Sponsored by Larssen
03 March, 2014
Estonia generally is not viewed as a low-tax jurisdiction, and as such it is probably overlooked by many international investors when they are planning the most appropriate corporate structures to optimise tax in favour of more high-profile low-tax territories. However, as can be seen from the following primer, corporate and withholding taxes in Estonia are low or non-existent in many scenarios, and the country also has a great deal of other factors going for it.
Where is Estonia?
Estonia is located in Eastern Europe, and has a land area of 45,000 sq km. The country borders the Baltic Sea and the Gulf of Finland, between Latvia to the south and Russia to the east. It has a population of just under 1.3m comprising mainly ethnic Estonians (70%) and Russians (25%).
A Brief History of Estonia
Estonia secured its independence in 1918, after centuries of Danish, Swedish, German and Russian rule, but was occupied by Germany and then the Soviet Union during World War II, only becoming independent again in 1991. Since then, the Estonian authorities have sought to build ties with Western Europe, and the country became a member of both NATO and the European Union in 2004. Estonia has been a member of the World Trade Organisation (WTO) since 1999.
Estonia has a modern market-based economy and one of the higher per capita income levels in Central Europe and the Baltic region (an estimated USD21,700 in 2012 at purchasing power parity). The economy benefits from modern electronics and telecommunications sectors and strong trade ties with Finland, Sweden, Russia, and Germany
Estonia's successive governments have pursued a free market, pro-business economic agenda and have wavered little in their commitment to pro-market reforms. The current government has followed prudent fiscal policies that have resulted in balanced budgets and low public debt.
As a result of sound economic management, Estonia is seen to have made substantial progress in its recovery from the economic crisis, when the economy contracted by 3.6% in 2008 and by 14.1% in 2009, with unemployment reaching nearly one in five. Unlike countries such as Latvia, Greece and Ireland, Estonia did not receive a bailout and instead implemented substantial budget cuts upfront. The value-added tax (VAT) rate was increased from 18% to 20%, excise duties on certain products were raised, pension, sickness and unemployment benefits were adjusted and public functions were consolidated. GDP growth of 7.6% was recorded in 2011, although the rate of growth has slowed latterly, to 2.4% in 2012 and an estimated 1% in 2013.
Estonia adopted the euro on January 1, 2011, and the banking sector, dominated as it is by mainly Nordic region banks, remains in a healthy position; the International Monetary Fund noted in its 2013 report on the Estonian economy that the country's banking sector is "profitable, liquid and well-capitalised".
Swedbank is Estonia's largest bank, with SEB following behind. Danske Bank is also a major player in the banking sector. Other smaller operators include Krediidipank, DnBNord, Handelsbanken, Ãripank, and Balti Investeeringute Grupi Pank.
By sector, agriculture represented (in 2009) 2.8% of GDP, industry 23%, and services 74.5%. Key sectors include engineering, electronics, wood products, textiles, information technology and telecommunications.
Estonia was the first country to introduce a "flat tax" on income (currently 21% on personal and corporate income), an idea that spread rapidly to other parts of Eastern Europe.
Although the Government recently postponed a phased cut to the flat tax, it has stuck by its pro-investment principles and resisted pressure to raise or unflatten income tax as other countries have amid growing budget deficits.
Estonia taxes income on a worldwide basis, although businesses trading in Estonia but whose main base is not in the country only pay tax on income generated within Estonia. Corporate income tax is due on gross distributed profits at the headline rate, and at 21/79 of net dividends.
A major incentive to establishing a company in Estonia is that undistributed profits are not subject to income tax, regardless of whether they are retained or reinvested. Also, there is no tax on profit that is converted to share capital by way of a share issue.
Another positive is that anti-avoidance legislation is not as comprehensive as it is in other EU countries. For instance, there are no controlled-foreign company or thin capitalization rules in Estonia. Transfer pricing rules generally follow OECD guidelines.
