-2018). In addition, recent business surveys and position papers have also identified complex and burdensome procedures, unstable regulatory framework and the tax system as key barriers to doing business in Croatia (e.g. AmCham, 2019-18 and Foreign Investors Council, 2017) and called for the need to improve the quality of regulations (see Chapter 7).34
Note: The index scores 161 economies from 0 (worst performance) to 100 (top performance) and generates annual rankings from 1 (top performance) to 171 (worst performance).
Source: WEF Global Competitiveness Report (2018)
Source: World Bank’s Doing Business Indicators (2019)
Given this feedback, it is not surprising that administrative simplification has been high on the government’s agenda and several governmental plans were developed in this area in the past decade.35 Most recently, the Government Programme for 2016-2020, the National Reform Programme 2017 and the MEEC’s Action Plan for Administrative Burden Reduction 2017-2019 outline the steps to be undertaken by the government.36 In support of these action plans, prior assessment using the standard cost model (SCM) methodology was carried out to allow for better identification of appropriate measures.37 According to the government, the implementation of all plans requires changes to at least 158 regulations by end of 2020 and so-far is going according to the schedule with implementation levels for 2017 and 2018 at about 75%, level (and the remaining measures still being implemented).38 The most recent report by the European Commission (2018) points to a steady progress albeit at a modest pace; while some stakeholders consulted in the context of this Review, notably business, suggest delays and important remaining gaps.
As for 2019, 314 additional measures to be streamlined have been identified. They relate primarily to the simplification in tax and accounting administration, employment procedures for foreign employees, digitalisation in tourism, e-procedures in the court system, streamlining of custom procedures by integration of customs and tax departments, administration of family and household farms, e-procedures and e-registers in environment protection. In addition, recognising the need to achieve further progress, the government recently created a Working Group on Enhancing Business Environment, charged with analysing remaining barriers to investment and economic activity, monitoring progress in implementation and proposing new actions to be considered by the government.39
In some areas related to administrative procedures, Croatia has made tangible progress, confirmed by international rankings, among others. For example, the government has undertaken a number of reforms related to resolving insolvency and registering property. As a result, the recovery rate in case of insolvency has increased from 29 cents per dollar in 2006 to 35 cents per dollar in 2019, and Croatia currently ranks relatively well, at 59th spot, in Doing Business ranking in this area (see Figure 6.6 above). The time needed to register property fell from 956 days in 2006 to 47 days during in 2019. In addition, there are on-going projects in these areas, including a recent digitisation of the land registry and further work on developing and better coordinating the land and the property registration systems.40 While dealing with construction permits is still problematic, reforms in this area were also undertaken– notably through amendments to the Building Code and the development of an e-permit.41 Consequently, the time spent dealing with construction permits reduced from 364 days in 2006 to 146 days in 2019.42 More generally, the progress in the use of e-services– including e-taxation, e-procurement, e-court, e-invoicing and others – can also help facilitate administrative procedures in Croatia and reduce the discrepancy in the application of regulations across the Croatian territory.43 These steps appear to be recognised by the private sector, considering that recent surveys have ceased to point to long and complex administrative procedures as the top business concern, marking a change from the past.44
Source: World Bank Doing Business indicators (2005-2019)
In case of starting a business, Croatia has also made important improvements in mid- and late 2000s. The implementation of a one-stop shop solution for business registration (HITRO.HR) has helped facilitate and shorten the time needed to start a company in Croatia (see Box 6.4 and Figure 6.7). In part to recognise this progress, Croatia was selected as Top Reformer according to the 2008 edition of Doing Business. Yet, since then, progress has been timid. According to the World Bank, it still takes over 22 days on average to open a business in Croatia, compared to the OECD average of 9 days (Table 6.1), even though available sub-national information points to quicker procedures in some cities outside of Zagreb (e.g. 6 days in Split or 11 in Varaždin, see Papahagi et al., 2018).45 Considering that there still exists a margin for improvement, the government is currently analysing the remaining obstacles to faster business registration with assistance of international donors46, and has reaffirmed its commitment to further facilitate starting a business in Croatia, including through additional efforts towards digitisation and the use of e-permits.47
Starting a business became easier with the creation of a one-stop shop (OSS) for company registration in Croatia. The implementation phase begun by establishing a first operational HITRO.HR office in Zagreb in May 2005. The principal goal has been to provide relevant information in one place and facilitate the process of starting a business in Croatia. Since then, the number of days to start a business fell from 29 in 2005 to 22 in 2019 (Figure 6.7).
With the subsequent expansion of its functionality in 2012, limited liability companies were allows to file their registration applications with the court registries electronically from any public notary’s or HITRO.HR’s office (so called e-Company service). In 2013 a new form of simple limited liability company with a lower minimum capital requirement was also introduced, which further simplified incorporation procedures and in 2014, some notary fees, related to company incorporation, were reduced. HITRO.HR is both an online service (www.hitro.hr) as well as physical offices located in over 60 different locations in 20 counties of all regions of Croatia. The role of OSS centres is to provide all the necessary information at one place to potential investors and support them while obtaining necessary permits. The service also allows accessing other relevant government e-services and e-permits, such as e-Cadastre (the land registry), e-Regos (a system for pension contributions), e-HZZO (health insurance) or e-VAT (the VAT tax module), among others.
