When does an Estonian company attract tax residency in a foreign country?

The exemption from corporate income tax, a special characteristic of Estonia, attracts foreign entrepreneurs to register companies in Estonia. Estonian entrepreneurs in turn are acting more and more actively in foreign countries while trying to retain a minimal tax burden. This is why it is important to note that the profit of a company registered in Estonia will only be taxed with income tax on paying out dividends if we are dealing with only an Estonian tax resident. In case the company is founded in Estonia but the actual management of the company takes place in another country, the tax residency of the company may arise in the respective country and the possibility of double taxation arises with that.

What is the management of a company from another country?

The actual management of an Estonian company from another country may for example be a management board located there as well as the sale of services and goods, daily economic transactions, holding negotiations and entering into contracts. In such a situation the respective country has a right to tax the income of the Estonian company according to its national legislation. If a contract for the avoidance of double taxation has not been signed between two countries or it is not possible to determine tax residency on the basis of the contract for the avoidance of double taxation, each country will be guided by its own income tax legislation. Therefore the respective country may tax an Estonian company’s income on the basis of its national legislation. This means that even though a company is founded and registered in Estonia and is therefore an Estonian tax resident, this company may also have tax residency in another country.

How to avoid double taxation?

Countries have entered into contracts for the avoidance of double taxation and the prevention of tax evasion in respect of taxes on income and wealth for the avoidance of double taxation, which, among other things regulates tax residency of companies and the taxation of permanent establishment. The Republic of Estonia has entered into contracts for the avoidance of double taxation with 58 countries.

How do countries reach an agreement?

According to the contracts for the avoidance of double taxation the tax residency of a company may be solved either with an intergovernmental agreement or for example specifically by the location of the management body. In case the states do not reach an agreement on which country’s tax resident the company is, the states will tax the companies according to the national legislation and the risk of double taxation arises. Therefore in each specific case the provisions of the company’s tax residency from the respective contract between the Republic of Estonia and the foreign state have to be considered.

What is the contract like with Finland and Sweden?

The provisions for the establishment of tax residency described are provided in the contracts for the avoidance of double taxation entered into with Finland, Sweden, Latvia and Lithuania. The contracts prescribe that if a person can be considered a tax resident of both contracting states on the basis of the contract, then the competent officials of the contracting states will decide the application of the contract in its case by agreement. If an agreement is not reached then the person is not considered a tax resident of either contracting state and the concessions prescribed by the contract do not apply to it.

What is the contract like with Russia?

Unfortunately there is no contract for the avoidance of double taxation with Russia to date. This may mean that both Estonia and Russia tax an Estonian company operating in Russia according to national legislation and a possible preferential scheme provided with the tax contract does not exist. The same applies in case of a Russian company operating in Estonia.

Taxation of income made through a permanent establishment

For companies, which are founded in one country but operate in another, the concept of permanent establishment and the possible taxation of income made through the permanent establishment is important. The general provision of permanent establishment comes from Article 5 of the OECD’s model contract Model Tax Convention on Income and on Capital. The question of the taxation of income made through permanent establishment is determined in the contracts for the avoidance of intergovernmental double taxation as well as in the national legislation of the states. Here, the specific tax contract and the national law of the states concerned have to be considered again. There have for example been cases in this field where an Estonian company, whose board member lives in Finland and all sales transaction take place there, has had to carry out its income tax obligation towards the Republic of Finland.

Summary

The Estonian national income tax system, where the state only taxes dividends payable on the basis of the 20/80 division with 25% tax, i.e. 100 units of paid out dividends brings 25 units of income tax applies on the precondition that a company is an Estonian tax resident and he does not have grounds for tax residency in other countries.

In case the Estonian company can also be considered a tax resident of another country or if it has a permanent establishment in another country, the intergovernmental contracts for the avoidance of double taxation as well as national laws of the states have to be taken into account, especially in a situation where Estonia does not have a contract for the avoidance of double taxation with the other state.