According to data from the Ministry of Finance, only approximately 12.7 thousand businesses in the country benefit from the Estonian Corporate Income Tax (CIT). Effectively, this number is relatively low given that the authors of this accounting system predicted that by the end of 2021, 200,000 firms would switch to it. What could be the cause, especially considering that in reality, it is a very good, profitable solution for companies?
Estonian CIT – No tax as long as the profit remains in the company
A 25% effective tax rate instead of 34.39% (and 20% instead of 26.29% for small taxpayers) or even no taxation at all until dividend payouts – these are the main advantages of the so-called Estonian CIT, which was designed to encourage Polish companies to develop their businesses. A company can avoid paying CIT, postpone the due date as long as the generated profit is not spent on dividend payouts, and instead, it is invested in the firm. The Estonian CIT can be used by both small and large businesses: joint-stock companies, limited liability companies, partnerships, and simple joint-stock companies. All that is needed is to employ at least three people based on an employment or civil law contract.
Estonian CIT offers lower taxation when paying out dividends than classic CIT
Although the tax offer of the Estonian CIT (10% for small taxpayers and 20% for the remaining taxpayers) does not seem more favourable than the classic income taxation of legal persons (respectively 9% and 19%), entrepreneurs reap a tangible benefit when paying dividends. Besides the CIT at the company level, natural persons also have to pay Income Tax on the dividend gained in the company. Contrastingly, with the Estonian CIT, the partner can reduce his PIT obligation by the tax paid by the company. Consequently, the combined CIT+PIT is then 200,000 PLN, or 20%. This translates to a 6.29% lower tax burden than the classic CIT.
Furthermore, the transition to the Estonian CIT allows for simpler settlement systems based only on accounting regulations. Companies also have the chance to handle larger funds because they do not have to pay advance payments on income tax with the Estonian CIT.
The number of companies using Estonian CIT is growing, albeit slowly
On Tuesday, 26th September 2023, Artur Soboń, the Deputy Minister of Finance, spoke in Lublin about the growing interest of companies in Estonian CIT. Although their introduction was successful, a mere several percentage of entrepreneurs have decided to use it so far.
Entrepreneurs’ apprehensions
The main reason for this low number might be legal uncertainty. Entrepreneurs may fear that they will not be able to effectively use the benefits of the Estonian CIT without constant assistance from a tax advisor or lawyer. For instance, they are worried that the company’s income may be classified as so-called hidden profits which are not exempted from CIT.
It is worth implementing the Estonian CIT in the company
Nevertheless, every entrepreneur should consider if the benefits gained from the Estonian CIT are worth transitioning to this system. Its implementation could be entrusted to a law firm and tax advisor. The entrepreneur needs only to ensure that revenues from other sources are not higher than revenues from the company’s main operation.
Author: Robert Nogacki, a legal counsel, managing partner, Legal Office Skarbiec, specialising in legal, tax and strategic advice for entrepreneurs.