Source: HITRO.HR’s website (www.hitro.hr), HAMAG-BICRO’s website (www.investcroatia.hr), AIK’s website (www.aik-invest.hr), FINA website (www.fina.hr) World Bank (2012), Croatia: Administrative Barriers to Foreign Investment, Foreign Investment Advisory Services (FIAS),
In some other areas, progress appears more elusive. For example, the incidence of so-called para-fiscal charges has been in recent years among the most frequently cited unresolved issues in Croatia, and this despite the 2018 tax reform. Business associations have been in general critical of the current legal framework, calling for the abolition of para-fiscal charges (Foreign Investors Council, 2016-2017). The European Commission (EC, 2015-2018) has also evaluated Croatia’s system of para-fiscal charges as requiring sustained reform. Despite commitment by the government to reduce their number, progress in this area has advanced at a slow pace. At the time of writing, only a few charges had been abolished. Amendments were on their way to reduce a few more. By the end of 2019, a financial analysis of the use of income collected from parafiscal charges should be completed, supporting the reform process (based on results, further measures would be proposed by March 2020).
The conduct of inspections is another area where further progress may be required, despite recent promising policy developments. The government has firmly stated its commitment to rationalising the systems of inspections as well as ensuring their greater transparency, consistency and fairness– for example, within the National Reform Programme 2017 and 2018. The interviews conducted in this Review suggested, however, that further progress could be achieved. The OECD Recommendation of the Council on Regulatory Policy and Governance (OECD, 2012) highlights that governments should ensure that inspections respect the legitimate rights of those subject to the enforcement and avoid unnecessary burdens on those subject to inspections, are not unduly burdensome as well as apply the principles of risk management, wherever possible. In this context, risk management systems can help governments focus its inspections on operations where the probability of violation is highest, optimising the use of resources and reducing the burdensomeness of repeated inspections, while further increase the use of electronic tools for reporting on inspections (e.g. via extension of e-INSPEKTOR service) could help reduce their burdensomeness. In some areas, regulatory enforcement in Croatia is carried out on the basis of the risk-based approach and sanctions (e.g. food safety inspections). However, this is still not a common practice. As such, the government could consult the OECD Regulatory Enforcement and Inspections Toolkit (OECD, 2018e) for further guidance and consider further capacity-building in this area.
The new Law on the State Inspectorate (Zakon o Državnom inspektoratu)48, which entered into force on 1 April 2019, is expected to support the objective of reducing the burdensomeness of inspections in Croatia. For example, the new State Inspectorate will concentrate a number of inspections previously undertaken by different bodies.49 In addition, the law introduces internal procedures and rules to improve the planning and coordination of inspections to avoid their undue repetition, allows for a better communication with the inspected subjects as well as facilitates corrections of minor offenses during the inspection procedure.
Last but not least, as further discussed in Chapter 7, stakeholders have regularly highlighted the more general need to improve a consistent application of laws across the different levels of administration. Difference in the ease of obtaining licenses and permits have been a case in point.
The recent sub-national study of Doing Business for Croatia has identified some of the key differences across five different cities in Croatia, with the largest performance gaps seen in dealing with construction permits, enforcing contracts and starting a business (Papahagi et al., 2018). For example, completing the construction permitting process for a simple warehouse in Varaždin takes 112 days and costs 5.3% of the warehouse value—half the time it takes in Split, at a third of the cost. Starting a business is easier in Split, where most limited liability companies are set up using HITRO.HR. Dealing with construction permits is easier in Varaždin, while Osijek shows best performance in registering property and enforcing contracts. At the same time, the results also identify pockets of excellence in various regions. For example, the report also shows that surveyed cities in Croatia outperform the EU average for enforcing contracts and the city of Split outperforms many OECD countries on the time needed for business registration (Papahagi et al., 2018). Identification of various best practices and promotion of local champions at sub-national level, combined with better monitoring and enforcement at the national level and continued institutional reform could help Croatia address some of the persistent obstacles in this area.
It is also worth noting that high administrative burdens – whether encountered in some regions or throughout the entire territory – tend to affect disproportionately small and-medium-sized enterprises. This is because they often do not have the required personnel and resources to absorb the additional cost of dealing with complex procedures, e.g. via outsourcing to professional service providers (see e.g. OECD, 2017b). As such, considering Croatia’s interest in supporting and promoting growth of domestic SMEs, which dominate the country’s economic tissue (Alpeza et al., 2016), it could attach particular attention to the implementation of the various administrative simplification and investment facilitation reforms discussed above as a horizontal support scheme for all firms, with disproportionally large positive effects on local SMEs.
Croatia's incentives scheme for investors
Beyond removing various legal and administrative barriers to foreign investment, countries at times decide to offer additional incentives to investors. These may include tax exemptions, exonerations from social contributions or import duty payments, or financial and in-kind support among others (see Box 6.6). On the expectation that private investment will raise employment, exports, technologies, or that some of the knowledge brought by foreign companies may spill over to the country's national development goals, Croatia has also introduced various forms of investment incentives to encourage both foreign-owned and domestic companies to invest in its jurisdiction. With the objective to encourage entrepreneurship further, it also recently introduced significant tax reforms.
While under some circumstances there may be an economic or political justification for granting incentives, often governments find this strategy simpler and more immediate than to correct deficiencies in infrastructure, labour skills, the legal system and other areas. As illustrated by the trend in some developing, emerging and transition economies to offer generous tax incentives, investment incentives schemes may reduce effective tax rates to a large extent (OECD, 2018; IMF, OECD, UN and World Bank, 2015). It is important to ensure that investment incentives, and tax policies in general, are not contributing to a disproportionate or unplanned strain on domestic resources.
For this reason, a country’s incentives framework is an important component of the OECD Declaration on International Investment, which includes the Instrument on International Investment Incentives and Disincentives [hereafter: the Instrument]. The Instrument encourages governments to ensure that incentives as well as disincentives are as transparent as possible so that their scale and purpose may be easily determined. Building upon the Instrument, the OECD Policy Framework for Investment further encourages countries to evaluate the costs and benefits of incentives, in particular the use of tax incentives together with the level of tax burden they impose on businesses with a view of meeting their investment promotion strategies and development goals.