Withholding tax on dividends was abolished in 2009, and the withholding tax rate for royalties and fees for entertainers and sports people was reduced to 10% in 2009. Payments to non-residents for services provided within Estonia are also subject to the 10% rate.
Where a resident of Estonia pays interest to a non-resident or legal person, this is not subject to withholding tax. Until recently, the tax authority applied withholding tax to outgoing interest payments if it was adjudged that such payments were not made at arm's length. However, Estonia abolished this provision effective January 1, 2014 following a European Court of Justice ruling.
Non-residents must pay tax on profits from a commercial lease relating to property located in Estonia, and income tax is imposed on royalties from the use of intellectual rights. However royalties paid by a resident of Estonia are not liable to withholding tax if the owner is a company incorporated within the EU. This exemption requires that the owner should have a minimum holding of 25% of the capital of the resident.
Where withholding taxes are due on cross-border payments, they may be reduced under one of Estonia's 50 double taxation treaties, which include Belgium, China, France, Denmark, Germany, Ireland, the United Kingdom and the United States.
Value-Added Tax (VAT)
The standard rate of VAT is 20% (increased in 2009 from 18%). Certain supplies attract a reduced rate of 9%, including books, some periodicals, and certain medicines and medical equipment supplies. The provision of accommodation also qualifies for the reduced rate. International services, international transport services and exports are all zero-rated.
Exemptions from VAT include insurance, postal services, financial services, health and education.
The threshold for VAT registration is EUR16,000 per calendar year.
Personal Income Tax
If an individual resides in Estonia for less than 183 days within any 12-month period, receives income from sources outside of Estonia, and has no connection with any established business based in Estonia, then tax will only be paid in the individual's home country â there is no liability for tax in Estonia. However, if an individual resides in Estonia for less than 183 days within any 12-month period but derives income from a state or local government body, or from an Estonian resident or non-resident employer in Estonia, then there is a liability to pay income tax.
Stays in excess of 183 days in any 12-month period will mean that an individual will be deemed to be a resident of Estonia and therefore liable to be taxed on their worldwide income, not just that derived from sources in Estonia.
Personal income tax is paid at a flat rate of 21%. This includes any capital gains.
Any investment income is taxed on a gross basis. Income from domestic dividends, paid to an Estonian resident, is exempt from income tax, as is interest paid by Estonian banks to residents of the country. Interest paid to an Estonian resident by a non-resident is liable for personal income tax.
Social Security Contributions
The Estonian social security system is comprised of seven schemes: health insurance, unemployment insurance, State unemployment allowances, State family benefits, social benefits for disabled people, State funeral benefits, and pension insurance.
The total rate of social tax is 33%, apportioned 20% to social security and 13% to insurance. Employers are required to pay social tax for payments made to employees.
The minimum base rate for paying social security tax is equivalent to the Estonian minimum wage, although upper limits apply to sole proprietors.
Property owners in Estonia are liable to pay an annual land tax based on the market value of the land. The rate varies between 0.1% and 2.5% and is set by the local authority. Income derived from property rentals is subject to withholding tax at the rate of 21%.
Like all other EU member states, Estonia is unable to offer tax incentives targeting certain industries, business activities or geographical areas because EU state aid rules prohibit them.
However, the Estonian government, under the auspices of the Estonian Tax & Customs Board, has established three Free Zones at Muuga Harbour (part of the Port of Tallinn), SillamÃ¤e Port and Valga, which are regarded as being outside the remit of the Customs area for purposes of import and export duties. VAT and excise duties do not have to be paid on goods brought in for later re-export.
Additionally, start-up and development grants are available through Enterprise Estonia in conjunction with funding available through the EU. Start-up grants of up to EUR5,000 are available and the business must contribute 20% of the total investment. For larger businesses (e.g. with more potential in the export market), grants of up to EUR32,000 are available, with the business contribution set at 50%. A decision will generally be made within 10 to 20 days, depending on whether the grant applied for is a start-up or development funding. For the former, the grant is available for businesses less than 12 months old: for the latter, the grant is available for businesses that have been active for up to 36 months.
