Estonia’s unique approach to corporate taxation
In a global landscape where corporate tax structures are often intricate and vary significantly across borders, Estonia stands out for its simplicity and innovation. With its distinctive policy of imposing a 0% tax rate on retained and reinvested profits, Estonia has positioned itself as an attractive hub for businesses seeking tax efficiency.
This article aims to explain Estonia’s corporate tax framework, shedding light on the advantages it offers to both resident companies and foreign entities operating within its borders.
Exploring Estonia’s 0% tax on retained and reinvested profits
Understanding Estonia’s progressive tax system
Estonia’s corporate income tax system deviates substantially from traditional models observed globally. The hallmark feature is the absence of corporate income tax on profits that companies choose to retain and reinvest.
This signifies that both Estonian resident companies and the permanent establishments of foreign entities enjoy a unique 0% income tax rate for profits earmarked for reinvestment. However, a 20% income tax comes into play exclusively for all distributed profits, whether actual or deemed.
Defining distributed profits
It’s important to define what counts as distributed profits in Estonia. These encompass:
- Corporate profits distributed in the tax period: Any profits disbursed to shareholders during the tax period fall under this category and are subject to income tax.
- Gifts, donations, and representation expenses: Expenses related to gifts, donations, and representation are considered distributed profits.
- Expenses and payments not related to business: Payments unrelated to the core business activities of the company are included in distributed profits.
- Transfer of assets to the permanent establishment’s head office or other companies: When assets are transferred from a permanent establishment to its head office or other entities, it is treated as a distribution of profits.
Reduction in tax rates for dividends
Effective from January 1, 2018, Estonia implemented a reduction in the corporate income tax rate for regular profit distributions. The rate saw a decrease from 20% to 14%, applicable in cases where dividends are disbursed to legal persons. This reduction enhances Estonia’s allure for businesses aiming to streamline profit distribution.
Taxation of fringe benefits
Estonia adopts a straightforward approach to fringe benefits taxation – these benefits are taxable at the employer’s level.
This means that employers are obligated to pay both income tax and social tax on the fringe benefits provided to employees. This transparent system ensures clarity and fairness in the taxation process.
14-20% tax on distributed profits
Insights into variable tax rates
Dividends paid to non-residents in Estonia no longer attract withholding tax, irrespective of their participation in the share capital of the distributing Estonian company. However, it is imperative to acknowledge that various withholding taxes may still apply to other payments made to non-residents lacking a permanent establishment in Estonia.
The applicability of these taxes hinges on specific tax treaties or agreements.
Monthly tax period for corporate entities
As of 2019, Estonia transitioned to a monthly tax period for corporate entities. This alteration holds significant implications for the regular filing and payment of income tax, necessitating companies to fulfil their tax obligations monthly by the 10th day of the subsequent month.
This shift underscores Estonia’s commitment to ensuring timely tax compliance.
Tax liabilities of companies established by e-residents
Estonia’s pioneering e-residency program has garnered widespread attention, permitting non-residents to establish and manage companies within the country. When an Estonian company is formed by an e-resident, it assumes residency status in Estonia and becomes subject to income tax on its global income.
However, the taxation of this income is deferred until profits are distributed through dividend payments, offering e-residents flexibility in their international business endeavours.
Prevention of double taxation
Estonia has proactively implemented measures to prevent double taxation, safeguarding companies engaged in international operations from undue tax burdens. Key aspects include:
- Income tax abroad: If an Estonian resident company conducts business outside Estonia, the income earned in foreign jurisdictions is subject to taxation in those countries. Estonia ensures the prevention of double taxation in such instances.
- Taxation in foreign countries: When an Estonian resident company maintains a permanent establishment in a foreign country, taxation aligns with the rules and tax treaties of that jurisdiction. Estonia adheres to these agreements, averting the spectre of double taxation.
- Estonian tax residency: Being a tax resident in Estonia does not automatically absolve companies from taxation in other countries where they conduct business or generate income. The prevailing taxation rules of each country remain applicable.
Dividend taxation for e-residents
The taxation of dividends in Estonia can be intricate, particularly for e-residents who own Estonian resident companies. Key considerations include:
- Income tax on dividends: An Estonian company pays income tax on dividends at the standard rate of 20/80. In such cases, no additional income tax withholding is applicable for the distribution of dividends to natural persons, including e-residents.
