It would be correct to say that the real estate arena has been the most rapidly developing market in the Baltics over the past few years, and one could also say that so far tax legislation has been rather favorable for foreign investment into real estate located in the Baltics.
Heretofore, the application of corporate income taxes was limited to direct real estate transfers, while the transfer of the shares in real estate companies was exempted from the tax (with some exceptions for Estonia). For investors it was rather common to have a holding structure in which a non-resident entity acquires and disposes of shares of the local real estate holding company.
However, the increasing number of successful cross-border real estate deals has delivered a sharp message to alert local governments, who are obviously not pleased to see large profits from real estate transactions being repatriated abroad without having paid any taxes locally.
Estonia was the first to react. Amendments to the Law on Income Tax, effective from 2007, opened the hands of Estonian tax authorities. Accordingly, any gain realized by a foreign undertaking from a transfer of shares in an Estonian company is taxed if the majority (over 50 percent) of assets held by the Estonian company consisted of real estate during the 2 year period preceding the year of the transfer. The investor must also have held at least 10 percent in the Estonian company.
It did not take much time for Latvia to react, either. The laws allowing taxation of share transfers in real estate holdings were included in the so-called 'anti-inflation package' and came into effect this summer. According to the amended law, a 2 percent corporate income tax applies to the sale of shares in a company that in either the year of alienation or the previous year had more than 50 percent of its assets directly or indirectly consisting of real estate located in Latvia.
So far Lithuania remains the only country that does not impose corporate income tax on transfer of shares in companies holding real estate in the country. However, taking into account the experience of its neighbors, and the needs of additional budget funding, the possibility of such a tax in the near future cannot be ruled out.
Obviously, current and anticipated changes in the domestic laws of the Baltic states will encourage foreign investors to plan and monitor their tax costs.
The tax treaties may offer some tax optimization possibilities. All three Baltic countries have a rather wide range network of tax treaties that are usually concluded under the OECD model tax treaty. Although in most of the tax treaties Lithuania, Latvia and Estonia opted for the possibility to apply corporate income taxes on share transfers in real estate holding companies, some of the tax treaties still protect investors from such taxation.
Therefore, the location where the company holds shares in Baltic real estate companies may limit the application of local corporate income taxes and, thus, reduce tax costs.
Tomas Davidonis is a senior associate at Sorainen in Vilnius