Global Tax Alert | 22 June 2017
Estonia enacts key changes to corporate income tax rules including reduced tax rate for regular dividend payments
Income Tax Act changes have been passed in the Estonian Parliament. All the amendments to the Income Tax Act outlined below were approved by the Parliament on 19 June 2017 and will enter into force on 1 January 2018. Key changes include a reduced tax rate for regular dividend payments, increased burden of proof for intra-group lending, and a specific tax regime for credit institutions.1
Reduced tax rate for regular dividend payments
A lower income tax rate of 14% will be available for regular profit distributions compared to the standard 20% rate. Profit distributions are considered regular if the amount of the distribution does not exceed the company’s last three years’ average profit distributions subject to taxation in Estonia. The income tax rate for all amounts exceeding the last three years’ average profit distributions subject to taxation in Estonia will remain taxable at 20%. The unused portion of the right to apply the lower tax rate cannot be carried forward (e.g., when profit distributions fall below the last three years’ average taxable dividends). The first year to be included in such income tax calculations will be 2018, but to a limited extent, the 14% tax rate can be applied prior to 2021 as follows: (i) in 2019 to one-third of the 2018 taxable profit distributions; and (ii) in 2020 to one-third of the 2018 and 2019 taxable profit distributions combined. Tax-exempt dividends received from subsidiaries will not be included in lower tax rate profit distribution calculations.
Dividends paid to natural persons (including nonresident natural persons) will be subject to an additional 7% income tax withholding if those dividends have been received from an Estonian company and are subject to the 14% corporate income tax rate.
The amendments are intended to encourage companies to distribute their excess retained earnings and continue profit distributions in future periods. Companies will benefit from stable yearly profit distributions by keeping their effective income tax liability lower, recognizing that when viewing all the years together the actual average corporate income tax rate on taxable profits will always remain above 14%.
Increased burden of proof in intra-group lending
The initial draft law to establish a deposit income tax on intra-group loans was revised prior to enactment with less stringent provisions involving additional reporting requirements and the obligation to prove that parties have entered into a true loan financing relationship.
Specifically, the taxpayer (Estonian resident company as well as the permanent establishment of a nonresident in Estonia) should be able to demonstrate the capacity and intention of collecting the loan receivable with a 30 days’ notice from the tax authorities. There are no specific guidelines, however, and therefore the practice of tax authorities and courts will shape the implementation of this burden of proof.
Loans granted to shareholders are subject to corporate income tax (loan amount is treated as net profit distributed and therefore divided by 0.8 before multiplying with a 20% tax rate) if the circumstances of the loan transaction indicate a hidden profit distribution. Special attention will be given to all loans granted to other group entities in Estonia and abroad, except for down-stream subsidiaries, with a term exceeding four years.
The burden of proof will become applicable to all loans granted on or after 1 July 2017 as well as to loans for which the amount has been increased, the loan agreement has been extended or other material terms and conditions have been changed on or after this date. As of 1 January 2018, companies are also required to report to the tax authorities on a quarterly basis all loans meeting the above criteria. The first such report will be due on 10 February 2018.
Specific tax regime for credit institutions
The third major amendment in the Bill on Amendments to the Income Tax Act is to impose advance corporate income tax to credit institutions at the tax rate of 14%. The aim of this amendment is to ensure regular income tax revenues to the state budget.
The amendment will establish an advance corporate income tax obligation for Estonian resident credit institutions and Estonian branches of nonresident credit institutions (credit institutions). Tax at the rate of 14% will be calculated and paid quarterly on accrued profits.
The advance tax paid by the credit institution can be netted with the corporate income tax payable on dividend distributions. Losses can be carried forward for five years.
As from 1 January 2018, credit institutions are obligated to report their quarterly results to the Estonian Tax and Customs Board by the 10th day of the third month of the following quarter. Such payments shall be first due on 10 September 2018, calculated from the profits earned in the second quarter of 2018.
1. See EY Global Tax Alert, Estonia proposes key changes to corporate income tax rules, dated 21 April 2017.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Baltic AS, Tallinn
- Ranno Tingas
+372 611 4578
- Hedi Wahtramäe
+372 611 4570
- Jevgeni Semjonov
+372 611 4616
EYG no. 03931-171Gbl