What is new in the Lithuanian-Estonian tax regime?
Lithuanian and Estonian investors should be aware of two pieces of tax news. As usual, one is good, and the other is bad.
First, upon amendments to Lithuanian domestic legislation, a more favourable tax regime was established for Lithuanian businessmen to invest in Estonia. Yet a new Lithuanian-Estonian tax treaty has been signed which, after coming into force, will introduce an additional tax burden.
Inclusion of Estonia in the "White List." Recent amendments to Lithuania's tax legislation have established more favourable conditions for investing in Estonian companies. The amendments, effective as from the end of January, included Estonia in the so-called White List.
First, the inclusion of Estonia in this list results in the abolition of the controlled foreign companies (CFC) regime in respect to Estonian subsidiaries of Lithuanian companies and private investors. So far, Lithuanian entities that have subsidiaries in Estonia have faced the risk of having profits of their Estonian subsidiaries taxed in Lithuania through application of the CFC regime.
Also, due to the inclusion of Estonia in the White List, a more beneficial tax treatment has been granted to private investors 's Lithuanian residents holding shares in Estonian companies. Henceforth, dividends received by Lithuanians from Estonian companies are subject to a 15 percent dividend-tax in Lithuania. Previously those dividends were subject to the tax at a rate of 33 percent.
New Tax Treaty. However, investors should be aware of the new Lithuanian-Estonian tax avoidance treaty that, after becoming law, will establish a less favorable regime compared with the one established by the current treaty of 1993. The new treaty, initiated by Lithuanian authorities, was signed by the countries' representatives on Oct. 21, 2004. The treaty is expected to come into force in 2005. If it does, the provisions regarding withholding taxes will be applicable from Jan. 1, 2005, and in the case of other taxes covered by the treaty 's from Jan. 1, 2006.
The new treaty abolishes the 0 percent regime for withholding taxes established for dividends payable at the corporate level, royalties and interest. In the case of dividends, the new treaty should not affect the regime applicable to major corporate investors, since both countries have implemented the EU Parent Subsidiary directive (90/435/EEC) abolishing dividend taxes for associated enterprises. However, establishment of a right for the source country to tax interest and royalties might affect respective transactions, since both countries provide withholding taxes on royalties payable to foreign entities: in Lithuania 's 10 percent, and in Estonia 's15 percent.
Further, Lithuanian companies paying royalties and interest to associated Estonian companies should be aware that Lithuania has been granted a six-year transitional period in terms of the Royalties and Interest Directive (2003/49/EC). Therefore, royalties and interest received by Estonian companies from Lithuania may still be taxed in Lithuania, even though the parties to the transaction qualify for the Royalties and Interest directive. Thus, pursuant to the new treaty, interest or royalties paid by Lithuanian companies to Estonian companies will be taxed in Lithuania at a rate of 10 percent.
Estonia has implemented the Royalties and Interest Directive. So royalties paid to Lithuanian companies that qualify for the Royalties and Interest Directive will not be taxed in Estonia. As a rule, interest paid by Estonian companies to foreign companies is not taxed at all in Estonia.
Consequently, inclusion of Estonia into the Lithuanian "White List" will facilitate investments from Lithuania into Estonian companies by abolition of the CFC regime and reduction of the dividend-tax for private investors.
However, the anticipated treaty will abolish the favorable tax regime by establishing withholding taxes in Lithuania for certain payments to Estonia.