Estonian CIT from 2021, i.e. flat rate on income in capital companies
An amendment of the corporate income tax act is planned to take effect next year. The amendment introduces a new taxation system, which is a form of a flat rate tax on income derived by capital companies, dubbed as “Estonian CIT”. According to the explanatory memorandum recently published by the Ministry of Finance, the planned regulations are intended to support entities which conduct or plan to conduct investment activities, and face difficulties obtaining external financing.
Presented below are the major assumptions of the new system of taxation. This will be a system which is planned to operate alongside the existing solutions, and optional for taxpayers.
New rules of tax settlement
Companies which decide to benefit from the Estonian CIT will not pay the monthly or quarterly tax instalments or make the annual settlements. The main benefit, and also the main difference, between the approach adopted to date and the new one will consist of payment of the income tax only upon distribution of profits to shareholders.
Also, a taxpayer who chooses to apply the Estonian CIT, will have no right to deduct a tax loss previously incurred. The tax loss can be deducted when the system is no longer used, provided that the loss is not barred by limitation.
During the period of application of the Estonian CIT, this form of taxation does not need to be reported as a domestic tax scheme under the regulations of the Tax Code governing tax scheme reporting.
Entities authorised to settle tax according to the Estonian CIT
Not all CIT payers can apply the Estonian CIT. The flat-rate tax can be used by capital companies (limited liability companies, joint stock companies), in which the total income from operations during the preceding tax year or the value of average income from operations does not exceed PLN 50 million including VAT. Additionally, potential income from passive activities (e.g. from interest, claims, sureties, guarantees, sale and exercise of rights from financial instruments or transactions with related parties, which do not give rise to added value in economic terms) will need to amount to less than half of the total income.
Companies can apply the flat-rate regulations if they meet additionally all of the following conditions:
- only natural persons are shareholders of the company,
- the company and its shareholders do not participate in equity of other companies, hold no units in an investment fund or collective investment institution, rights and obligations in partnerships, other property rights involving eligibility to receive payments as a founder or beneficiary of a foundation, trust or another entity.
- the company has at least 3 employees who are not its shareholders or close relatives of shareholders.
- the company incurs the required investment expenditure.
A company which follows the Estonian system can benefit therefrom for 4 years, and the period can be extended for subsequent 4-year periods. The extension will be possible if in the last (4th) year of applying the solution, the taxpayer still meets the above-mentioned criteria, provided that exceeding the threshold value of PLN 50 million during the 4-year period will not preclude the use of the system. In this case, the taxpayer will need to pay an additional tax at 5% of the base provided for in the regulations.
The Estonian CIT cannot be applied by those who do not meet the aforesaid conditions, and, without limitation, by financial companies, lending institutions, companies which operate in a special economic zone which are in bankruptcy or liquidation, created as a result of division or combination, and companies which benefit from the research and development or IP Box reliefs.
The Estonian CIT provides for a new way to calculate income for taxation. The taxation base will be based on the result calculated according to the balance sheet law. Thus, this is a deviation from the hitherto method of calculation of income for taxation as the difference between revenues and deductible costs in favour of a tax on profit distribution.
Taxation under the Estonian CIT will apply to income from:
- distributed profit,
- profit allocated to cover losses, if they occurred in the period preceding the flat-rate taxation,
- expenses not related to business activity,
- changes of the value of assets,
- hidden profits, i.e. payments to a related entity, in particular loans, donations and presents, entertainment expenses, or profit allocated to share capital.
The basic tax rate will amount to:
- 15% of the tax base with respect to small taxpayers and taxpayers whose average income does not exceed the maximum income specified for a small taxpayer,
- 25% of the tax base for other taxpayers.
The basic rate can be reduced to 10% and 20%, as appropriate, provided that the required investment expenditure is incurred.
Requirement of investment expenditure
Companies which choose the be taxed with the flat-rate tax will be obliged to make investment outlays – increase the expenditure on production or acquisition of brand new fixed assets included in group 3-8 of the Fixed Asset Classification (including machines, equipment, means of transport) or on fees agreed in the lease contract for such assets. Expenditure for the aforesaid fixed assets is not deemed incurred for the purpose of investment if they primarily serve to accomplish personal goals of shareholders or their family members.
The regulations will require that the outlays are increased with respect to the current initial value of fixed assets falling under group 3-8 of the Fixed Asset Classification:
- over the period of two years – by 15% (but no less than PLN 20 thousand) or
- over the period of four years – by 33% (but no less than PLN 50 thousand).
Annual tax return
A company which applies regulations concerning the Estonian CIT will need to file a return on the amount of income earned in the previous financial year by the end of the 3rd month. The return will be primarily of informative nature, because payment of the tax will be made only upon distribution of profit, and thus will be independent of filing the return. The taxpayer will only need to inform about the sum total of income derived in successive months of the tax year for which the return is filed.
Additionally, partners in companies taxed according to the Estonian CIT will each year be obliged to submit a statement that they do not additionally hold shares, stock, rights or obligations in a partnership which is not a legal person or other property rights involving the right to get payment as the founder or beneficiary of a foundation, trust or another entity or legal relationship of fiduciary nature.
Simplicity and transparency?
Despite assurances of the Ministry of Finance that it plans to implement a simple tax solution intended to support innovative companies, the draft regulation raise numerous interpretative doubts, and the very structure of the flat-rate tax is not so simple given the considerable number of exclusions and exceptions, e.g. five different deadlines for payment of the flat-rate tax.
Please contact us if you would like to get more detailed information about the planned solutions.