Dear SORAINEN client and cooperation partner,
Please find below another overview of recent significant tax law-related Supreme Court cases and legal amendments, which we consider relevant for all undertakings. This newsflash covers the following issues:
- Sale of immovable property is not always transfer of an enterprise
- Amendments to the Taxation Act
- Increasing taxation pressure on work abroad
- Interest on overpaid taxes – money that needs to be brought home
- Planned changes to the Income Tax Act and Value-Added Tax Act
We would also appreciate your attendance at our “Current tax law issues and optimal solutions” business breakfast on 22 October(please note that presentations are in Estonian). Finance minister Jürgen Ligi will deliver the keynote address on growth-friendly taxation, recommendations by international organisations, focusing also on how to keep control of the tax exemptions and incentives. Registration is open until Thursday, 17 October.
1. Sale of immovable property is not always transfer of an enterprise
The Supreme Court recently issued two decisions on whether the sale of a dormant real estate development should be treated for tax as an ordinary sale or as a transfer of an enterprise. In brief, the Court found (see decisions 3-1-1-108-12 and 3-3-1-85-12) that a registered immovable does not as such necessarily constitute an enterprise and it is vital to establish whether a property item is in fact an enterprise involved in economic activities. If the answer is negative, a registered immovable should not be considered an enterprise or in the context of transfer of an enterprise, as it is impossible to transfer an enterprisethat does not exist.
The tax authority has frequently issued notices of assessment where it rules that certain transactions do not constitute ordinary VAT-taxable sale of goods, which would allow the buyer to deduct input VAT, but instead constitute a transfer of an enterprise, in which case input VAT is not deductible. These tax notices are justified in many cases as certain circles have been commonly discharging their obligations by transferring business activities from one company to another and using the VAT paid by the buyer to perform the seller’s other “obligations”. The old shell is then discarded along with VAT arrears. Encouraged by its achievements, the tax authority has increasingly begun to see transfers of an enterprise in transactions that obviously do not involve such intent. In one dispute, the tax authority claimed that the sale of a registered immovable was in fact a transfer of an enterprise. The Supreme Court disagreed, although in this case the notice of assessment remained in force for other, formal reasons unrelated to the transfer of an enterprise issue.
The case addressed by the Supreme Court decisions is not the first or only instance where the tax authority has treated stalled bubble-era developments as operational enterprises transferred upon sale of immovable property. In reality, such property has not been involved in any revenue generation in years, so that a reasonable taxable person sees no reason to treat it as an enterprise to be taxed according to the rules of transfer of an enterprise. New owners attempting to revive the development may find, to their great surprise, that the tax authority thinks an enterprise has been transferred along with the registered immovable. The consequences may be rather unpleasant for the buyer – besides not being able to deduct VAT, it may face other tax liabilities of the former owner, which, according to the tax authority, were transferred together with the enterprise.
In principle, the sale of a registered immovable may indeed involve a full or partial transfer of an enterprise. However, for an immovable to be treated as an enterprise it needs to carry the set of rights and the identity of an enterprise and involve a flow of revenue or an immediate possibility of revenue. If a property has not generated revenue for the seller, it should be assumed that economic activities have not begun and there is no economic entity that could be transferred in the first place. An immovable should be treated as an enterprise in cases where the seller transfers immovable property along with the means of production, employment contracts (organisation) or other contracts and the property generates rent or other income to which the new owner is entitled. Otherwise, any transfer of immovable property could be re-qualified as a transfer of an enterprise and sellers would be unable to dispose of their property at all, as buyers would fear the transfer of sellers’ obligations. This would also lead to the question of applying similar regulation to movable property, as the distinction between movable and immovable property is merely formal. Such a situation would not be compatible with the normal functioning of the real estate market, or with common sense. Thankfully, the Supreme Court also found that sale of immovable property does not necessarily constitute a transfer of an enterprise.
Although the Supreme Court decisions should somewhat curb the tax authority’s enthusiasm for excessive application of transfer of an enterprise provisions and help assure property buyers that they are not unintentionally purchasing an “enterprise”, the tax authority has continued to issue preliminary assessment decisions in defiance of the Supreme Court’s guidelines. How to proceed in these cases is one of the topics at our tax law business breakfast on 22 October 2013.
2. Amendments to the Taxation Act
New amendments to the Taxation Act (TA) entered into force on 1 July 2013, notably shortening the limitation period for assessment and collection of taxes and broadening the tax administrator’s rights in delivery of documents and notices.
