Taking counsel: Aspects of Estonian corporate income tax

  • 2006-04-12
  • Tuuve Tiivel
Tax on real estate is obviously of interest to real estate investors the world over, and Estonia is no exception. Estonia's tax regime is generally business friendly, especially corporate tax with its flat rate of 23 percent, which is to be reduced to 20 percent by 2009, or 1 percent yearly. Undistributed profits are not subject to income tax, regardless of whether they are invested or merely retained.

To put it simply, there is no classical corporate income tax system in Estonia. Estonian companies do not pay income tax on the profit derived from their enterprise 's for example, from transactions (sale, lease, etc) related to real estate. Instead of taxation of profit earned by resident companies, actual and deemed profit distributions (usually done in the form of dividends) are taxed at 23 percent of the gross amount of the distribution.
Expenses that are not deductible in a traditional system are taxable in Estonia. These may be fringe benefits, gifts, donations and representation expenses and expenses and payments not related to business. In addition to such profit allocations ("distribution" is treated wider than direct dividend payments), transfer-pricing rules apply against hidden distributions of profits.
Under the traditional system, the starting point (the basis) for taxing profits of a company is usually a profit and loss account that is calculated according to the accounting rules and then adjusted according to the tax rules. In the Estonian system, dividends reflect the commercial profits and in addition to that, non-deductible expenses are taxed. The simple Estonian system utilizes cash-basis accounting and from a tax perspective there is no need for amortization and depreciation rules.

In terms of taxation, there is no difference between investments through Estonian partnerships and limited liability companies because they are all similarly treated tax-wise and considered non-transparent for tax purposes and subject to corporate income tax. Furthermore, the profits of permanent establishments of nonresidents are taxed in a similar manner as income of a resident company 's i.e., only on distributions or deemed distributions. However, as in the latter case there are no dividends, the direct distributions of the permanent establishment are considered to be the assets taken out of it (for tax base the input assets are subtracted).

There is also a separate (additional) withholding tax of 23 percent on dividends paid to non-resident legal entities if the recipient has less than 20 percent of the shareholding (rate shall be 15 percent as of 2007 and 10 percent as of 2009) in the distributing local company. In case there is a double taxation avoidance treaty executed between Estonia and the country where the recipient is residing, the withholding tax rate is lowered usually to 15 percent. However, similarly to the case of residents, no additional withholding income tax is charged on dividend payment received by a non-resident natural person.
In case a company's activities are financed through loans, income tax is not charged on interest received by a non-resident, if the rate of the interest corresponds to market conditions. However, from the part of the interest crossing the usual rate, the income tax of 23 percent is withheld unless there is a double taxation avoidance treaty, which lowers the tax rate to 10 percent.
With regard of the gains or income derived by a nonresident respectfully from a transfer or lease of real estate (also transferred real right or claim related to an immovable) located in Estonia income tax of 23 percent is charged.

As the gains derived by a non-resident from the transfer of securities are considered to be outside of Estonian based sources of income, such gains are not taxed in Estonia. However there are exceptions. The payments of liquidation proceeds and the ones made upon the reduction of the share capital exceeding the acquisition cost of the holding, made to a non-resident by a resident legal person, are taxed by 23 percent.
Furthermore, income tax is also charged on gains derived by a nonresident from a transferred shareholding, which represents at least 10 percent of the share capital of a company whose property, according to the balance sheet as of the last day of the preceding financial year, is more than 75 percent is made up of real estate located in Estonia. There is a draft law that will somewhat change the regulation and decrease the rate to 50 percent.

However, there is a possibility that the current corporate income taxation system may change because it has been argued that it is not in compliance with Article 5 of the EU Parent Subsidiary Directive. Though concrete steps have not been taken yet, the issue has to be resolved within the derogation period set by the accession agreement to join the EU, that is, by the end
of 2008.

Tuuve Tiivel is an advocate of Law Firm Teder, Glikman & Partners, a member of Baltic Legal Solutions, a pan-Baltic integrated legal network of law firms which includes Kronbergs & Cukste in Latvia Jurevicius, Balciunas & Bartkus in Lithuania, dedicated to providing a quality 'one-stop shop' approach to clients' needs in the Baltics.