TALKING TAX: Tax efficient structures in the Baltic states

  • 2006-11-22
  • by Konstantin Kotivnenko
The purpose of this article is to give a concise overview of the possible tax structures which can reduce the overall tax burden of investors in the Baltic States.

Estonia has no annual corporate income tax on re-invested profits, but there is an income tax of only 23 percent on profit. Estonia has implemented the EU Parent-Subsidiary Directive and Interest-Royalties Directive. Nonetheless, Estonia has been given a transition period until the end of 2008 to bring its taxation system in conformity with the EU Parent'sSubsidiary Directive. The current system does not comply with this directive.

The current taxation regime in Estonia is tax favorable for EU companies which can benefit from withholding the tax exemption on the distribution of royalties, interest and dividends. However, Estonia has corporate income tax anti-avoidance rules and will tax excessive payments of interest and royalties with a withholding tax of 23 percent. Transfer pricing rules are also taken into account.

With Latvian and Lithuanian income taxation principles, the income generated is subject to the same amount of tax regardless of the form of business organizations chosen. Latvia and Lithuania have an annual corporate income tax of 15 percent which is levied on profit. One of the drawbacks of the current system is that the period for the implementation of the EU Interest-Royalties Directive has been extended up to the end of 2013 in Latvia and 2011 in Lithuania, making the distribution of interest and royalties from Latvia and Lithuania to an EU company tax inefficient due to the levy of a 10 percent withholding tax.
The Tax Treaties and the law can reduce the withholding tax levied on royalties and interest to 5 percent in certain cases or even down to zero for non-related parties. Dividends under certain conditions can be distributed without tax liability in Latvia and Lithuania.

The repatriation of profits in the form of dividends is more tax efficient in Latvia and Lithuania, as the total tax burden there amounts to 15 percent, whereas in Estonia it is up to 23 percent.
EU investors can capitalize on having an Estonian company be more tax efficient with loans where, opposite to Latvia and Lithuania, the payment of interest and royalties to a EU company within the range of market values is tax exempt. In Latvia and Lithuania, a 10 or 5 percent withholding tax is applied.

When trying to limit the overall taxation burden both in the Baltic states and in the company's EU home country, domestic tax rules and the corresponding Tax Treaty in the foreign-based company's country need to be considered. In most cases, the foreign company can credit the withholding tax paid abroad at home. Making the withholding tax eventually only having an effect on the parent's cash flow position. That being said, the Baltic States may still remain an attractive location for effective tax planning.

Konstantin Kotivnenko is an attorney at law at Sorainen Law Offices in Tallinn