TAX PROFILE, ESTONIA (published in BNAI's Global Tax Guide) Kaido Loor and Elvira Tulvik Estonia Pärnu mnt 15, 10141 Tallinn phone +372 6 400 900, estonia@sorainen.com Latvia Kr. Valdemāra iela 21, LV-1010 Riga phone +371 67 365 000, latvia@sorainen.com KEY FACTS Main tax rates Corporate tax rate: 21% VAT standard rate: 20%, reduced rate 9% Personal income tax top rate: 21% Population/GDP Population: 1.34 million GDP: USD 20 billion (approx EUR 15 billion) (2010) Currency Lithuania Jogailos 4, LT-01116 Vilnius phone +370 52 685 041, lithuania@sorainen.com Belarus ul Nemiga 40, 220004 Minsk phone +375 17 306 2102, belarus@sorainen.com ISO 9001 certified www.sorainen.com Estonian kroon, abbreviated here to EEK, replaced by the euro, abbreviated here to EUR, as of 1 January 2011 Membership of economic groups European Union (EU), World Trade Organization (WTO) Major industries Retail and wholesale business, manufacturing, banking, tourism, transit services, forestry Website of tax/finance authority http://www.emta.ee Tax Authority http://www.fin.ee Ministry of Finance INTRODUCTION Estonia provides a unique corporate income taxation system as resident companies (and permanent establishments of nonresident companies) do not pay income tax on retained or reinvested earnings. The corporate income tax (CIT) obligation is deferred to the moment of distributing profits. CIT is levied at the gross rate of 21% on profit distributions, dividends, gifts, fringe benefits, other nonbusiness expenditure, and excessive capital reductions made by companies. RECENT DEVELOPMENTS Amendments to the Estonian Income Tax Act applicable from 1 January 2011 are: The definition of a permanent establishment was broadened to include non-fixed places of business (eg, a mobile office). It was clarified that income earned through a permanent establishment is taxed at the moment when it is transferred out of the PE. The exclusive list of persons considered affiliated persons for income tax persons was replaced
by a non-inclusive list and a broad definition that persons are affiliated if they have common economic interests or dominating influence over one another. Tax relief on gifts and donations was made available to non-residents. Religious organisations must now be entered into the list of non-profit organisations with tax relief, instead of benefiting from the relief automatically. Benefits provided to employees by any company belonging to the same group with the employer will be considered fringe benefits. Share options to employees are to be taxed on realization and never on issue. Share options are not taxable if the period between issue and sale is at least three years. If at least 50% of a person s activities are real economic activities, or if a person s state provides the Estonian tax authorities with information on the person s income, then that person is not to be considered as located in a tax haven. Private persons are now obliged to inform the tax authorities of changes in their tax residence. Private persons can benefit from tax relief on investments in securities until profit is realized, provided that the securities are held on a separate bank account. Amendments to the Value Added Tax Act applicable from 1 January 2011 are: VAT reverse charge is to be applied to internal supply of taxable immovables and scrap metal. Small businesses (with annual turnover of less than EUR 200 million) are eligible for cash based VAT accounting on internal supply. Under certain conditions the taxable value of imported goods that have initially been subject to a customs procedure other than importation, may be lower than their value at the moment of arriving in the customs territory. CORPORATE TAXES General outline Estonia provides a unique corporate income taxation system as resident companies (and permanent establishments of nonresident companies) do not pay income tax on retained or reinvested earnings. The corporate income tax (CIT) obligation is deferred to the moment of distributing profits. Therefore, to the extent that profits are not distributed, there is no CIT obligation for resident companies. CIT is levied at the gross rate of 21% on profit distributions, (dividends, gifts, fringe benefits, and other nonbusiness expenditure and excessive capital reductions) made by companies. There are no traditional thin capitalisation rules. Taxable persons, within the meaning of the Income Tax Act, are legal persons including public limited companies, private limited companies, general partnerships, limited partnerships, commercial associations, and nonprofit organisations and foundations. Nonprofit organisations and foundations are not allowed to distribute profit. However, income tax is imposed on fringe benefits and gifts distributed by these entities. A benefit of the unique Estonian CIT system is that there is no need for depreciation/amortisation rules. However, the outcome is the same as if there was unlimited depreciation for tax purposes. For the same reason there are no limits on carry forward of losses. The taxable period is the calendar month. Distribution subject to income tax 2