Support from Government for the promotion of SMEs dates from 2001, when the first Government programme, “The Programme for the Development of Small Business” was approved. From 2001 to 2012, support for SME development, was provided, initially by the Ministry for Crafts and Small and Medium Entrepreneurship (2001 to 2003), and then (2004-2012) by the Ministry of Economy, Labour and Entrepreneurship. The initial policy programme (2001-2004) comprised of three main instruments: a) grant aid, b) interest rate subsidies, and c) the establishment of credit lines with a number of commercial banks as well as participation from local authorities.
Grant schemes have been developed to provide funding to enterprises, local authorities (to support enterprise zone development) and to crafts and vocational organizations (to provide support to entrepreneurs and business persons and develop the capacities of craftsmen). Interest rate subsidies were funded jointly by the ministry and the counties for loans taken out by entrepreneurs and enterprises borrowing from participating commercial banks. Development funds were established with the participation of the Ministry, Counties and municipalities and a number of commercial banks to promote SME investments. Finally, loan guarantees (provided by HAMAG-BICRO) were added to the policy portfolio during the period. SME policy continued along similar lines until 2011, when, in addition, Ministry funded contributions towards the establishment and functioning of a small number of venture capital funds.
This situation changed in the mid 2010s as a result of the availability of the EU Structural Funds and the National SME Development Strategy 2013-2020. From 2015, the main sources of SME promotion have been EU structural funds. Steps have been taken to bring about changes in the formulation of SME policy and support in reaction to this development. These include: capacity development in policy impact assessment; the collection of information on policy effectiveness from the SMEs’ perspective; and, the establishment and adoption of policy indicators for monitoring and evaluation purposes. Currently, HAMAG BICRO and HBOR are responsible for management and disbursements of funds to firms. In addition, HAMAG BICRO also provides micro- and small loans and other financial instruments.
In addition, the Ministry of Economy, Entrepreneurship and Crafts is in charge of overseeing the implementation of the “SME test”, i.e. an assessment of the likely impact of a proposed change on SMEs, as part of regulatory impact assessment (RIA) undertaken when developing new regulations (see Chapter 7).
Source: Government of Croatia
Mapping Croatia's corporate income tax policy and investment incentive regime
Croatia's tax regime
With the aim to encourage entrepreneurship and attract investors, Croatia introduced significant tax reforms in 2018. A result of these reforms, which have affected a number of tax and social contribution related laws, the overall tax burden on business appears low in comparison with Croatia's EU peers. For example, in the area of corporate profit tax (CIT), the general tax rate has been decreased from 20% to 18%, below the EU average. With regard to agricultural producers and small businesses with annual revenues less than HRK 3 million (EUR 400 000), it has been further discounted to 12%.
Among EU neighbouring countries, Croatia and Slovenia have almost the same rate, whereas Austria, Italy and Hungary have rates at 24% and 25%. Within Southeast European economies, all peers have lower rates (Table 6.2), which likely illustrate the incentive competition that Croatia is facing with some of its direct neighbours. Uncoordinated, unilateral regulatory efforts may be inefficient to govern and select the flows of investment; on the contrary such policies may fuel undesired regulatory arbitrage by companies. They are able to shift the location of their investments in response to the diversity of incentives and the inherent advantages of different market, thus favouring some countries to the expense of others (OECD, 2015a; OECD, 2008; OECD, 2004). In this respect, the Instrument on International Investment Incentives and Disincentives has aimed to fill this gap to facilitate international cooperation in this area.
In the area of personal income tax, the applicable rates were also reduced in 2018 with the objective to remove the tax burden on salaries which was said to negatively impact the competitiveness of labour. While Croatia is not yet included in the OECD databases on different aspects of tax regime and a comprehensive review of the tax system lies outside of the scope of this Review, existing studies attempted to apply the OECD Taxing Wages methodology to calculate the tax wedge50 - which is used as proxy for the extent to which taxes can discourage employment – find that they have fallen over time.51
Investment incentives
While investors may consider statutory CIT rates as a first reference point when evaluating the tax competitiveness of a jurisdiction, it is the entire tax regime – including in particular various tax and other incentives – that indicates a tax system's burden on businesses or incentives to invest. As such, a calculation of average effective tax rates (AETR) and marginal effective tax rate (METR) is often a more meaningful metric (OECD, 2008). As outlined in Box 6.7, the most common types of incentives are so-called tax holidays, reduced tax rates, accelerated depreciation, tax credits, and investment allowances. These measures aim at influencing the size, location or industry of an investment project by affecting its relative cost or by altering the risks attached to it.
Corporate tax incentives
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Tax holidays or reduced corporate tax rates.
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Tax credits.
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Investment allowances.
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Accelerated depreciation.
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Reinvestment or expansion allowances.
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Double deduction of certain expenses for tax purposes (usually related to e.g. employment, exports, R&D or infrastructure).
Other tax incentives
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Personal income tax exemption on dividends.
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Exemption from, or reduction of, withholding taxes.
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Duty drawback schemes.
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Exemption from import tariffs, particularly for capital goods, equipment or raw materials.
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Exemption from export duties.
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Exemption from sales, property and wage income taxes.
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Reductions in social security contributions.
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Financial incentives
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Subsidised or concessionary financing.
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Government equity participation.
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Insurance at preferential rates.
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Loan guarantees.
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Direct grants.
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Provision of dedicated infrastructure.
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Provision of training, pre-screening of potential employees.
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Preferential treatment on foreign exchange.
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Preferential government contracts.
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Protection from import competition.
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Subsidised services such as feasibility studies or product marketing.
Regulatory incentives
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Derogations from national and sub-national rules and regulations, e.g. social, labour or environmental standards, ethnic quotas, local equity participation.
