Estonia: Taxation Of Transfer Prices In Estonia As Of 1 January 2007

Introduction

Transfer prices mean the prices of goods and services between transactions with parent companies and subsidiaries or so-called associated companies. Although the Estonian Income Tax Act has included a basis for taxation of transfer prices already for years, this possibility has virtually not been used in Estonia until now.

As of 1 January 2007, amendments to the Income Tax Act became applicable which expand the possibilities for taxation of transfer prices.

Among other things, provisions of the Income Tax Act concerning the taxation of transfer prices are applicable irrespective of a person with whom an Estonian sole proprietor or legal person makes transactions. Before 1 January tax would be levied only from the transactions made by the sole proprietor or legal person with natural persons or non-resident. The aim of this amendment is to take into consideration the practice of the European Court of Justice. In its decision C-324/00 Lankhorst-Hohorst GmbH v Finanzamt Steinfurt the European Court of Justice said that the regulation which will make difference between the persons on the bases of their legal status while levying tax is violating the principle of freedom of establishment and principles of free movement of goods and services and therefore it is in conflict with the principles of common market.

In addition, provisions were incorporated in the Income Tax Act according to which a tax authority is granted the right to demand a resident legal person the additional data for determination of the market value in respect of transactions made with related parties and the structure and activities of the group to which a resident company belongs.

Along with those amendments to the Income Tax Act, regulation No 53 of the Minister of Finance of 10 November 2006 "Methods for determination of the value of transactions made between related parties" entered into force on 1 January. The regulation sets out more detailed methods for determination of the market value and also established additional requirements for documentation of transfer prices. Such documentation requirements arise, among other things, from the "Code of Conduct on transfer pricing documentation for associated enterprises in the European Union", approved by the European Council on 20 June 2006.

The documentation requirements established by the Minister of Finance are not applicable to all Estonian taxpayers, instead they concern only:

• resident credit institutions, insurance companies and listed companies;

• resident companies with 250 employees, including related parties or whose turnover in the financial year before the transaction in respect of the related parties was 50 million euros or more, or whose consolidated balance volume was 43 million euros or more; and

• transactions where one party is a person located in a territory where a low-rate tax is applicable.

In the case of those events, the taxpayer has to document the transactions containing transfer prices, by preparing two so-called files:

• documents concerning an international group, which comprises the masterfile;

• documents concerning an Estonian resident legal person and its transactions, which is comprised of country specific documents.

The comprised documents must allow the tax authority to be convinced that the taxpayer had a reason to believe that the transfer price corresponds to the market value. As a rule, a term of at least 60 days is granted for the preparation of documentation and its submission to the tax authority during fiscal control, but it is recommendable to certainly prepare it on an on-going basis, during the conclusion of transactions.

However, the limited circle of subjects of documentation requirements, established by the Minister of Finance, does not mean that the taxation of transfer prices would not necessarily concern persons who are not covered by the documentation requirement. The requirements for taxation (not documentation) of transfer prices provided for in the Income Tax Act are applicable to all legal persons and sole proprietors. However, pursuant to the general principles, the burden of proof has been fulfilled by a taxpayer if such documentation requirements are satisfied. If the documentation on the formation of transfer prices and underlying circumstances has been prepared correctly, the burden of proof relating to taxation of transfer prices is conveyed to the tax authority. For this purpose, the fulfilment of clear documentation requirements should give the tax authority some certainty that the prices in the case of in-group transactions have been determined correctly.

Since it is estimated that 60% of international trade is performed through international companies, the issue of transfer prices has attracted ever increasing attention across the world over the last few years. In Estonia, where the retained profit of a legal person is not taxed with income tax, the interest has been smaller to hide the actual values of transactions. Undoubtedly, the Estonian tax authority is going to draw more attention to the taxation of transfer prices, incl. also with a view to participating effectively in the cooperation for avoidance of double taxation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.