From 2021, certain CIT payers can reinvest their earnings tax-free; this is a tax measure dubbed the ‘Estonian CIT’. It should be noted that this is by no means a reduction of the tax paid; it is about shifting the time when taxable income is recognised while making the accounting records simpler.
What the Estonian CIT is all about
The underlying assumption of the Estonian CIT (referred to as a “flat rate tax on income in capital companies” in the CIT Act) is that tax collection is shifted until the time the capital company distributes its profits. Thus, even though the company generates income, it does not have to pay tax advances and the tax after the end of the tax year until the generated profits are distributed among its shareholders (e.g. in the form of a dividend).
The system supports reinvesting the generated earnings, and it comes with simplified tax accounting requirements as the output tax does not have to be calculated on an ongoing basis. The taxpayer’s financial accounting should suffice for the calculation of the flat-rate tax.
Estonian CIT is optional
The Estonian CIT is just an alternative to the ‘default’ CIT regulations and it is for the taxpayer to decide whether to opt for this solution or not. If the taxpayer decides to do so, they must submit a relevant notice to the head of the relevant tax office by the end of the first month of the fiscal year in which the Estonian CIT is to be applied.
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The taxpayer should consider this decision thoroughly, because the Estonian CIT precludes reliefs and settlements provided for in the CIT Act (e.g. R&D tax relief or tax deduction of donated amounts from the taxable income).
Who can apply Estonian CIT
There are a number of preconditions for applying the Estonian CIT. The flat rate tax is dedicated to businesses that do not exceed the income threshold as well as entities commencing their business activity. Some restrictions have been introduced to exclude those entities that, despite small-scale operations, undertake activities that are not approved by the legislator, e.g. create complex structures, do not conduct any genuine business activities, carry out restructuring, etc.
In simple terms, if you want to apply the Estonian CIT, you have to meet the following conditions jointly:
- total revenues generated in the previous fiscal year cannot exceed PLN 100 million (including the output VAT),
- passive income (e.g. from interests, warranties, exercise of rights from financial instruments) and income from transactions with related entities must be below 50% of the revenue structure,
- the required headcount must be met, and there are two options: (1) average headcount of at least three employees (note: this does not include the shareholders of the taxpayer), employed on a full-time basis under an employment contract or (2) incurring monthly expenses in the amount of at least three times the average monthly salary in the enterprise sector for the payment of salaries and wages to at least 3 natural persons employed under a contract other than an employment contract (again, excluding shareholders), provided that the taxpayer is obliged to collect advance payments for PIT and social contributions due to the payment of the said salaries and wages,
- business is carried out as a limited liability company or a joint stock company with only natural persons as shareholders,
- the taxpayer does not hold shares or stocks in the capital of another company, and does not have any titles of participation in an investment fund or in a joint investment institution, does not hold all the rights and obligations in a company that is not a legal person and does not hold any other property rights as defined by law;
- the taxpayer does not prepare the financial statements in accordance with IAS.
Entities starting a business are exempt from meeting some of the conditions (in the first fiscal year, the revenue threshold will not be applied, and the headcount requirements will also be less stringent).
Notwithstanding the fulfilment of the aforementioned conditions, the Estonian CIT legislation sets forth a number of restrictions for entities. The presented solutions cannot be applied by: financial enterprises, loan institutions, companies operating in special economic zones/Polish investment zones, companies in bankruptcy or liquidation and entities that have recently undertaken certain restructuring procedures.
A pivotal requirement for taxpayers applying the Estonian CIT is the obligation of incurring direct capital expenditure. It must reach a predefined percentage of the initial value of fixed assets classified in group 3-8 of the Classification.
These thresholds are as follows:
- 15% (but not less than PLN 20,000) in the period of two consecutive fiscal years, or
- 33% (but not less than PLN 50,000) in the period of four fiscal years.
The reference value for determining the increase in capital expenditure shall be the initial value of fixed assets determined as at the last day of the fiscal year preceding the two-year or four-year period of flat-rate taxation, as appropriate.
Capital expenditures include funds spent on the acquisition of brand-new fixed assets or production of fixed assets, and, in special cases, also payments under lease and tenancy agreements (excluding operating lease contracts, in their part being the repayment of the initial value of fixed assets). Capital expenditures do not include passenger cars, selected means of transport and other assets used primarily for personal purposes of shareholders or their family members.
As an alternative, instead of incurring capital expenditures, you can increase the funds allocated for salaries. To be specific, this is about incurring expenses on salaries of employed natural persons (excluding shareholders) in the amount higher by 20% (and not lower than PLN 30,000) than the amount of such expenses incurred in the fiscal year preceding the two-year period of flat-rate taxation.
What is being taxed, tax rates and deadlines
What is being taxed in the Estonian CIT regime is the effective distribution of profit from the capital company to its shareholders. However, the regulations are far from only taxing dividends. The legislator has made the system effective by introducing a broad scope of taxation in order to prevent implicit profit distribution to shareholders (e.g. in the form of gifts for shareholders).
