Dear client and cooperation partner,
In this tax newsflash, we present a brief overview on recent developments in the Estonian tax scene, covering topics such as intra-group lending, distribution of branch profits and building tax-effective marketing strategies in Estonia.
Last but not least, a reminder to declare capital contributions before February 2018 in order not to lose the right to tax-exempt payments from equity.
Have a pleasant read!
Your Sorainen Tax team in Estonia
- Can a fixed-term promise given to entrepreneurs be broken by tax regulation?
- New and aggressive “collateral income tax” – every company should pay attention to loans and guarantees to group companies as well as using group accounts
- Final possibility to declare tax exemption
- Branches of Latvian companies should consider distributing their income annually
- Advertising tax does not apply to all information
CAN A FIXED-TERM PROMISE GIVEN TO ENTREPRENEURS BE BROKEN BY TAX REGULATION?
In recent years, many instances have occurred where, through tax regulation, the Estonian Parliament has broken promises to entrepreneurs. As a rule, the reason for breaking promises is the need to fill the state budget.
On 19.12.2016, the Parliament passed amendments to the Social Tax Act, the Income Tax Act and other laws. Under the amendments, excise duties on beer, fermented beverages and wine will be raised more quickly than was previously stipulated in the timetable set by law. When the Parliament passed the previous timetable, they used a regulatory technique which gave entrepreneurs a clear promise that excise duties would not be raised for a certain period.
On 16.03.2017, the Chancellor of Justice filed an application with the Supreme Court to declare the accelerated speed of raising excise duties unconstitutional.
The Chancellor of Justice notes that Estonia is a state governed by law. A law-governed state honours the promises it has made, even if they seem like a mistake in retrospect. In law, a promise bound by a fixed term (eg a fixed-term employment or lease contract) is more certain than a promise with no term. The state may back out of a fixed-term promise only in exceptional circumstances, eg in the case of a severe economic crisis. When it was decided that the rate of raising excise duty would be increased, no exceptional circumstances applied.
The Supreme Court’s decision will be important because it will help to explain to what extent the Parliament is tied by fixed-term promises imposed by law that they have made. It is not yet known when the Supreme Court’s decision will be announced.
NEW AND AGGRESSIVE “COLLATERAL INCOME TAX” – EVERY COMPANY SHOULD PAY ATTENTION TO LOANS AND GUARANTEES TO GROUP COMPANIES AS WELL AS USING GROUP ACCOUNTS
The Estonian government is planning to implement tax measures to increase corporate income tax revenue. The problem addressed relates to long-term loans from subsidiaries to parent companies, which are not repaid and which can be treated as profit distributions. The government plans to implement so-called “collateral income tax” to improve tax revenue and hinder this hidden distribution of profits.
The draft bill covers loans and guarantees between related entities and groups using group accounts. The new tax is planned to be effective from 2018 and should cover all loans and guarantees from 01.07.2017. We have highlighted the main types of upstream financing transactions causing tax risks:
- A subsidiary has provided a loan to its parent company. Income tax is levied on loans issued to a parent company and a company located above the parent company, also loans to other subsidiaries of the parent company. Only large-scale profit-based loans will be taxed, ie loans exceeding contributions to the equity of the company and inbound loans. Tax must be paid upon issuing the loan.
- Providing collateral securing parent loans. Collateral provided by a subsidiary guaranteeing a loan to the parent company is taxed similarly to a loan. This may have significant importance when planning group guarantee structures and syndicated loans.
- Providing credit in other forms. Income tax may be levied on credit agreements and other agreements with a similar economic function. Excessive payment terms may qualify as a loan.
- Using group accounts. Using group accounts will not be taxed only if the financial means are made available for the other group members for a short term (up to one year), provided its purpose is to manage group liquidity. No specific details are provided on how to define this function of the loan.
Scheme: Which transactions may be taxed?
How to avoid tax liability? Assuming that the draft bill will be enforced in its current wording, solutions for avoiding tax liability (which is absolutely normal, even expected, behaviour) are the following:
- Restructure group financing.
- Refinance loans/guarantees through entities not in the group/foreign entities.
- Increase payments to the equity of the subsidiary or loans taken by the subsidiary.
- Merge the lender and the borrower (including cross-border merger).
FINAL POSSIBILITY TO DECLARE TAX EXEMPTION
10 February 2018 is the last day for declaring past circumstances that allow tax free distributions from the equity of a company. Failure to hand in a declaration can result in loss of tax exemption.
In 2015 an amendment was enacted to the Estonian Income Tax Act under which all resident legal persons and non-resident legal persons having a permanent establishment in Estonia had to declare circumstances entitling them to tax free withdrawal of money invested. The declaration had to be handed in by 10 February 2015. The final possibility to hand in the declaration is 10 February 2018, allowing for a 3-year deadline to amend past declarations.
To obtain tax exemption, it is necessary to declare the following circumstances in the income and social tax declaration for January 2015:
- contributions to company equity,
- income tax withheld and paid in a foreign state,
- income received from which a tax free dividend can be paid and payments made from equity,
- similar rights, which used to belong to another company, received in the course of merger, division or transformation of companies.
BRANCHES OF LATVIAN COMPANIES SHOULD CONSIDER DISTRIBUTING THEIR INCOME ANNUALLY
Latvian companies pay tax on their worldwide income. This means that every tax year profits made by branches of Latvian companies are included in the taxable base of a Latvian company, which pays 15% income tax on those profits. The profits of a branch of a Latvian company in Estonia may be taxed in Estonia so far as they are attributable to that branch. If they are taxed in Estonia and the Estonian branch declares that tax has been paid in Estonia, then according to the double taxation treaty between Estonia and Latvia, Latvia should allow a deduction in an amount equal to the income tax paid in Estonia.
In practice it means that a deduction can be given only in a tax year when profits accrue in Estonia. Latvia allows a change to a tax declaration only for three years back from the year in which income accrues. If the Estonian branch pays out profits which have accumulated, for example, over five years, then Latvia will allow correction of the income accrued during the last three years but income in excess cannot be credited against Latvian income tax. In other words, Latvia will refund income tax paid for the past three years but income tax for the preceding two years cannot be refunded. In effect, this causes economic double taxation of branch profits. The difference in taxation is caused by inconsistency between the case based method (which Estonia uses) and the accrual method (which Latvia uses).
We recommend that Estonian branches of Latvian companies should distribute their income regularly in order to avoid potential tax loss in Latvia.
ADVERTISING TAX DOES NOT APPLY TO ALL INFORMATION
Entrepreneurs commonly encounter problems with local municipalities regarding advertising tax. Local municipalities usually wish to levy advertising tax on any information that entrepreneurs present at or near their place of business. Among other things the tax is levied on signs with neutral information that does not advertise anything or anybody.
Under paragraph section 2 subsection 2 of the Estonian Advertising Act, the following is not considered to be an advertisement – marking a location of business or professional activities with its name, type, times of sale of goods or provision of services, the name of the person, the trade mark and the domain name on a building where the location of a business or professional activities is situated and at the entrance to the location of business or professional activities. Many issues arise from this provision – mainly, what can be seen as a “type of business” that can be presented without tax. Additionally, it is debatable when such information is “at the entrance to the location of business or professional activities”. The Advertising Act and decrees of local municipalities also foresee other exemptions that could apply.
Before paying advertising tax it would be wise to think through and discuss with a specialist whether information presented is an advertisement or whether a reason exists to contest the findings of the local municipality.