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Estonia Abolishes Corporate Taxation

Lisa Ugur, Tax-news.com, London

13 June 2000


New in Estonia in 2000 is a revised tax regime in which corporations pay no tax other than a 26% levy on gross distributions to private individuals.

Given Estonia's generally liberal business environment, and its array of 21 tax treaties, the new legislation creates some very interesting tax planning opportunities for companies with business in those 21 countries.

Examples include:

  • Full avoidance of capital gains taxes on the sale of securities;
  • avoidance of CFC legislation (which is not normally applicable to countries having tax treaties);
  • investment holding companies (the double taxation treaty treatment of flows of dividends, royalties and interest is normally superior to what can be achieved in a non-treaty offshore jurisdiction).

Commenting on the stunning simplicity of the Estonian tax system, the Economist said: "The tax declaration, once a sheet of A 4 paper, has doubled in size to A 3."

The following article, describing the new legislation in greater depth, has been provided by:

CONSULT FINANCIAL, Estonia

Contact: Mr Pertti Rahnel, e-mail perttirahnel@hotmail.com

Corporate taxation in Estonia

Estonia is renowned for successful economic reforms, a liberal economic environment and educated people. Being situated by the Baltic sea, surrounded by the well developed Scandinavian countries, Latvia and Russia, its terrific strategic location has resulted in large trade flows and high level of foreign investments. Numerous multinational corporations have their Baltic headquarters in Estonia, as highly developed infrastructures, telecommunications, liberal developed legislation and proximity to the vast Russian markets provide good base for expansion.

Estonia is frequently trumpeted as a Baltic Switzerland due to the highly developed and stable banking system, which has been the flagship for the whole Estonian economy.

Since January 1, 2000 Estonian corporations are operating under the provisions of the new Income Tax Act. The profits of Estonian corporations are tax-exempt until the time of final profit distribution. Corporate profits are free of tax whether invested in the stock market, bank deposits, securities, fixed assets or inventory.

Estonia cannot be considered as a pure tax haven though. Rather Estonian tax legislation offers possibilities to decrease tax liabilities and to completely avoid current taxation, postponing it into the future. A significant advantage when compared to most tax havens is the existence of double taxation avoidance treaties. Currently there are tax treaties in force with 21 countries.

As mentioned earlier the main principle of Estonian corporate tax law is now the tax exemption of reinvested profits. All legal persons, including non-residents who have a permanent establishment or registered baranch in Estonia will pay tax only on dividends and other forms of profit distribution.. Profit distribution is taxed at 35 % on the net pay-out (equivalent to 26% on the gross amount to be distributed. No income tax is levied on dividend payments to resident corporate bodies though.

Interest paid to Estonian residents by Estonian banks is free from income tax. This provides a perfect opportunity for foreign investors to reap tax-free interest rate gains from Estonia. An investor would only need to set up an Estonian corporation and invest the funds into Estonian bank deposits on behalf of this corporation.

Corporations with annual turnover exceeding 180 000 kroons (22,500 DEM) are required to register for VAT, but if the corporation trades with non-residents only, it does not have to register. As a result, most interantional users are not obliged to register.

Many countries, among others United States and United Kingdom have CFC (controlled foreign corporation) legislation in force, according to which the parent companies in high tax rate countries pay tax on their offshore subsidiaries profits, whether or not they have distributed those profits to the parent. An Estonian corporation cannot be classified as a CFC or as being situated in a low tax rate country, because there still is a corporate tax in Estonia. This possibility is additionally ruled out by Estonia's tax treaties. Thus an Estonian corporation is an ideal vehicle for the postponement of a taxation liability.

Estonian corporations are inexpensive in comparison with other offshore jurisdictions which have signed double taxation treaties. The availability of off-the-shelf corporations ensures quick incorporation, which is of vital importance in some situations. The documention necessary for incorporation is similar to that of other code law jurisdictions:

  • Deed of Incorporation executed before a Notary Public;
  • Articles of Incorporation;
  • Confirmation by the bank that the share capital is held in the account;
  • Consent forms signed by the proposed directors;
  • Declaration of the applicants;
  • Application to the Commercial Register covering the above documentation, and including the notarised signature of the person appointed to represent the company.

Many users of offshore companies prefer to remain anonymous in order to protect the privacy of their financial affairs. Estonia has a public company register; however it is possible to use nominee directors and shareholders to protect the privacy of the client's financial affairs. In the case of a PLC only one director and one shareholder are required.

Applications

Tax exemption of reinvested profits provides ample tax planning opportunities for investors, high net worth individuals and corporations operating on stock exchanges in countries which have signed tax treaties with Estonia. According to the tax treaties business profits made by an Estonian company in the other treaty country are tax free, except in the easily avoidable cases where the Estonian corporation has a permanent place of business in the other country. Capital gains from the sale of common stocks, bonds, options etc. are classified as business profits under the tax treaties and therefore remain tax free.

In order to avoid permanent residence it is necessary to avoid using resident directors or signing contracts in the other treaty country. Permanent residence does not occur if the Estonian corporation employs an independent agent or broker who has other clients besides the said Estonian corporation.

Interest earned by the Estonian corporation in treaty countries is taxed by withholding tax. The tax rate is set by the tax treaties and it ranges from ten to fifteen percent depending on the specific treaty. In comparison to solutions entailing offshore companies, the treaty rates applied to Estonian corporations are substantially lower.

Corporations situated in onshore countries will find that their interest income is taxed three times - first by the withholding tax in the foreign country, then in the country of residence and finally when dividends are paid out. With adequate tax planning, the Estonian corporations are taxed only by the withholding tax rate, which is reduced by the tax treaty.

In many countries dividend payments to offshore holding companies are subject to withholding tax in addition to corporate tax. The withholding tax rate is usually higher than the treaty rate applied to shareholders resident in Estonia (e.g. Estonian corporations). Using the Estonian corporation as a holding company would result in lower taxation of the dividends compared to offshore holding companies.

An Estonian corporation can be used as a trading intermediary in a foreign trade or in intercompany trade by multinational corporations (transfer pricing). In case of export Estonian company would buy the goods from the exporter and sell them to the foreign partner, collecting the intermediary fee, which accumulates into the Estonian corporation tax free.

An Estonian corporation can also be used by professional service providers for tax planning reasons.

An Estonian company can contract to supply the services of an individual outside the country in which he/she is normally resident and the fees earned can accumulate in the company, free from taxation in Estonia. Payments to the individual can then be structured in such a way to minimise income tax.

As Estonian corporate and tax legislation is more complicated than those of the traditional offshore jurisdictions, professional tax advice and maintenance of the tax structure become vital. Quality service is quite inexpensive in Estonia though due to the generally low price level.

Estonia's Double Tax Treaties at March 2000
New Treaties
Armenia
France
Lithuania
Ukraine
Austria
Canada
Germany
Moldavia
United Kingdom
Belgium
China
Iceland
Netherlands
USA
Cyprus
Czech Republic
Ireland
Norway
Kazakhstan
Denmark
Italy
Poland
Singapore
Finland
Latvia
Sweden
Switzerland

.

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