Source: OECD (2004)
Croatia offers a panoply of different investment incentives. Its incentive scheme is available to all investors, foreign as well as domestic, and can be divided into five broad categories: corporate tax credits applicable for up to ten years upon completion of certain conditions; incentives for investments in certain activities and high value added services; incentives for investments into capital intensive and work intensive projects; employment and training incentives; R&D incentives; and additional incentives applied to companies in special economic zones. Box 6.8 outlines the specific conditions that apply to investment incentives. Croatia provides an online investment incentives calculator on the website of HAMAG-BICRO that calculates an expected level of state support based on project characteristics (e.g. employment, location, capital investment).
Croatia provides the following investment incentives:
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Reduction of the profit tax rate from 50 to 100% depending on the size of the investment and the number of newly created jobs. For micro enterprises (companies with up to 10 employees) that invest at least EUR 50 000 and create a minimum of three new jobs, a 50% reduction applies for a maximum of ten years. For small, medium and large enterprises, a 50% reduction applies for a maximum of ten years for companies that invest up to EUR 1 million and create at least 5 new jobs; this reduction increases to 75% for companies that invest between EUR 1 and EUR 3 million and create at least 10 new jobs, and to 100% for companies that invest over EUR 3 million and create at least 15 jobs.
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Employment incentives, for creating new jobs in relation to the investment project. Non-refundable subsidy for eligible costs of new jobs created depends on the unemployment rate in the county in which the investment is located. The incentive rate is applied to eligible costs of jobs creation.
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Incentives for education and training. The eligible costs for the purpose of training may include trainers’ personnel costs, for the hours during which the trainers participate in the training; trainers’ and trainees’ operating costs directly relating to the training project such as travel expenses, materials and supplies directly related to the project, depreciation of tools and equipment, to the extent that they are used exclusively for the training project. The non-refundable subsidy shall not exceed 50% of the eligible costs. It may be increased, up to a maximum aid intensity of 70% of the eligible costs by 10 percentage points if the training is given to workers with disabilities or disadvantaged workers; by 10 percentage points if the aid is granted to medium-sized enterprises; and by 20 percentage points if the aid is granted to small enterprises.
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Incentives for labour-intensive investments creating at least 100 new jobs within three years from the start of the investment project. An additional incentive in the amount of 25% of the amount of incentive granted for new jobs is granted to investment projects creating up to 30 jobs; this amount increases to 50% for a minimum of 300 new jobs, and up to 100% for 500 new jobs.
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Incentives for capital-intensive investment projects, which apply to investments whose minimum amount is EUR 5 million and generate at least 50 new jobs within 3 years of the start the investment. These investment projects can benefit from additional non-refundable subsidies between 10% and 20% of the cost of new factory construction, production facility construction or purchase of new equipment depending on the employment rate of the county where located and subject to certain conditions (e.g. the part of investment in the equipment must equal to at least 40% of the investment and at least 50% of this equipment must be of high technology).
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Incentives for research and development (R&D) projects, which apply to the conduct of certain activities that must conform to specific criteria such as bringing new knowledge. These projects can benefit from tax relief, reducing the tax base for income tax for justified R&D project and feasibility study costs. A 200% of eligible R&D project expenses is deducted for basic research, a 150% deduction is provided for industrial research and feasibility study costs, and a 125% deduction for experimental development. Deductions for industrial research and experimental development may be further increased by 20% for small businesses and by 10% for medium enterprises under certain conditions.
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Incentives for economic activation of inactive assets in public ownership, which apply to investments in land and/or buildings owned by the Republic of Croatia and administered by the Ministry of State Property, which are not in operation and in which no economic activity is performed. The incentive consists of a free lease of inactive property for up to 10 years from the start of the investment project. Requirement for benefiting from this incentive is at least EUR 3 million invested in the fixed assets and the creation of 15 jobs within a three-year period from the start of the investment project.
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Special economic zones. Free zones and entrepreneurial zones are another vehicle through which Croatia aims to attract investors and facilitate economic development of different regions.
Source: Government of Croatia (January 2019)
Recent past has seen efforts by the government in rationalising the country’s incentives scheme. Following good practice, Croatia has been moving away from a volume-based approach to investment promotion, with generous incentives across the board, to a more nuanced one where incentives are designed to achieve specific outcomes: incentives have increasingly focused on those activities that create the strongest potential for economic spillovers, including linkages between foreign-owned and domestic firms, education, training and R&D. In addition, both the Act on Investment Promotion and the Act on Strategic Investments that outline the provision of state aid in Croatia have been developed in compliance with the EU state aid rules that the country is subject to.
Special economic zones
One specific type of investment incentives offered to investors in Croatia are services and benefits associated with locating in in special economic zones. Special economic zone system in Croatia comprises free and entrepreneurial zones that are governed by dedicated legal acts. Building of the industrial infrastructure for the production of goods aimed for exports is the primarily objective behind the creation of free zones; meanwhile, the main goal of entrepreneurial zones is to support regional development, including in the least prosperous counties (see also Borozan and Klepo, 2013 as well as Kontošić, Pamić and Belullo, 2018).
In early 2019, there were 220 entrepreneurial zones and 11 free zones operating in Croatia. Table 6.3 provides an overview of free economic zones operating in Croatia. As can be seen, most of the free zones were created towards the end of 1990s and early 2000s, the two largest zones being located in Split and Ploce. Special economic zones (SEZs) in Croatia’s neighbouring economies tend to be larger on average, with the exception of the Republic of North Macedonia (OECD, 2017b). According to the government, the functioning of the zones has been evaluated by an independent institute and its results have confirmed their effectiveness.52 It has also been shown that less developed municipalities and counties have received more support from the state for the development of the zones, in line with the objective of supporting regional development (Kontošić et al., 2018).
