New rule for employee registration before commencing work

Taxation Act amendments to create a national register of employees were enacted by the Parliament (Riigikogu) on 26 March 2014. Details of everyone starting work in Estonia must be registered in advance. The amendments are due to enter into force on 1 July 2014

According to an explanatory letter, registration should reduce the use of illegal workers and improve protection of workers’ social rights. To achieve this, all individuals are to be registered before commencing work, thus also facilitating supervision over labour taxes, reducing the use of unaccounted-for workers and strengthening the social guarantees foreseen for employees.

The instructions of the Tax and Customs Board (in Estonian) are available here.

The 1000-Euro invoices bill back in the Parliament

Also back before the Parliament is the VAT code amendment requiring separate listing of all invoices of over EUR 1000 in an appendix to each VAT declaration.

After entrepreneurs denounced the initiative and the President refused to sign it, the Ministry of Finance made some cosmetic changes to the draft and added an explanatory letter, hoping for better success this time.

It has been proposed that businesses should demand a 1% cut in the VAT rate in return for the requirement to make the declaration. This should not cause fiscal problems for the government as the new measure is supposed to improve tax collection.

Company car tax amendments also back in Parliament

Unlike the EUR 1000 invoices proposal, which the government tried to push through at any cost, amendments to taxation of company-owned passenger vehicles were blocked by the Parliamentary Financial Committee during the previous round and returned to the Ministry of Finance for review.

The Ministry has indeed produced a new draft, with cosmetic amendments which largely ignore the substantive issues previously raised by business circles.

Now the amendments have been sent to the Parliament – check out the proceedings here.

Application of tax incentive to pre-2000 profits

Amendments to the Income Tax Act repeal some transitional provisions with effect from 1 January 2015. Tax incentives set out in these transitional provisions will thus apply to dividend payments or reductions of owner’s equity until the end of this year. Therefore it is reasonable to pay out  any profits made before 2000 by the end of 2014 at the latest.

Under the pre-2000 system, income tax was applied to corporate profits as well as dividends. Tax paid on dividends could subsequently be deducted from corporate income tax.

From now on, Subsection 60 (2) of the ITA allows companies to reduce their dividend tax obligation on profits posted in 1994-1999 by the amount of corporate income tax paid during that period, but this possibility will be terminated by the amendments. This means, theoretically, that any dividend payments from next year on could be subject to income tax even though the profits in question have already been taxed. Therefore, any profits made before 2000 should be paid out by the end of 2014 at the latest.

According to the letter of explanation accompanying the amendments, the deduction in question has been applied only a few times during recent years. However, any such double taxation could raise issues of constitutionality as it ignores the uniform taxation requirement of Section 12 of the Constitution.

Estonia’s tax system beginning to lag behind its neighbours

Latvia established a social tax ceiling from the beginning of this year, prompting a welcome debate on whether Estonia’s taxation system was also developing in a successful and sustainable direction.

Besides international tax planning, much of our daily work is focused on comparative analysis of Baltic legal and tax systems. We explain to our clients the benefits of choosing Estonia, Latvia or Lithuania for a given activity. Latvia’s new social tax ceiling is another ticked box in the list of reasons why foreign undertakings entering the Baltic markets should target their investments and activities to Latvia instead of Estonia.

Since the late 1990s, Estonia had a lead in tax comparisons for a number of reasons, such as a presumably simple and transparent system of taxation, zero corporate tax on reinvested profits, withholding obligations applicable to only a few types of payments. However, recent analyses are increasingly indicating that Estonia may no longer be the preferred tax environment for a rational entrepreneur. The scales are tipping towards Latvia.

The social tax ceiling is just one of recent visible steps putting Latvia ahead of Estonia in what used to be our strength internationally – creating a business-friendly environment. Latvia levies a 15% corporate tax and zero tax on share transfers, provides a favourable tax environment for holding companies and micro-companies and offers a number of tax incentives/reliefs. All these measures contribute to business development, job creation and, in the longer term, a rise in employment levels and tax revenue. Meanwhile, Estonia’s recent tax law developments are less than laudable and the country is falling behind in regional tax competition.

This is because Latvia is not the only country out to attract development-minded investors to the region. Finland is also taking steps to facilitate business, for example by slashing its corporate income tax rate from 24.5% to 20% from the beginning of 2014. Lithuania is promoting its free zones and takes care of small businesses by offering a 5% corporate income tax rate for companies with less than 10 employees and an annual turnover of less than EUR 289,000.

Meanwhile, Estonia has opted for hostile short-term solutions for tax collection (like rushing through the obligation to declare all 1000-Euro invoices, which failed the constitutionality test). Such steps cast doubt on the stability of Estonia’s business environment and make it even harder to explain to clients why they should choose Estonia over its neighbours as an investment location.

Recent debates on tax amendments indicate that the state is out to improve tax collection by burdensome measures instead of facilitating the business environment to secure an increase in tax revenue and prosperity in the future. We urge Estonian policymakers to view the system of taxation and collection in a longer term than just the next annual budget and come up with changes to ensure government revenue after five, ten or fifteen years as well. A social tax ceiling would be a welcome first step towards this, but further action is needed: the overall income tax rate should be gradually lowered to 15%, while abolishing income tax on the sale of shareholdings, licence fees and profits from international trade. These steps would improve the attractiveness of Estonia’s business environment and its competitiveness among its closest neighbours.

The constitutional dimension of tax law

Tax laws and regulations are not autonomous or outside the constitutional framework. Planned tax amendments should comply with the constitution and new burdens cannot be justified merely by the need to fill state coffers.

At the end of the last decade, the government often justified tax hikes by economic hardship and the need to bring the country out of crisis, but such hasty proceedings are no longer acceptable. Taxpayers demand a certain level of sound reasoning for any last-minute tax increases intended to boost government revenue.

The state’s need of money cannot in itself serve as a basis for arbitrary and disproportionate increases in the tax or administrative burden without an impact analysis. The end of the last year brought a series of positive developments for those who believe that the state should also follow the constitution in its dealings, including tax matters. The Supreme Court repealed a Government regulation which increased environmental charges contrary to a previous agreement and the President refused to sign VAT law amendments which included a requirement for all businesses to separately declare invoices exceeding EUR 1000. In both cases, the government’s intention to improve its fiscal position while trampling on the constitutional rights of taxpayers was sharply rejected. Our law firm is pleased to have significantly contributed to both cases.

Institutional support is strong for the notion that the state budget is not above the constitution and that government initiatives to increase the tax burden must be in line with constitutional principles. This inspires us to continue the fight for free enterprise.

For further information on the successful cases referenced above see „Government increase of mineral resources extraction charge ruled unconstitutional“ and „Refusal to proclaim the Act amending the Value Added Tax Act and Accounting Act“.

We can guarantee more ground-breaking tax law and fundamental rights cases in the future.