The tax authority previously had the right to assess amounts of tax up to six years after an established intentional breach of tax provisions, but this period is now reduced to five years. The limitation period for compulsory execution of tax liabilities incurred after 1 January 2014 is cut from seven years to five. Liabilities incurred before that date remain subject to the 7-year term of execution. The tax authority’s opportunity to suspend limitation by procedural acts is also reduced and any act towards compulsory execution will no longer result in suspension of expiry.
Shortening and harmonising limitation periods appears reasonable, as the probability of successfully assessing transactions six years back was rather low even before the amendments and the tax authority will now be able to better target higher-yield issues such as combating VAT fraud, instead of investigating hopeless cases. It is also clear that if the state has not succeeded in recovering taxes due over five years, the likelihood of success will not increase by the sixth or seventh year.
The second significant amendment affects delivery of documents. The tax authority is now entitled to send documents by e-mail without the taxable person’s prior consent or deliver documents through the e-Tax Board portal. However, this will not mean that documents sent by e-mail or to the e-Tax portal are deemed delivered in lieu of the taxable person’s reaction. A document is not considered delivered until the taxable person has confirmed receipt or opened the document in the e-Tax Board. The tax authority can now also receive and send notifications by e-mail or mobile SMS. Hopefully, the tax authority will not abuse this right to spam taxable persons with irrelevant information.
The procedure for mailing documents is also amended – whereas previously only documents sent by registered mail to a company’s registered address were considered delivered, the tax authority may now also deliver documents to a mailbox at an address notified to it. We strongly recommend companies to attach importance to their mail management policy. This is vital to avoid situations where the tax authority has a registered mail notification delivered to a mailbox at a company’s registered or notified address and calculates the term for appeal against its administrative act from the date of delivering the notification. To avoid issues with the term of appeal, which is usually 30 days, companies should have their mailboxes checked regularly.
Another significant amendment is the requirement for foreign companies to submit the name and identification or registry code of a shareholder upon registration of a permanent establishment in Estonia. For persons with no identification code, the date of birth may be indicated. In relation to international agreements, a new provision stipulates that in case of conflicts between tax law regulation and international agreements, the latter will apply. Previously, the law allowed only international agreements ratified by the Parliament of Estonia (in Estonian: Riigikogu)to supersede national tax law.
A number of other amendments of lesser importance were also made: these are available here (in Estonian). The explanatory memorandum to the amendments is available here (in Estonian).
Amendments related to new rules concerning establishment of a register of employment should enter into force in early 2014. We will cover those amendments in detail in our next newsletter.
3. Increasing taxation pressure on work abroad
The tax authority is increasingly focusing on the taxation of Estonians working abroad. Improved information exchange between tax administrations means the Estonian tax authority can more efficiently target situations where taxes have been avoided in both countries or paid in significantly lower amounts than required by laws and tax agreements. Unfortunately, the tax authority’s campaign has also resulted in attempts to squeeze blood from a stone and impose excessive and unwarranted taxes.
At the end of 2012, the Supreme Court issued a decision explaining the permissibility of treating employment abroad as business trips, the principles of taxing employee-related expenses as fringe benefits in Estonia and the division of social tax obligations between Estonia and other countries.
The complainant in the case was a company that recruited employees in Estonia and sent them to work in Latvia and Finland under the cover of business trips. The tax authority concluded that the company had in fact been leasing staff to Finnish companies. The lower courts found that the assignments did not qualify as business trips and daily allowances paid to employees should be taxed as income from employment. The main consideration was that contracts of employment indicated Narva as the place of employment, with a possibility for job assignments in other Estonian locations or abroad. The court found that as the possibility to be sent for work abroad had been set out in the agreements, employees’ work abroad did not qualify as business trips. After analysing the circumstances of the case, the courts also found that the parties’ intent had been to conclude fixed-term employment contracts for work abroad. According to the court, Estonia could not be considered the principal place of work even if the employees had also worked in Estonia for short periods.
The courts did not expressly exclude payment of tax-free daily allowances in cases where employees are not recruited for immediate dispatch for work abroad and employment contracts do not expressly mention the possibility of work abroad and if most of the work is in fact performed in Estonia. If an employer wishes to pay allowances to employees performing assignments in other countries, those assignments must be real business trips, i.e. situations where an employee is irregularly sent on an assignment abroad. However, if the original intent was to have the employees work in another country, payment of tax-free daily allowances is hardly justifiable.