The following categories of income are taxed with the Estonian CIT:
- income from distributed profit, in particular the payment of dividend or dividend advances (net profit earned during the period of Estonian CIT taxation in its part allocated for distribution or loss coverage),
- hidden profits (payments transferred to shareholders and related entities, excluding e.g. work remuneration, provided that it does not exceed five times the average salary),
- profit allocated to loss coverage (provided that these losses were incurred prior to the period of Estonian CIT taxation),
- expenses not related to the taxpayer’s business activity,
- income from the change of the value of assets (resulting from selected restructuring transactions),
- income from undisclosed business operations (values of revenues and expenses that should be accounted for in the fiscal year and included in net profit or loss in accordance with the Accounting Act, but have not been included in this net profit or loss).
What is more, in the case of taxpayers who no longer apply the Estonian CIT, income determined in the amount of the total net profit will also be taxed, to the extent this profit has not been earlier (in the period of Estonian CIT taxation) distributed or allocated to cover the loss.
Rates of tax paid in the Estonian CIT regime are as follows:
- 15% (for small taxpayers) and
- 25% (for other taxpayers).
In special cases, the Estonian CIT rate can be reduced by 5% (if the taxpayer has some major capital expenditure).
The rates of 15% for small taxpayers and 25% for other taxpayers are higher by 6 percentage points than standard CIT rates (9% and 19%, respectively). Thus, the Estonian CIT is by no means a reduction of the tax paid; it is about shifting the time in which taxable income is recognised while making the accounting records simpler.
The deadline for paying the tax will vary depending on the category of income subject to taxation:
- income from distributed profit and income from profit allocated to loss coverage: by the 20th day of the seventh month of the fiscal year;
- income from net profit: by the end of the third month of the fiscal year following the last year of flat-rate taxation;
- income from undisclosed business operations: by the end of the third month of the fiscal year following the year in which the revenues or expenses should have been accounted for;
- income from hidden profits and revenues not related to the business activity: by the 20th day of the month following the month in which the payment was made or expense was incurred;
- income from the change of the value of assets: by the 20th day of the month following the month of acquisition, conversion or contribution in kind.
How to opt out of Estonian CIT
As a rule of thumb, the choice of the Estonian CIT taxation shall be made for a period of four fiscal years. If the statutory conditions are met, it will be possible to continue with this regime in periods to come. The taxpayer may as well opt out of the Estonian CIT, provided that the tax authority is notified of this in the annual tax return submitted for the last fiscal year in which this solution was applied.
If the taxpayer is in breach of the terms and conditions of this solution, the taxpayer may lose the right to apply it in the course of the four-year period, as well. If the breach is about exceeding the statutory income threshold, the regime can still be applied; however, a surtax is going to be collected.
Should the taxpayer lose the right to this taxation regime, they can submit a new notice that they wish to opt for the Estonian CIT after three fiscal years.
You can freely opt out of the Estonian CIT regime in the early stage of its operation. Taxpayers who apply this solution in the years 2021-2024 may submit an opt-out notice in their tax return for any fiscal year (with the effect at the end of the fiscal year for which the return is submitted).
“Simplified” Estonian CIT
Taxpayers may also opt for a simplified “partial” model based on a special investment account. If you choose this option, you still have to pay CIT according to the rules in place (and be allowed to apply most reliefs provided for in the CIT Act), but you can benefit from a fast-track procedure when accounting for your capital expenditure. What should be noted is that this option requires you to meet the same conditions as in the case of the “full” Estonian CIT.
The basic idea is that the “simplified” Estonian CIT is about having the right to claim that write-offs to a fund set up for investment purposes in the taxpayer’s reserve capital are your tax deductible expenses.
Write-offs should correspond to the value of the company’s profit (or its part) earned in the year preceding a given fiscal year and the equivalent of cash actually paid to a dedicated settlement account. Furthermore, write-offs must constitute the economic/factual costs incurred by the taxpayer (the funds may not come from a loan, credit, grant, subsidies and other forms of financial support), and the funds must be used for investment, the rule being that it is not later than in the fiscal year following the year in which they were written off.
Rely on expert support to implement the Estonian CIT
RSM Poland Consultants have some practical experience in consultancy on reliefs and similar solutions in CIT. That is why we can offer comprehensive and tailor-made support to entrepreneurs, including:
- verification whether the preconditions for applying the Estonian CIT are met;
- comparison of the potential benefits of the Estonian CIT and other solutions available in income taxation;
- preparation of the necessary documents;
- identification of potential risk areas.
Keep your funds in the company owing to the Estonian CIT. Rely on the expertise and experience of RSM Poland experts who will help you apply this solution safely and effectively.
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Should you have any questions or wish to discuss the topic further, we encourage you to contact our expert, Piotr LISS:
tel. +48 61 8515 766
fax +48 61 8515 786