Companies which operate in Croatia’s free zones benefit from an exemption from customs duties or taxes, including VAT, levied on goods stored in the zone; investment friendly areas and possibility to use privileges prescribed by the Investment Promotion Act for investments in the free zone; unlimited deadline for storage of goods; safe and guarded places; customs services open 24 hours a day; and reduced administrative burdens. Meanwhile, entrepreneurial zones are located in nearly each county and primarily provide infrastructure to firms in the form of good locations with utility services, logistical support and transport links. In terms of organisation, the founders and oversight bodies of entrepreneurial zones are local and regional authorities while the founders of free zones can be local and regional authorities, institutions and public or private companies. It appears that, while formally the Ministry of Economy, Entrepreneurship and Crafts is responsible for the policy, there is no central oversight or coordinating body at the central government level that would monitor and coordinate the zone activities.
Similarly, as in the case of other investment incentives, SEZs should be regularly evaluated to ensure that they achieve their intended results, and do not put budget under undue pressure, affect negatively the level playing field for firms operating in the economy or lead to creation of enclaves within the domestic territory. It appears that no such assessment is being undertaken by authorities in Croatia. However, the government has just commissioned to the Institute of Economics in Zagreb (EIZ) a study of the entrepreneurial zones effectiveness over the years 2003-2014.53 The goal of the study is to assess the costs and outcomes of the policy. Given the number of such zones in Croatia, and an apparent lack of oversight at the central government level, such an exercise could be particularly beneficial. Moreover, as information on ownership of firms established in the zones is not readily available, it is impossible to ascertain how important the zones are in supporting Croatia’s FDI attraction efforts. Finally, regular monitoring and periodic assessments can also provide an opportunity to gauge the socio-economic impacts of the zone system, considering in particular their contribution to the country’s development goals and ensuring that the legal and regulatory framework for responsible business conduct and measures to fight corruption should apply to companies in the zone to the same extent as elsewhere in the country.
Effective and efficient use of investment incentives
When countries do use incentives, the Instrument on International Investment Incentives and Disincentives and the OECD Policy Framework for Investment highlight the need for a transparent and non-discriminatory use of incentives as well as their frequent evaluation to ensure that they achieve intended objectives.
In Croatia, the legal framework for investment incentives is governed by several legal acts. The general framework for investment incentives is regulated by the Investment Promotion Act. Other incentives are spread about in different laws and regulations - for example: the Free Zones Act (Official Gazette no. 44/96, no. 92/05 and no. 148/13), which regulates the establishment and functioning of the free zones; the Entrepreneurial Infrastructure Improvement Act, in force since 2013 (Official Gazette no. 93/13, no. 114/13 and no. 41/14), which regulates entrepreneurial zones54; and the Act on State Aid for Research and Development Projects (Official Gazette no. 64/18), in force since July 2018. The Personal Income Tax Act also stipulates the conditions under which income from a self-employment activity can be reduced under specific conditions. Consolidating all tax incentives, along with their eligibility criteria, into the main body of the tax law, would increase transparency and could help remove any doubt that the tax administration is empowered to administer them (OECD, 2015). The multiplicity of regimes may generate disorientation among investors.
Furthermore, there is an uncertainty as whether Croatia’s investment incentives scheme meets its intended objectives. Tax and other forms of incentives may generate distortions in the allocation of resources between different types of tax payers, different sectors or industries and different types of businesses in favour of those receiving preferred treatment. Another concern over the use of investment incentives is the resulting foregone revenue. Currently, there are no procedures in place that allow for ex post impact assessment of the allocated investment incentives in Croatia. Establishing mechanisms to evaluate the costs and benefits of investment incentives could help them assess against their intended policy objectives as well as the associated fiscal cost, which may be particularly important given the prominent role of investment incentives in Croatia’s investment promotion and facilitation policy. In particular, a comprehensive and accurate measurement of both costs and benefits is necessary to allow for a reliable assessment of incentives impact.55
Overall, investment incentives should be transparent; non-trade distorting; oriented toward long-term investment; temporary, proportionate to the expected benefits; subject to strict impact assessment; and rooted in a coherent business model, also from an RBC perspective. In this regard, some countries provide incentives to encourage businesses to uptake responsible business practices, including financial incentives such as credits for demonstrated commitment to RBC in government contracting or investment or tax incentives to encourage business to invest for example in low-carbon technologies.
Outlook and policy recommendations
Croatia has taken steps to improving its investment promotion and facilitation policies. The main focus has, nevertheless, been so far on the use of various investment incentives and, more recently, allocation of the EU Structural Funds. Meanwhile, progress has been timid in several key aspects of business climate. According to business surveys, administrative procedures remain complex and lengthy in certain areas (e.g. business and land registration or obtaining of construction permits). Investors have also complained about retroactive changes, conflicting interpretations and uneven application of laws or of administrative requirements by different public bodies across Croatia’s territory (e.g. inspections). In light of this, continuing efforts to improve the quality of administrative procedures and the underlying regulations as well as progress in rationalising existing ones and providing better investment public investment facilitation services (e.g. OSS solutions, e-permitting) could help reduce barriers faced by firms.
The institutional set-up for investment promotion itself appears to be fragmented and is currently evolving. As such, a number of stakeholders, not least business, call for a more comprehensive, long-term vision for Croatia’s investment attraction policy to build a whole-of-the-government approach.
In the area of tax, the 2018 reform has reduced the overall tax burden and a relatively wide palette of investment incentives in Croatia offers a further possibility to reduce effective tax rates. Still, questions remain around the issues of transparency, predictability and effectiveness of the system. First step to successfully orienting future policies is evaluating past performance and drawing appropriate conclusions. As such, evaluations of effectiveness of the use of investment incentives, including with respect to the incentives provided in the special economic zones, as well as of the capacities of agencies involved in investment promotion could help the government decide on future reforms.
