TALLINN - Estonia's new corporate tax system will be known in a matter of months after the Finance Ministry released two draft proposals that satisfy European Commission directives. Both proposals will allow companies to avoid paying tax on profits if they are reinvested. However, one of the proposals risks raising further strife with the European Commission by doing away with tax on dividends paid by so-called "daughter" companies to their "mother" corporations.
Finance Minister Ivari Padar detailed both proposals on April 16, and said he would make his final decision before the end of June. The chosen tax system will be in place by 2009.
Estonia was forced to reconsider its corporate tax system after the European Commission raised concerns about the taxation of dividends paid between subsidiaries and their parent companies.
A European Court of Justice decision in 2001 found that a similar system operating in Greece breached EC directives because it was effectively a withholding tax.
Under the first proposal, Estonia would abolish the tax paid between subsidiaries and parent companies, and would also retain the current scheme of tax free re-invested profits. This model has long been favored by Prime Minister Andrus Ansip.
However, a Justice Ministry spokeswoman explained that such a system may create further problems.
"There is a considerable risk that the European Commission might then say that Estonia does not have a corporate tax system at all, putting us in breach of its directives," the spokeswoman said.
Under the second proposed system, a new concept of an "investment reserve" will be introduced. Companies could channel profit into an investment reserve where it will be free from tax, and would only be taxed once the money is withdrawn as a dividend.
"In principal, it would be a classical tax system. But in effect it would change the point at which the money is taxed, which would address the current problem," the Finance Ministry spokeswoman said.
The current tax on dividends between subsidiary and parent companies would be retained, however the EC concern would be alleviated because the point of taxation would have shifted.
However, the spokeswoman said this model was not without potential problems either, and could also draw further scorn from the EC. It will be up to the Commission's interpretation of the Estonian model as to whether the system is deemed to be in compliance with its directives.
Padar said the Cabinet would now consider both proposals and select the one which is least likely to raise concern with the EC.
Businesses said they were happy that the government sought to keep retained profits from being taxed, but said it was time the European Union took a lesson from Estonia.
Anders Hedman, president of the Swedish Chamber of Commerce in Estonia, said "old Western Europe" could benefit from adopting Estonia's tax model, instead of imposing changes upon it.
"In the first ten years of independence, countries in Eastern Europe were able to experiment with new ideas that were politically impossible to test in Western Europe. Now it's time for the West to look at what was achieved here and to take a lesson," Hedman said.
