Estonia: Estonia Abolishes Corporate Income Tax

Estonian Parliament adopted on December 15, 1999 a new Income Tax Act which became into force on January 1, 2000. On June 14, 2000 the law was amended whereby a number of drafting mistakes caused by great time pressure at adoption were corrected.

The most important change effective from January 1, 2000 is that the income of Estonian companies is no longer taxed on the condition that it is invested within the company.

Instead the legislator chose to tax more stringently payments away from the companies (excluding of course payments in the normal course of business between Estonian companies and "non-offshore" foreign companies). For this purpose the legislator included new or improved considerably several specific tax rules, few of which are described below.

Low tax territories are foreign countries or parts thereof, where no tax or a tax lower than 2/3 of the Estonian tax applicable to business income of Estonian individuals, has been established for taxing income earned or distributed by legal entities.

Persons situated in low tax territories, but receiving more than 50% of their annual income from the production or sale of goods, transportation, communication, housing services and insurance activities or chartering ships registered in such territories are not considered to be situated in low tax territories. Persons situated in low tax territories but being subject to a tax higher than described above are treated as situated outside respective low tax territories.

Government of Estonia has adopted a list of 27 countries and territories which are automatically excluded from being a low tax territory.

Any services provided to Estonian residents by legal entities situated in low tax countries, are taxable at the rate of 26% all of which must be withheld by the payer of the services fee. This rule applies irrespective of where the services are provided i.e. services provided outside Estonia are also taxable by Estonia.

Any income earned by such legal entities, is taxed by Estonia, provided that the legal entity is controlled by Estonian residents and regardless whether the entity has distributed its income or not.

Such legal entities are considered to be under the control of Estonian residents if the latter own individually or jointly, directly or through related persons at least 50% of the shares, votes or rights to profit in such low tax territory legal entities.Income of such foreign legal entities is considered taxable income of an Estonian resident, if in addition to the control by Estonian residents, a particular resident owns at least 10% of the shares, votes or rights to profits in such person.

Estonian Companies pay income taxes at the rate of 26/74 upon all dividends paid to or other profit sharing arrangements with individuals and non residents.

In addition, the same amount of tax is payable upon payment of any sums or upon any other benefits to persons entitled to a share of profits. Such benefits can be for example sale or exchange of assets or services for a price lower than market price and purchase of assets or services for a price higher than market price etc.

Tax department is entitled to revaluate transactions between Estonian companies/ non-residents related to each other and Estonian companies/resident individuals related to each other on the basis of similar transactions between unrelated parties. In such cases either the income that the tax payer would have received or the cost that the taxpayer would have carried if the correct values would have been used, is taxed at the rate of 26/74.

Estonian companies pay income taxes at the rate of 26/74 on top of all costs not related to its business and any other payments not related to its business. For example the following costs and the following payments are unrelated to the taxpayers business:

• payments with regard to which a taxpayer does not have an original invoice;
• costs for purchasing of services not necessary for taxpayers business;
• acquisition of property not necessary for taxpayers business;
• acquisition of securities or shares issued by legal entities situated at low tax territories (unless such securities meet the standards set in the Estonian investment fund regulations for allowed securities or in case the acquirer is a resident credit institution);
• payment of late payment fees or liquidated damages without judgement by courts or arbitration to legal entities situated in low tax territories (unless payments are made by resident credit institutions to similar institutions situated in low tax territories); and
• lending or making prepayments or otherwise acquiring claims against legal entities situated at low tax territories (for resident credit institutions it is allowed to acquire claims against legal entities situated at low tax territories, however taxes at the rate of 26/74 are payable if the credit institution makes losses out of transfer of release of such claims).

Persons who are obliged to pay taxes under sections 3-4 herein and upon payment of fringe benefits, making of gifts, donations and reception costs, must prepare income tax declarations and pay taxes with regard to the last calendar month by the 10th day of the next calendar month. This means that the taxing period is changed from more usual year, to a calendar month.

In conclusion, Estonian business circles and government are very excited about the courageous initiative of abolishing corporate income tax. Hopes are high with regard to attracting new business into Estonia. Although the governmental promotional work has started rather slowly, Estonia welcomes foreign investors more attractive than ever. The fastest decision makers have already increased production in their Estonian subsidiaries.