New Year 2018 brings us many changes in tax laws (partly retroactive) that affect almost everyone, from individual natural-person entrepreneurs to credit institutions and non-residents. We have summarized the main changes you should be aware of in order to prevent unpleasant surprises and make use of the tax benefits which the state offers.
Regular dividends: tax rate down to 14% from 20%
To motivate corporate tax payers to distribute profits more systematically, the new changes to the Income Tax Act enable a reduced CIT rate of 14 % (on the gross amount) to apply to regular dividend payments from 2019. To apply the reduced tax rate in 2019, dividend payments must already have been made in 2018.
Under the general rule, dividends are taxed at the corporate tax rate of 20/80. The special rule applicable to regular dividends enables a reduced CIT rate of 14/86 to apply to regular dividends. The amount of dividends subject to the reduced rate is the arithmetical average amount of annual dividends calculated based on the dividends paid within the last three years. Dividends exceeding this amount will be taxed at the current tax rate of 20/80.
In 2019, the reduced tax rate can be applied to 1/3 of dividends paid in 2018, while in 2020 it can be applied to up to 1/3 of dividends paid in 2018 and 2019.
Example: If you pay dividends of EUR 120,000 in 2018, the reduced tax rate applies on dividend payments up to EUR 40,000 for dividend payments made in 2019. Dividends exceeding this amount will be taxed at the standard 20/80 tax rate.
A shareholder that receives dividends who is a natural person must pay additional personal income tax on dividends at the rate of 7%. So the reduced tax rate has an effect only on dividend payments between corporate taxpayers.
Intragroup loans and cash pooling arrangements need review due to new declaration and tax requirements
Amendments to the Income Tax Act that enter into force as of 1 January 2018 and expected increased scrutiny by the tax authorities may lead to taxation of certain upstream intragroup lending as concealed profit-sharing. Under the new provisions, loans to shareholder or other subsidiaries of a parent company with a term exceeding 48 months may be deemed taxable profit-sharing unless the taxpayer proves ability and intention to repay. In determining intention to repay, the tax authorities in particular consider repayment schedules, extensions granted for repayments, increases to the loan amount, the correlation between company profit and loans issued, use of the loan and whether the company pays dividends.
To bolster oversight by the tax authority, the new amendments also require that the issue and repayment of upstream intragroup loans are declared to the tax authorities on a quarterly basis. The first of these declarations is due on 20 April 2018 and must include loans issued or loans whose terms have been significantly amended since 1 July 2017.
While details of the new rules are still being worked out by the tax authorities, especially concerning cash pooling arrangements, it is clear that all such arrangements need to be reviewed to ensure compliance with the declaration requirements and to avoid incurring taxes unintentionally.
Using company cars for personal purposes gets more expensive
For years, use of company cars for personal travel has been a problem for the tax authorities. From 2018, the related rules are once again becoming stricter and the personal travel in company cars will be more expensive.
Up to this year, the tax base for using a company car was EUR 256 a month, on which fringe benefit taxes (income and social tax) were EUR 169.90. Starting from the coming year, the tax base depends on the age and power (engine capacity) of the car. The tax base for each unit of engine capacity (in kW) for cars not older than 5 years is EUR 1.96 a calendar month, while for cars older than 5 years it is EUR 1.47 a calendar month.
Example: The tax base for a vehicle produced in 2015 with power of 180 kW is 1.96*180 = EUR 352.80. Income tax for each calendar month is EUR 88.20 and social tax is EUR 145.33. Total fringe benefit tax comes to EUR 233.72. However, tax for a newer car with engine power of 80 kW is EUR 103.88 a month.
If the car is used only for business travel, a special entry must be made in the Estonian Motor Register. Absence of this entry gives the tax authority a basis to assume that the car is used for private travel and should be taxed with fringe benefit taxes. Although keeping driving records is to be non-mandatory, the company must still be able to prove to the tax authority that the car is not used for private travel. Driving records can be used for this purpose. Having a separate parking lot for a company car as well as the existence of a personal car for the employee or management board member suggest that a company car is not used for private purposes.
A single “private meter” will create tax liability for the whole month. Kilometre-based compensation will apply to vans and (small) trucks.
The new rules will cause employers to consider whether it is reasonable to replace company cars with employees’ personal cars, for which tax-exempt compensation is payable, leading to a cheaper solution from the tax perspective. It also may prompt employees to review their tasks within the framework of which to cover company car costs without tax liability.