The following distributions are subject to income tax under the Income Tax Act: Fringe benefits granted to employees incur income tax liability for the employer. As a general rule, resident legal persons pay income tax on all gifts, donations, and costs of entertaining guests on which personal income tax has not been withheld, or corporate income tax paid in connection with fringe benefits. A resident company (including a general or limited partnership) must pay income tax on profit distributed as dividends or other profit distributions in monetary or nonmonetary form, with distribution triggering the obligation to pay tax. Income tax is not charged on profit converted to share capital by way of a bonus issue. Payments made on reduction of share capital or contributions, purchase of own shares, or liquidation of a legal person to the extent the payment exceeds contributions are subject to income tax at the company level, with some exceptions. Transfer pricing: if the price in a transaction between a resident legal person and a nonresident or natural person associated with the resident legal person differs from the price in similar transactions as between unassociated persons, the tax administrator may, in determining income tax, use the price in transactions applied by unassociated independent persons under similar conditions. A resident company must pay income tax on expenses and payments not related to business except where income tax has been paid on such expenses or payments under other provisions of the Income Tax Act. Corporate tax rates The tax rate is 21%. Capital gains taxes Thanks to the unique Estonian CIT system there is no special capital gains tax. Capital gains are taxed with CIT upon profit distribution. Income tax is charged only on gains derived by a nonresident from sale of shares in a real estate company if the nonresident's holding in that real estate company is or exceeds 10% and more than 50% of the latter's property is directly or indirectly made up of real estate located in Estonia in any preceding two years. No income tax is charged on a share deal if DTT allows taxation of capital gains in the seller's country only. Position of losses In the unique Estonian CIT system there is no need for special loss carry forwards for tax purposes. However the outcome is the same, as losses could be carried forward for an unlimited period in a conventional CIT system. Group treatment There is no group taxation regime as taxation does not depend on a combination of earnings and losses. WITHHOLDING TAXES Position of resident companies As mentioned below, income tax is collected by way of withholding tax generally at a rate of 21%. As an exception, a tax rate of 10% applies to royalty payments, remuneration for artists and sportsmen, as well as to payments to nonresidents for services provided (except by an offshore entity) in 3
Estonia. Withholding tax rates may be reduced by double taxation treaties. Position of nonresident companies Nonresident companies are generally taxable in Estonia only on income attributable to immovable property or a permanent establishment in Estonia. DIVIDENDS, INTEREST AND ROYALTIES Dividends Since Estonia's membership of the EU, withholding tax is not imposed (in addition to CIT payable at Estonian company level) on distribution of dividends paid to nonresidents (also including nonresidents of non EU countries). Interest Interest paid by an Estonian resident to a nonresident legal and natural person is not subject to withholding tax. Withholding tax can only be imposed on interest if the interest rate paid substantially exceeds the rate of interest receivable from a similar debt instrument on the market. Royalties Nonresidents are liable for income tax on profits derived from a commercial lease involving immovable property located in Estonia or movable property entered into a register or used in Estonia. In addition, income tax is imposed on a number of other payments, including royalty payments for use of intellectual property rights. Since Council Directive 2003/49/EC has been fully implemented in Estonia, royalties paid by a resident legal person are not subject to withholding tax if the beneficial owner and resident