Challenges ahead are multi-layered. Reforms are said to be slowed down by special interest groups and many of the ills of the Croatian administrative inefficiencies originate in the organisation of the state apparatus, the quality of public governance and processes of creating regulations. As such, progress in these areas will be critical to avoiding accumulation of problems in the future. In this regard, ex post reviews of existing regulations, using the recently adopted SCM methodologies, could help rationalise the current system, including in the area of permits and licenses and para-fiscal charges. With the stabilisation of the political situation in the country and prospects of further economic recovery, the government could focus on implementation and delivering on promises.
Last but not least, a transition from an incentives and volume-based approach to investment attraction to a more targeted approach to investment promotion – and more generalised approach to investment facilitation (relying less on special regimes such as SEZs) is not a change that can take place over night. The government will face increasing challenges in balancing the requests from businesses and those of civil society and other stakeholders (see Chapter 8) as it attempts to strike the right balance between economic growth and broader development and societal objectives. In this context, a better framework for monitoring and evaluation of various investment promotion actions can help the government identify the true costs and benefits of different approaches.
Policy recommendations
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Establish a consistent and unified institutional and policy framework for investment promotion and facilitation encompassing all relevant entities with the ultimate goal of maximising synergies and effectiveness, eliminating duplication of efforts and giving clarity to investors. This could involve endowing one government body with adequate resources and capacities to perform such functions and ensure that it coordinates its efforts with other relevant bodies at the national and subnational level. Regardless of the legal status of such a body, the government should clearly outline its objectives and the planned course of action to reduce uncertainty.
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Focus efforts on effectively streamlining administrative procedures, in particular in the area of starting business, getting construction permits and paying taxes including parafiscal charges. This requires that these efforts are conceived in a way that reduces the heterogeneity of practices across different levels of government and regions. It also involves setting clear, procedure-specific deadlines and monitoring progress to ensure implementation within the planned timeframes.
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Introduce systems of monitoring and evaluation of Croatia’s investment promotion and facilitation policy, including investment incentives. In that context, establish formal channels of consultation between the tax authorities and other stakeholders to allow for a comprehensive view of costs and benefits of the current system.
References
Alpeza M., M. Has, M. Novosel, and S. Singer (2016), Small and Medium Enterprises Report Croatia – 2016 including the results of GEM – Global Entrepreneurship Monitor research for Croatia for 2015, CEPOR SMEs and Entrepreneurship Policy Centre, www.cepor.hr/wp-content/uploads/2015/04/Cepor-izvjesce-2016-ENG-web.pdf
Amcham (2019), Survey of the Business Environment in Croatia, www.amcham.hr/storage/upload/doc_library/amcham_-_survey_of_the_business_environment_in_croatia_15192.pdf
Amcham (2018), Survey of the Business Environment in Croatia, www.amcham.hr/storage/upload/doc_library/amcham_-_survey_of_the_business_environment_in_croatia_143454.pdf
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Notes
← 1. In addition, about 90% rated their overall experience as average, good or very good and three forth planned to expand and hire new employees in the next three years (AmCham, 2018).
← 2. According to the AmCham (2018) survey, 48% of respondents identified the level of taxes, 48% slow administration, 43% lack of long-term government vision, and 43% the small size of the local market as top obstacles to doing business in Croatia.
← 3. Furthermore, the Act on Investment Promotion, specifies sub-categories of several of the above mentioned activities that can benefit from additional state support (see Article 12).
← 4. All the opinions and administrative acts except for those which are issues in accordance with Article 25 paragraph 2 of the Act shall be issued by the central state administration bodies competent for their issuance within 15 days upon receipt of a the dully submitted request by the interested investor (Article 13 of the Act on Strategic Investments).
← 5. In March 2018, amendments were made to the Act, lowering the required investment threshold from HRK 150 million to HRK 75 million and from HRK 20 to 10 million in case of areas of special concern, islands, agriculture or fisheries – and the use of securities as proof of financing, among others.
← 6. The Government Plan is available (in Croat) on the Central Government Portal: https://vlada.gov.hr/UserDocsImages/ZPPI/Dokumenti%20Vlada/Program_Vlada_RH_2016_2020.pdf
← 7. More information on the national development strategy of Croatia can be found on the government’s website: www.vlada.gov.hr/news/pm-plenkovic-national-development-strategy-will-define-objectives-until-2030/23290
← 8. “A strategic project will be considered the project the implementation of which creates conditions for the employment of more people, depending on the type and location of the projects that significantly contribute to the development or improvement of conditions and standards for the production of goods and provision of services that introduce and develop new technologies to increase competitiveness and efficiency in the economy or public sector and/or which rise the overall level of safety and quality of life of citizens and environmental protection, which have a positive effect on more economic activities and the implementation of which creates added value, and which largely contribute to competitiveness of the Croatian economy (…)”.
← 9. The required value of total capital investment cost has been lowered from HRK 150 million to or higher than HRK 75 million (or lower if co-financed by the EU funds and programmes); or be realized in the assisted areas (or in the units of local self-government of certain type) and have total value of capital investment cost in that area equal to or higher than HRK 10 million; or are realized on the islands and have total value of capital investment cost equal to or higher than HRK 10 million. For projects that fall within the area of agriculture and fisheries and total value of capital investment costs must be equal to or higher than HRK 10 million
← 10. FIC formulated key recommendations in those areas: 1) developing a sustainable strategy for encouraging investment and attracting foreign investment; 2) maintaining a stable and predictable regulatory environment, in order to reduce uncertainty and encourage investment, with special emphasis on the stability of the tax system and predictability of work of the Tax Administration, as well as abolition of acts which negatively impact competitiveness; 3) accelerating business procedures in order to reduce regulatory and administrative business costs; 4) improving the consistent application of law in the entire economy, advancing the quality and credibility of laws and regulations.