Business account for natural persons simplifies tax compliance
Starting from 2018, the law enables natural persons to open a bank account and nominate it as a business account. All taxes on the amounts received in the account will be calculated and transferred by the bank. But as the account solution must be provided by the private sector, it has not yet been implemented and will likely become operational from the second half of the coming year. The account was introduced mainly for participants in the sharing economy such as Uber drivers, cleaners and child-minders.
The tax rate is 20% on income from goods and services not exceeding EUR 25,000. For income exceeding this threshold, a tax rate of 40% will apply. Social contributions, income tax and pension payments are covered by tax, whereas under ordinary regulation the tax rate would be at least 20% income tax + 33% social contributions + 2% pension payments = 55%.
A business account is effective only if services or goods are sold to private persons. If sold to corporate entities, then the corporate entity must pay additional income tax at a rate of 20/80.
A natural person with a business account cannot act as a sole proprietor in the same area and cannot have a VAT registration.
Cheaper support for employees’ healthy lifestyle
Costs related to promoting a healthy lifestyle among employees have been taxed with fringe benefit taxes (equated to salary). However, under the recent changes an employer can make these costs exempt from fringe benefits for up to EUR 100 a quarter for each employee. The following costs are covered by this tax exemption:
- Participation fees for public sports events, such as running events. “Public” means the event should also be open for individuals not working with the employer.
- Costs related to regular use of sports facilities.
- Costs related to the employer’s own sports facilities, such as an in-house gym.
- Payments for health insurance.
- Costs related to services from certain specialists, such as a rehab physician or psychologist registered in the national register or holding an occupational certificate.
A precondition for tax exemption is that services are available to all employees. However, this does not mean that all employees have to use these services.
When concluding a group client agreement with a gym, the tax exemption will be calculated based on employees having a right to visit the gym under the agreement. This motivates physically less active employees to list themselves and make deals with sports clubs to limit visiting rights to a monthly overall number of visits.
Changes with share options – notification and full exit
A change in taxation of share options took effect in July 2017, addressing full exit, changes in the underlying asset and notifying the tax authorities about share option agreements.
If the underlying asset to which the option refers are a holding in the employer or a company that belongs to the same group as the employer, then acquisition of the holding is still not taxed as a fringe benefit if the holding is acquired not earlier than three years as of the grant of the share option (concluding the option agreement).
In practice, share option agreements have been backdated to shorten the three-year period. To avoid that, a requirement was introduced to notify the tax authorities about concluding an agreement within five business days of doing so. This does not apply to option agreements that are notarized or digitally signed.
In the case of full exit (sale of 100% of the shareholding in the employer or employer’s group company) or the employee’s death or incapacity for work, the tax exemption regulation was softened. If such an event occurs within the three-year period, the tax exemption is applied proportionally.
General tax allowance for natural persons – meeting the summer vacation with full or empty pockets? How to understand the formula “6000 – 6000 / 10 800 × (income – 14 400)”?
Starting from January 2018, natural persons can apply a general income tax allowance of EUR 500 a month, reducing from annual income of EUR 14,400 or higher, until the monthly tax allowance is zero for annual income over EUR 25,200. For annual income between EUR 14,400 and 25,200, calculation of the annual allowance must be based on the formula “6000 – 6000 / 10 800 × (amount of annual income – 14 400)”.
Practical tips and a step plan for employers and employees are the following. For the employer it would be reasonable to explain the following steps to employees:
- Calculate your annual income (use a crystal ball if you have one). This includes annual taxable income earned in 2018 plus dividends received and income earned through a business account (minus social tax). Tax-exempt income, such as income from the sale of a home, is not included in the calculations. NB! If you earn income only from your employer, the employer must calculate the applicable allowance every month under the formula “500 – 500 / 900 × (payment – 1200).”
- Calculate how much allowance applies in your case. For annual income exceeding EUR 25,200, the monthly tax allowance is zero. For annual income less than EUR 14,400, the allowance of EUR 6,000 applies yearly. An income between these two numbers requires application of the formula mentioned above.
- Please think through whether you earn some income from sources other than your employment relationship. If not, do not worry as the employer will calculate the correct amount of tax allowance. However, the Christmas bonus can be a game changer.
- Please think through whether it is reasonable to terminate application of the allowance or not. Remember that if you apply the monthly allowance, a Christmas bonus may terminate the allowance for the whole year retroactively. If annual income is above EUR 25,200 or between EUR 14,400 – 25,200, then it would be reasonable to terminate application and perhaps recover some money from the state in 2019.