legal persons are associated companies and are incorporated in the EU. In order to benefit from exemption, the beneficial owner should have a direct minimum holding of 25% in the capital of the resident legal person for a period of two years. On the other hand, withholding tax would not be imposed if a resident legal person has a direct minimum holding of 25% in the capital of the beneficial owner. See Table 1 for treaty withholding tax rates. INDIRECT TAXES VAT/GST: main and reduced rates, exemptions The VAT rate is generally 20% on taxable supply. For the supply of certain goods and services, the law prescribes lower rates. A VAT rate of 9% applies mainly to the following: insurance services, including insurance services provided by insurance brokers and insurance agents, and reinsurance; 4 books and periodicals; medicinal products, medical equipment, or medical devices; and accommodation services. The VAT Act also envisages a 0% VAT rate for certain types of supply. Certain types of supply are exempt from tax. In particular, VAT is not imposed on supply of the following goods and services:
leasing or letting immovables or parts thereof, with certain exceptions; securities; and organisation of gambling, including lotteries and lottery tickets. Other indirect taxes Other indirect taxes are excise duty and customs duty. PERSONAL TAXES Domicile and residence requirements For the purposes of the Estonian Income Tax Act, a natural person is a resident of Estonia if he or she has a permanent place of residence in Estonia or stays in Estonia for 183 days or longer during a period of twelve consecutive calendar months. Resident natural persons must pay income tax on their worldwide income. If a double taxation treaty applies, income tax paid abroad may in most cases be deducted from income tax payable in Estonia. Main rates and bands The income tax rate for natural persons is a flat 21% rate, and the taxation period is one year. As an exception, income from voluntary pension insurance is taxable at a rate of 10% in certain cases. Dividends There is no PIT on dividends received by Estonian resident natural persons from Estonian resident legal persons. PIT is charged on dividends received by Estonian resident natural persons from nonresident legal persons. PIT is not charged on such dividends in any of the following situations: Income tax has been paid on the share of profit on the basis of which the dividends are paid. Income tax on dividends has been withheld in a foreign state. Social security/national insurance payments A flat rate social security tax of 33% is payable by employers on gross salary. The employer also pays unemployment contribution of 1.4% and withholds the employee's unemployment contribution of 2.8% from gross salary. The employer withholds contributions to mandatory funded pensions at a rate of 2% of gross salary. These contributions are mandatory for employees born in 1983 or later. However, contributions to the mandatory funded pension scheme are temporarily suspended from 1 June 2009 to 31 December 2010. TRANSFER PRICING AND ANTI AVOIDANCE RULES Transfer pricing rules (documentation requirements, APAs, etc) Transactions between related parties should be conducted on an arm's length basis. There are five transfer pricing methods in use: comparable uncontrolled price, resale price, cost plus, profit split, and transactional net margin. A preliminary ruling cannot be sought for transfer pricing transactions. Anti avoidance provisions 5
There is a general substance over form rule that has been applied with limited success. Measures to combat erosion of the taxable base through payments to low tax countries include the following: Fees paid to companies resident in low tax territories for services to Estonian residents are subject to a 21% withholding tax irrespective of where the services were supplied or used. Various payments made, or benefits provided, to recipients resident in low tax territories are regarded as nonbusiness expenses for CIT purposes. Income tax liability is incurred by the payer acquiring securities of, shares in, or claims against, or issuing loans to a company in a low tax country. Income tax is imposed on all income received for services of a nonresident in a low tax country supplied to a resident. Thin capitalisation/other interest deductibility rules There are no traditional thin capitalisation rules, that is, substantial debt financing with market rate interest is tax neutral. Controlled Foreign Company (CFC) rules The Estonian Income Tax Act contains special controlled foreign companies (CFC) provisions with regard to taxation of income earned by legal entities