Cross-border financing challenges in the Balkans – a never ending story

Cross-border transaction legislation in the region (Bosnia and Herzegovina, Croatia, Macedonia, Montenegro, Serbia) has been one of the main cause of „pain“ for foreign investors over the past decade. The accession of Croatia to the European Union (EU) and progress made in the rest of the region have made it a more favorable place of interest. Serbia is an example of late liberalization of cross-border payments regime, compared to Macedonia, for example, but the changes over the last four years are frequent and corresponding to the development of the market.

The discussion that never ends in both countries is related to the status of the lenders that are not registered financial institutions – the differences in funds usage depending on whether they come from the financial institution or from the legal entity or individual out of the financial sector have led to diversification of rules applied to interest calculation manner, as well as transfer pricing threshold guidelines (in terms of „at arm’s length” interest rate measurement).

Recent developments in legislation in Serbia and Croatia – going back and forth

From turtle to the rabbit – how to fit the cross-border financing and payments to fit the needs of the investors

In Serbia, the difference between financing sources has been made through the Obligations Law, by naming the financing from the non-financial agents „zajam“, while the financing from the financial institutions is defined as „kredit“. However, by the virtue of the Foreign Currency Transaction Law, all cross-border financing transactions are registered as „kredit“ transaction, regardless of the type of the lender. The difference also exists in terms of interest calculation set-up – only financial institutions are allowed to use conformity interest calculation, while the rest of lenders can only use proportional interest calculation. The type of interest rate (fixed or variable) is subject to agreement between the parties. From the perspective of transfer pricing, should the borrower or the lender decide to use comparable uncontrolled price method (CUP), the Ministry of Finance has provided a tool for all taxpayer, defining the market level of interest rate per type of lender, duration of lending period (short-term vs long-term) and selected currencies, disregarding the differences in purpose of financing. Offsetting of the cross-border payables and receivables is performed through the simple agreement, without any special registration procedure. Serbian resident is allowed to receive financing from any foreign lender, at prescribed registration procedure that lasts up to seven days, with appropriate lending contracts and details to the purpose of financing, repayment terms and any collateral details being presented to the National Bank of Serbia upfront. Since April 2018, Serbian residents are also allowed to lend money to the EU residents without restrictions while in other jurisdictions the lending can be done only if the borrower is a dependant party of the Serbian resident (direct shareholding required). Hence, back-to-back loans with the EU domiciled entities has been enabled, which is a common tool of group financing. Also, the recent implementation of online payments of EUR for digital products even if the provider is a Serbian resident has enabled easier and faster access to services used both by residents and non-residents with the temporary presence in Serbia, without exchanging the currency and opening a local bank account.

Retroactive application of the laws to solve the „old“ problems brings in the brand new ones

In Croatia, the understanding of the difference between financial institutions and non-finance agents is similar, as well as the guidelines for transfer pricing in this respect. The EU accession has led to the opening of the market for cross-border transfers with EU countries with less paperwork and bringing more financing possibilities. However, the Act on Nullity of Loans with an International Element Concluded in the Republic of Croatia that has entered into force on 29 July 2017 has brought many doubts in terms of the liberalization process. The act applies to loan agreements with an international element that are concluded in Croatia between debtors and unauthorized creditors. The act prescribes that loan agreements with an international element that are concluded in Croatia between debtors and unauthorized creditors to be null and void ex tunc (with retroactive effect), except in the case of being fully effected (i.e. loans have been repaid). The same mechanism applies to other legal transactions concluded in Croatia before the act entered into force between debtors and unauthorized creditors arising as a consequence of or based on loan agreements with an international element. The crucial  elements of identification whether the loans fall into the scope of this act are: (a) place of execution (the loan is considered as executed in Croatia or not) and (b) non-authorization of the lender to provide the loan to the Croatian borrower (had no prescribed authorizations or consents from the competent Croatian authorities).

The place of loan agreement execution is defined per the Croatian law as the place of lender’s registered seat, however, the international agreements may opt for application of the rules prescribed by another state. As to the status of a place of service supply, if the activity of the lender is not effectively carried out in Croatia (activity includes offering period, through agent or representative in Croatia), the lender would not be obliged to register. So, the reference is made to the definition of “permanent establishment” – if there is an ongoing, regular activity of lending in Croatia (personal presence) the lender would need to register a branch office and consequently to register as the “authorized lender”.

The contracts affected by this law, retroactively, are those concluded within the period between 2000 and 2010 – since 2010, Croatia had to comply with the EU accession framework, enabling foreign credit establishments temporarily to provide financial services, without any permission from the National Bank of Croatia. At the end of 2017, the Rijeka Municipal Court referred a request for a preliminary ruling to the European Court of Justice (ECJ) raising questions concerning the compatibility of the act with EU law. The request refers to the loan contract concluded by an individual-Croatian resident, A.M. and the Austrian Raiffeisen bank in 2007. In the opinion of the Advocate General from 14 November 2018, in Case C-630/17, „the Court should rule that a national law that allows loan contracts concluded with foreign lenders who were not authorized to provide credit services in that country to be retroactively annulled is contrary to EU law when the same law does not apply to Croatian lenders“. The Advocate General considers that the Croatian Law discriminates against lenders established outside of Croatia wishing to provide credit services in that Member State because the law does not apply to unauthorized lenders established in Croatia. The national law’s definition of ‘unauthorized lender’ refers only to moral persons that have their statutory seat situated outside of Croatia.

By definition of the place of the loan agreement execution, the case should not exist – the seat of the lender is in Austria, presumably, the loan has been concluded in Austria. However, the local Court has decided that the loan has been executed in Croatia due to the fact that collateral documentation has been signed in front of the notary in Croatia, which is a mandatory procedure, so the lender could not opt for a different location. The problem is that the act remains unclear on many of the matters that it aims to regulate and at the same time raises many concerns as to its application in practice, since In disputes arising out of a loan agreement with an international element, a debtor may institute proceedings against an unauthorised creditor either before the courts of the state in which the unauthorised creditor has its seat or, notwithstanding the seat of the unauthorised creditor, before the courts of the place where the debtor has a residence or seat, while an unauthorized creditor may institute proceedings against a debtor only before the courts of the state in which the debtor has a residence or seat – Croatian law is the exclusive governing law for agreements which are null and void under the Law.

Remaining challenges

The current framework still leaves the open topics on investing from Serbia and Croatia into „third countries“ (non-EU countries), more clear identification of recommended source for „at arm’s length“ interest rate identification per the purpose of cross-border financing and more transparent and faster cross-border loan registration procedures.

The outcome of the ECJ in terms of retroactive application of the Act on Nullity of Loans with an International Element Concluded in the Republic of Croatia, if the Court remains with the opinion of the Advocate General will for sure make higher level of assurance for foreign financial institutions and other investor-lenders that have been providing cross-border financial support to their subsidiaries in Croatia.

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