Ultimately though, the fact that there is no corporate income tax on undistributed profits is seen as an incentive for new businesses to reinvest.
The Commercial Code, introduced in 1995, regulates the business sector in Estonia. Private and Public Limited Liability Companies are the most common form of business. Other company formats include General and Limited Partnerships, Sole Proprietorships, and Branches.
A Private Limited Liability Company must be entered in the Commercial Register, and a Memorandum of Association and Articles of Association must be submitted. Details in the Memorandum should include the name of the business, the trading address, details of the founding shareholders, the amount of share capital and value of shares, and details of the management and supervisory boards.
The minimum amount of share capital is EUR2,550 and the minimum shareholding EUR1. A Private Limited Liability Company must have a management board that constitutes the body that gives strategic direction to the company. Members of the board must be legal residents of Estonia, though do not necessarily need to be shareholders.
A supervisory board is required where the total share capital exceeds EUR25,000 and where the number of members of the management board is less than three. It is a requirement of the law that a Private Limited Liability Company has an auditor once the size of the company's share capital exceeds the EUR400,000 limit.
A foreign company may establish a branch office in Estonia. A branch also must be registered with the Commercial Register even though is not considered a legal business entity in Estonia. The parent company is responsible for the activities of the branch, and one or more directors may be appointed to the branch. The parent company must ensure that a branch maintains proper accounting records in accordance with Estonian accounting laws and Estonian authorities may audit a branch at any time.
Estonian Company Uses
Estonia provides a cost-efficient base for production and export and is handily placed for access to the affluent markets of the Baltic states and north-west Europe.
Estonia's corporate tax legislation and its membership of the EU free trade and fiscal areas also combine to make the country an ideal jurisdiction in which to locate a European trading company, as profits can be accumulated in the trading company tax-free. If distributed to shareholders, corporate income tax is due at the rate of 21/79, but if distributed as interest, no tax is paid.
Similarly, an Estonian holding company can be established to receive group dividend, interest and service fee income. Under the EU parent subsidiary directive, dividends paid to the parent company will be free from withholding tax as long as the parent is located in the EU and owns at least 10% of the holding company's shares. Additionally, interest paid to the parent company of an Estonian holding company will not be subject to tax unless it is not conducted at arm's length, i.e. if the interest charged is not in line with prevailing market rates.
Estonia's Advantages: In Summary
Political stability: Estonia is a democratic and peaceful state, and the country's stability and international credibility are further underpinned by its membership of the EU, the WTO and NATO.
Economic stability: Although economic growth has slowed of late, the Estonian Government welcomes foreign investment with open arms, a policy reflected in the country's favourable "flat tax" system. Sound macroeconomic management has led to a strong banking system, and while the euro has brought costs, such as labour costs, more into line with the rest of the EU, they remain broadly lower than in Western Europe.
Location: Estonia is situated at the crossroads of Eastern Europe, Russia and Scandinavia and is well connected to these territories by sea, road and air.
Tax: Corporate and personal income taxes are comparatively low and simple thanks to the introduction of a "flat tax", while corporations pay no tax on undistributed and reinvested profits. Withholding taxes are also favourable, and Estonia has a large network of double tax avoidance treaties. Estonia is therefore an ideal hub for export, trading and holding company activities.
Technology: Estonia has invested fairly heavily in telecommunications infrastructure. The birthplace of Skype, the country is also gaining a reputation for its expertise in IT, and as a hub for investment in IT-related ventures.
E-Government: Following on from the above, e-government is pervasive in Estonia, and almost all interaction with government departments and administrative agencies can be done online through various e-portals. The company registry is fully automated, documents can be filed online and it takes just one day to register a company through these "fast track" electronic systems.
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