established in low tax territories ( offshore ) but controlled by Estonian resident natural persons. Such income is considered income of Estonian resident natural persons and is subject to income tax in Estonia. Estonian residents are considered to exercise control over a company located in a low tax territory if they individually, jointly, or through associated persons hold at least 50% of the shares of that offshore company. Income of offshore companies controlled by Estonian legal persons is not taxed in Estonia. A territory is considered a low tax regime if the tax rate charged on profits earned or distributed amounts to less than 7%. However, this rule does not apply if it can be established that a company located in a low tax territory actually earns most of its annual income by way of production, trade in goods, or by supplying other services listed in the Act. The Estonian Government publishes a white list which lists all countries not considered to have a low tax regime (see http://www.emta.ee/?id=1783). The Tax Board also publishes an informational black list for the purpose of advising taxpayers to be careful in transactions with companies located in listed countries (see http://www.emta.ee/?id=1950). The black list is not legally binding, and the fact that a particular country is not on the black list does not mean that the CFC provisions will not apply. Tax treaties Estonia has 47 double tax treaties with the countries listed in Table 1. MISCELLANEOUS TAXES Payroll taxes There are no payroll taxes other than those described above under social security payments. Taxes on capital There is no capital tax or general wealth tax in Estonia. Taxes on property There are no taxes on property except land tax and heavy vehicle tax. Land tax varies from 0.1% to 2.5% of the cadastral value of land excluding buildings. The rate is set by municipalities by 31 January each year. Heavy goods vehicle tax is up to EUR 232 for each quarter of a year for each vehicle. 6
OTHER TAXES In addition to the taxes mentioned above, Estonia levies gambling tax, customs duty, excise duty, and some local taxes. Table 1 Tax treaty withholding rates Country Dividends Interest a Royalties b Individuals, companies c (%) Qualifying companies d (%) (%) (%) Domestic rates Companies 21 0 0/10 Individuals 0 0 10 Treaty rates Country Albania 10 5 5 5 Armenia 15 5 10 10 Austria 15 5 10 5/10 Azerbaijan 10 5 10 10 Belarus 10 10 10 10 Belgium 15 5 10 5/10 Bulgaria 5 0 e 0/5 f 5 a Many treaties provide exemption for certain types of interest, for example interest paid to the state, local authorities, the central bank or export credit institutions, or in relation to sales on credit. Such exemptions are not considered in this column. b In the case of two rates, the lower rate applies to equipment rentals. c There is no withholding tax on dividends paid to nonresident individuals under domestic law; no tax is levied even where a treaty would allow it. d Usually a 25% holding is required for the reduced rates in this column. e A 10% holding is required. f The zero rate applies to interest paid to a bank (by virtue of the protocol of 2005 between Estonia and the Netherlands and the respective most favoured nation clauses of the final protocols to Estonia's treaties with France, Spain, Switzerland, and the United Kingdom. 7
Canada 15 5 10 10 China (People's Rep.) 10 5 10 10 Croatia 15 5 e 10 10 Czech Republic 15 5 10 10 Denmark 15 5 10 5/10 Finland 15 5 10 5/10 France 15 5 e 0/10 f 5/10 Georgia 15 5 g 10 10 Germany 15 5 10 5/10 Greece 15 5 10 5/10 Hungary 15 5 10 5/10 h Iceland 15 5 10 5/10 Ireland 15 5 10 5/10 The Isle of Man 0 0 0 0 Israel 5 0 5 0 Italy 15 5 e 10 5/10 Kazakhstan 15 5 10 15 Latvia 15 5 10 5/10 Lithuania 15 5 i 10 10 g The value of the (25%) holding must be at least EUR 100,000. h The lower rate applies to 1) equipment rentals; and 2) royalties for transmission by satellite, cable, optical fibre, or similar technology. i A 20% holding is required. j The treaty does not apply to income paid to exempt Luxembourg holding companies. k The zero rate applies to interest on a loan granted to an Estonian enterprise by a Luxembourg bank. 8
Luxembourg j 15 5 0/10 k 5/10 Macedonia 5 0 5 5 Malta 15 5 10 10 Moldova 10 10 10 10 Netherlands 15 5 0/10 f 5/10 Norway 15 5 10 5/10 Poland 15 5 10 10 Portugal 10 10 10 10 Romania 10 10 10 10 Serbia 5 10 10 5/10 Singapore 10 5 10 7.5 Slovak Republic 10 10 10 10 Slovenia 15 5 10 10 Spain 15 5 0/10 f 5/10 Sweden 15 5 10 5/10 Switzerland 15 5 i 0/10 f, l 5/10 Turkey 10 10 10 5/10 Ukraine 15 5 10 10 United Kingdom 15 5 0/10 f 5/10 USA 15 5 e 10 5/10 l The lower rate applies to interest on government bonds, etc. 9