Although the courts found that tax-free allowances may not be paid to employees, they disagreed with the conclusion that all payments to all employees should be subject to Estonian social tax. Social tax is usually charged in the country of employment, so that in this situation Estonia did not have the right to tax the same payment with social tax a second time. An exception to this rule is the situation where the Social Insurance Board, acting upon the employer’s request, has issued assignment certificate Form A1 (E101) to employees, indicating that the person working abroad remains insured in Estonia and will pay social tax in Estonia.
In the case in question, some employees had been issued with the form and some had not, yet the tax authority decided also to tax the payments for which tax liability was incurred in Finland. The courts did not agree and the notice of assessment was disallowed for social tax on persons without an assignment certificate.
The Supreme Court also ruled that an employer’s expenses on visas and work and residence permits for assigned persons were not fringe benefits but business expenses. On the other hand, compensation for employees’ travel insurance was regarded as a fringe benefit. The court noted that business expenses only cover insurance that is compulsory by law, which the travel insurance in question was not. These considerations should also be noted when sending employees on assignments abroad.
As work abroad is currently under the tax authority’s spotlight, more court judgments in related issues can be expected soon.
4. Interest on overpaid taxes – money that needs to be brought home
It is quite well known that late payment of taxes involves an interest obligation of 0.06% a day, i.e. almost 22% a year. For corporates this interest is taxable with corporate income tax so that the effective interest rate is close to 28%. However, it is much less well known that the tax authorities might also be obliged to pay interest to taxpayers.
The obligation arises in respect of court disputes where the taxpayer pays the assessed tax amount at the beginning and later wins the case. E.g. in the Sylvester’s ex-shareholders dispute the tax authorities had to pay interest of over 11 million euros.
Even fewer taxpayers expect to receive interest in the regular monthly input VAT refund procedure. The tax authorities have 30 days to fulfil a taxpayer’s claim for a refund. In practice this deadline is often prolonged by the tax authorities. This should be especially familiar to exporters who have the right to deduct input VAT and who sell goods at the 0% VAT rate. E.g. this is the case with dealers in timber, grain etc. who export to Scandinavia or elsewhere.
It is useful to know that the tax authorities have to pay interest for every day that follows the 30-day deadline. This interest obligation arises regardless of the prolongation being legally correct. Interest has to be paid regardless of whether the applicant wants it to be refunded to their bank account or set off against other tax obligations.
The obligation to pay interest as described lies on the tax authorities. Unfortunately, the tax authorities often do not pay interest. If necessary, with the help of your legal counsel you should remind the tax authorities about their obligations to pay your rightly earned interest.
5. Planned changes to the Income Tax Act and Value-Added Tax Act
The Government ignored specialists and interested parties in initiating draft laws that will significantly change taxation of the purchase and use of an employer’s automobile. Draft laws will also change the requirements for filing VAT declarations.
One of the draft laws amends the Income Tax Act, the aim being to tax use of an employer’s automobile for personal needs as fringe benefits in the sum of EUR 256. The price would not depend on whether the employee drove the automobile for personal needs for 10 or 10 thousand kilometres. Additionally, the draft law aims to abolish the possibility of giving EUR 64 tax-free compensation to employees as compensation for using their personal automobiles for employment related use without keeping driving records. If the amendments come into force, it will be obligatory to keep records about use of personal automobiles to qualify for tax-free compensation.
Planned changes to the Value-Added Tax Act foresee that upon purchase (or use under an operational lease for the whole period) of an automobile used for business purposes, only 50% of the VAT paid can be deducted, with a cap of EUR 2000. Additionally, while buying goods and services related to an automobile used for business purposes, only 50% of the VAT paid will be deductible. The draft has come under intense scrutiny from the public and professional organisations.
The draft law also imposes a new form to the VAT declaration, on which data about all invoices which exceed EUR 1 000 per business contact must be shown in detail. That draft has also been not very welcome among honest taxpayers, since it places a disproportionate administrative burden on them.
The changes in the Income Tax Act are planned to be effective as of 1 Jan 2014, the regulation about use of an employer’s automobile for personal needs and the Value-Added Tax Act as of 1 July 2014.
6. Recent tax law publications and articles
- Estonian Corporate Tax System: Advantages and Specifics
- Main comparative corporate tax principles for the SORAINEN Baltics and Belarus – SORAINEN Tax Card 2013
- Transfer Pricing International Journal: Latvian developments