- Double taxation relief: E-resident natural persons may encounter challenges in leveraging the income tax paid by an Estonian company for the purposes of double taxation relief in their home country. This is due to the divergence in entities paying the Estonian income tax.
- Lower dividend tax rates: Since 2019, dividends regularly paid by Estonian companies attract a reduced rate of 14/86. In these scenarios, an additional 7% withholding tax is applied to the dividend income disbursed to non-resident natural persons. This supplementary withholding tax often serves as a tool for double taxation relief in the recipient’s country.
How Incorporate can assist
Incorporate provides a range of financial management services to assist businesses operating in Estonia. Our services include comprehensive accounting, tax calculation, and the management of tax and customs declarations with the Estonian Tax and Customs Board.
- Accounting services: We offer professional accounting services to ensure your financial records are accurate and in compliance with Estonian regulations.
- Tax calculation: Our team of experts will accurately calculate your company’s taxes, including VAT, income tax, and social tax.
- Tax and customs declarations: We can prepare and submit various declarations, such as VAT, income tax, and social tax declarations, to the Estonian Tax and Customs Board on your behalf.
With Incorporate’s accounting financial management services, you can focus on growing your business while we handle the financial and tax aspects, ensuring compliance and peace of mind.
Contact us today to streamline your financial management.
Conclusion
Estonia’s prowess as a business hub
In concluding this exploration of Estonia’s corporate income tax system, characterised by its 0% tax rate on retained and reinvested profits, it is evident that Estonia offers a compelling proposition for businesses and entrepreneurs alike.
The commitment to preventing double taxation, coupled with transparent tax regulations, establishes Estonia as a standout choice for international operations. Whether you are an e-resident contemplating the establishment of a company in Estonia or a business eyeing expansion into the region, the business-friendly tax environment of Estonia is worth careful consideration.
FAQ
Can foreign companies benefit from Estonia’s 0% tax on retained profits?
Absolutely. Both Estonian resident companies and foreign entities with a presence in Estonia can reap the benefits of the 0% tax rate on retained and reinvested profits. This means businesses can reinvest profits without incurring corporate income tax.
How does Estonia prevent double taxation for international businesses?
Estonia has a robust system in place to prevent double taxation. When an Estonian company operates abroad, the income earned in foreign jurisdictions is subject to taxation in those countries. Estonia respects international tax treaties, ensuring that income is not taxed twice.
What is the dividend tax rate for e-residents owning Estonian companies?
The dividend tax rate for e-residents owning Estonian resident companies can vary. The standard rate is 20/80, but as of 2019, lower rates of 14/86 apply to regular dividend payments. Specific rates depend on the circumstances, and withholding tax may be applicable for non-resident natural persons.
How can Incorporate assist businesses in Estonia?
Incorporate offers a range of financial management services, including accounting, tax calculation, and the management of tax and customs declarations. We ensure your financial and tax compliance, allowing you to focus on your business’s growth.
What are the key tax obligations for companies established by e-residents in Estonia?
Companies formed by e-residents in Estonia are considered Estonian residents for tax purposes. They are subject to income tax on their worldwide income, with taxation deferred until profits are distributed as dividends.
What are the reporting requirements for Estonian resident companies conducting business abroad?
Even if an Estonian resident company avoids income tax in Estonia due to its international operations, it may still have obligations related to filing tax returns in Estonia. For example, the prevention of double taxation on dividends paid in Estonia against foreign income necessitates the filing of specific forms.
Can e-residents leverage the tax paid by Estonian companies for double taxation relief in their home countries?
E-residents may face challenges in leveraging the income tax paid by Estonian companies for double taxation relief in their home countries. This is due to differences in the entities paying the Estonian income tax.
What is the additional withholding tax applied to dividends regularly paid by Estonian companies to non-resident natural persons?
Since 2019, dividends regularly paid by Estonian companies to non-resident natural persons are subject to an additional withholding tax of 7%, in addition to the standard dividend tax rate.
What expenses are subject to taxation in Estonia, even if a company’s core business activities are outside the country?
Non-business-related expenses are subject to taxation in Estonia, regardless of the location of a company’s core business activities. This holds unless a foreign state with a permanent establishment has already taxed such expenses as part of profit.
What is the monthly tax period for corporate entities in Estonia, and how does it impact tax compliance?
As of 2019, corporate entities in Estonia are subject to a monthly tax period. This change requires companies to file and pay income tax on a monthly basis by the 10th day of the following month, enhancing the efficiency of tax compliance.
