Latvia suspends tax exemption for Estonian companies

RIGA - Relations between Latvia and Estonia took a tumble last week when the Latvian government reversed part of a tax treaty which gave tax exemption to Estonian companies doing business in Latvia, but which were not registered in Latvia.

Andrejs Berums, head of the tax convention division at Latvia's Ministry of Finance, said the decision to suspend part of the 1994 treaty was made in response to changes in Estonian tax law, which took effect on Jan. 1, 2000. Under the changes, companies are charged tax on payments to shareholders but not on profits.

Berums said companies operating in all three Baltic states were likely to take advantage of Estonia's more favorable tax laws and register there. "We are afraid that if we keep these exemptions, it may influence investment decisions."

Estonia's Ministry of Finance responded angrily to the Latvian letter, which it received on June 5, according to Madis Muller, an adviser to the ministry. Latvia had failed to give six months' notice of its intentions, as required under international law, he said, and had violated diplomatic protocol by failing to send the letter via the two countries' foreign ministries.

"We are ready to discuss the issue," Muller told the Baltic News Service. "But you can't unilaterally suspend an international agreement. Sanctions can be applied when such agreements are violated."

But Berums rejected such complaints. "We informed the Estonians more than a year ago of our concerns, but we avoided implementing changes immediately when consultations between the two ministries were organized. It is rather ignorant of them to delay finding a solution."

Only next year will many companies be affected, added Berums. Companies that obtained their Estonian residence permits before June 1 this year would be exempt from a Latvian corporation tax until the expiration of those certificates on Dec. 31. "Hopefully by December the Estonians will have done something to improve the situation," he said.

But for all Latvia's objections Monty Akesson, managing partner at the Ernst and Young financial consultancy in Riga, questioned whether Estonia's corporation tax system gave it much advantage.

"It is difficult to say what is good or bad," he said. "Taxing pay-outs to shareholders, rather than profits, is good for companies' cash flow, but investors have to take home their profits at some stage.

"In some cases Latvia comes out better for investors. For example Estonia's 34.2 percent tax rate on payment to shareholders is higher than Latvia's 25 percent corporation tax and Latvia is thinking of reducing that rate even further."

In addition, he said, any company with an office in Latvia is regarded as permanent and is encouraged by the authorities to register, at which point it becomes liable for corporate tax.

Latvian Finance Minister Gundars Berzins and his Estonian counterpart, Siim Kallas, may use a meeting expected in a few weeks to discuss the issue, said Estonia's Muller. An exact date for the meeting has yet to be decided.