← 11. The Centre for Monitoring Business Activities in the Energy Sector and Investments was in charge of investment projects in infrastructure and energy at the time of writing of the Review. It has since then been abolished and all its activities transferred to the Ministry of Environment and Energy.
← 12. For example, HAMAG BICRO also has its network of partner institutions, HITRO.HR has its offshoots in over 60 locations across the country and AIK had 19 partner institutions at the county-level across Croatia. The Croatian Chamber of Economy has a network of 20 county chambers, and many municipalities and cities lead their own investment attraction efforts.
← 13. Meanwhile, MEEC was responsible for public strategic investment projects under the Act on Strategic Investments.
← 14. The Government of the Republic of Croatia issued a Decision on the reduction of central state agencies, bureaus and funds, which contained a list of 54 bodies to be abolished or merged. AIK was one of those agencies.
← 15. The Act on the cessation of the Act on the establishment of the Agency for Investments and Competitiveness is available (in Croat) in the Official Gazette (OG 115/2018) at www.narodne-novine.nn.hr/clanci/sluzbeni/2018_12_115_2242.html
← 16. See Articles 3-5 of the abolishing act.
← 17. According to Article 7 of the abolishing act, the Ministry is to issue such regulation within 30 days from the date of entry into force of the Act.
← 18. Information provided by the government during the discussions within the OECD Investment Committee, taking place as part of this Review.
← 19. The government explained the rationale for abolishing 54 central government agencies, including AIK, in the following press release: www.vlada.gov.hr/news/public-finances-are-viable-and-under-control/24243
← 20. As part of this Review, the government had assigned AIK to participate in the OECD-IDB IPA Survey. Considering that all the AIK’s resources, staff and activities were taken over by the Ministry, the findings remain relevant for the future functioning of the Ministry’s new department.
← 21. For example, it helped promote regions in its activities with investors and created promotional materials for certain regions, see www.aik-invest.hr/en/investment-region/. Also, the map of investment opportunities and the map of business zones enable search by regions (counties), providing investors with information on the available investment possibilities. In addition, under the Strategy for the regional development of the Republic of Croatia until 2020, AIK was in charge of creating a unified communication model towards investors on all levels of the Government, providing support to the activities of regional development agencies and developing joint actions for several counties and local units in attracting (foreign) investments.
← 22. Information based on the responses provided by the government as part of Review.
← 23. For example, most of the OECD countries that have dedicated PPP units usually locate them in the Ministry of Finance or establish an independent agency (OECD, 2010a); and only very few (9% of OECD IPAs) have tourism promotion as part of their mandate (OECD, 2018a).
← 24. The Act also includes the definition of large investment projects that AIK used to be responsible for, specifying minimum value thresholds.
← 25. See www.aik-invest.hr.
← 26. See www.aik-invest.hr/en/investment-projects-map
← 27. Firms tend to engage in more complex or high-value added activities, such as R&D, after having operated in the host economy for some time (OECD, 2008d); and reinvested earnings account for a large share of OECD FDI inflows (OECD, 2018b).
← 28. Higher budgets are found to be associated with a larger number of investment generation and facilitation activities (including aftercare services), see Volpe Martincus and Sztajerowska, forthcoming. In addition, IPAs that prioritise certain investors and projects tend to have higher budgets enabling them to provide higher quality services to selected firms (OECD, 2018a).
← 29. Higher budgets of IPA and targeting intensity are associated with a higher stock of inward FDI per capita and total number of foreign affiliates located in the economy per capita (see Volpe Martincus and Sztajerowska, forthcoming).
← 30. For example, as highlighted in Box 6.2., the agency had no foreign offices abroad, which may have limited its ability to generate prospective investment leads; no customer management relationship (CRM) system, used by 94% of OECD IPAs and considered a critical IPA management tool (even if it had another internal tool to track investment projects); and had less than half of its staff with prior private sector experience (compared to the average of two thirds in the OECD IPAs).
← 31. As an autonomous agency, AIK was able to pay wages above the level of the public sector. This is a common practice among the IPAs that by its nature require staff with prior private sector experience and sectoral knowledge to interact with investors and hence compete for talent with the private sector. With the absorption into the Ministry, wages of staff in the new department would be subject to the public sector pay scale.
← 32. In 2016, UK Trade & Investment, UK’s national IPA, has been turned into the Department for International Trade.
← 33. Croatia was ranked 58th on World Bank’s Doing Business 2019 edition out of 190 and 68th out of 161 in the WEF’s Global Competitiveness Report 2018.
← 34. AmCham (2018) and Foreign Investors Council (2017) have stressed complex administrative burdens, unstable regulatory framework, and tax policy as key constrains to doing business in Croatia. According to an earlier survey of Croatian CEOs conducted by PWC (2015), tax burden and overregulation were also among the major concerns mentioned by business in 2015. The 2013 World Bank’s Enterprise Survey also found that 20% of senior management’s time was spent dealing with the requirements of government regulation, compared to 12% in Central and Eastern Europe and 10% globally, and 46% of firms identified tax rates as a major constraint to doing business (World Bank, 2013).
← 35. The government developed several administrative simplification plans or strategies in the past. For example, in 2006, the so-called HitroRez Plan was announced with the goal to reduce administrative burdens (via the so-called administrative guillotine approach) and improve in the quality of regulatory policy in Croatia. By the end of the review process, HitroRez recommended the elimination of 425 regulations and a simplification of 374 others. After a promising start (see e.g. OECD, 2010), HitroRez office has been discontinued in 2007 and many of the identified reforms have not been implemented (Šimić Banović, 2015). Following the entry into the EU, other plans were developed to reduce administrative burdens. For example, an administrative simplification plan 2015 aimed to achieve reductions in administrative burden amounting to HRK 300 million in 2015 and another HRK 300 million in 2016 (Government of Republic of Croatia).
← 36. The Action Plan for Administrative Burden Reduction 2007 set out 104 measures to be reduced, resulting in a cut of administrative burden by 30%, which is equivalent to 0.4 % of GDP (Ministry of Economy, 2017). According to the government, out of 104 measures from the Action Plan 2017, 75 measures were implemented. Furthermore, SCM measurement was extended further and a thorough assessment was conducted in 70 legislative areas to identify new measures to be addressed in the Action Plans for Administrative Reduction 2018 and 2019. Within the plan for 2018, 142 measures were proposed and 107 measures have been already implemented. Within the plan for 2019, adopted in January 2019, a total of 314 additional measures were proposed.
← 37. Initially, the government applied the SCM methodology to the retail and real estate sectors, achieving a reduction in the administrative burden by 20% in those sectors (European Commission, 2016). Since then, the SCM methodology was applied in other sectors and 70 different legislative areas to identify measures to be removed as part of the action plans for administrative burden reduction.
← 38. For example, in 2018, six laws and 20 bylaws were changed implementing 107 out of 142 measures, and five additional laws and bylaws are being processed to complete the process, according to the information provided by the government as part of this Review.
← 39. According to the information provided by the government as part of this Review, the Working Group was created on 8 March 2019.
← 40. The government has implemented several projects aiming to strengthening, digitising and improving the coordination between the property and land registration systems in cooperation with the World Bank, the EBRD and the EU. In August 2018, the World Bank approved a loan to Croatia for the Integrated Land Administration System Project in the amount of EUR19.7 million (USD24.07 million equivalent) to further modernise the property and land registration service. According to the World Bank (2018), under the ongoing project, the average time to register mortgages and real property transactions decreased from 46 days to 12 days in Land Registry Offices and from 30 to eight days in Cadastre Offices and the very first e-services for land administration were introduced.
← 41. The Ministry of Construction and Physical Planning developed the ‘e-permit’ system that allows all building and use permits for construction works to be issued electronically (https://dozvola.mgipu.hr).
← 42. As will be explained later, some cities in Croatia are performing much better in this regard (Papahagi et al., 2018).
← 43. The implementation of e-procedures is part of a wider government plan to provide services online (so-called e-Croatia). For an overview of services available to-date to Croatian citizens, consult the Central Government Portal: www.vlada.gov.hr/highlights-15141/archives/smart-government-e-croatia/18023.
← 44. For example, a recent business survey undertaken by the American Chamber of Commerce (AmCham, 2019) finds that, unlike in previous years (e.g. 2017 and 2018), long and complex administrative procedures were not anymore among the top limiting factors for doing business in Croatia, and almost half of respondents found that business conditions had improved in the past five years.
← 45. In addition, the government suggests that it takes eight days on average to establish a business in Croatia using HITRO.HR services or 24 hours if the new e-Company service is used. Information retrieved from the Ministry of Economy, Entrepreneurship and Crafts’ website: http://investcroatia.gov.hr/en/investment-guide/establishing-a-company/setting-up-a-company/
← 46. For example, the World Bank has been conducting a diagnostic of the current business registration systems to provide the government with recommendations on needed reforms.
← 47. Information provided by the Croatian authorities during the discussions within the OECD Investment Committee that took place as part of this Review in March 2019.
← 48. The State Inspectorate is established as an independent inspection body a state office that would report directly to the Government). The central office will be based in Zagreb with five to six regional offices and departments across the country.
← 49. As per the new Law, the State Inspectorate is taking over the inspection of pressure equipment and the inspection of the management of poisonous chemicals from the Ministry of Economy, Entrepreneurship and Crafts, the sanitary inspection from the Ministry of Health, veterinary, agricultural, hunting, forestry and phyto-sanitary inspection from the Ministry of Agriculture, tourist inspection by the Ministry of Tourism, energy inspection, environmental inspection, inspection of nature protection and water inspection from the Ministry of Environmental Protection and Energy, Labour Inspectorate from the Ministry of Labour and the Pension System, and construction inspection from the Ministry of Construction and Physical Planning.
← 50. Tax wedge is defined as the ratio between the amount of taxes paid by an average single worker (a single person at 100% of average earnings) without children and the corresponding total labour cost for the employer. The average tax wedge measures the extent to which tax on labour income discourages employment. This indicator is measured in percentage of labour cost.
← 51. For example, while earlier studies rank Croatia above the OECD average or among high tax-wedge countries (e.g., Šeparović, 2009, Grdović et al., 2010 and Škrbić and Šimović, 2014), more recent studies rank Croatia lower (e.g., Urban, 2016 and Beketić, 2016).
← 52. Further information on the study and its objectives can be found on the website of the Institute of Economics in Zagreb (www.eizg.hr).
← 53. Information can be located at the Institute’s website: www.eizg.hr.
← 54. The Act on Improving Entrepreneurial Infrastructure was amended in the second half of 2018 (Official Gazette, No. 93/13, 41/14, 57/18).
← 55. An evaluation of the economic benefits of tax incentives should take into account a) direct impact by the incentives-motivated investment; b) indirect and induced impact due to inter-industry transactions and changes in income and consumption; c) positive externalities, such as technology and know-how transfers by incentives-induced FDI; and d) social and environmental benefits where tax incentives serve to correct market imperfections. The costs that should be considered include; a) primary revenue forgone due to tax incentives; b) revenue leakages due to unintended and unforeseen tax-planning opportunities; c) costs incurred by taxpayers in order to comply with a given tax incentives regime; d) the administrative costs from running the tax incentives programmes due to the complexity introduced to the legislative and regulatory framework; and e) the costs to the economy of creating an “uneven playing field” where domestic firms are not entitled to the same tax incentives as their foreign competitors. See OECD (2015) for more detail.