Tax advantages in Estonia

Company versus Tax and Customs Office:

Whether a board member can operate a subcontractor and how should this activity be taxed?

On 4 March 2020, the Administrative Chamber of the Supreme Court of Estonia (State Court) announced its decision in the tax law case between an OÜ (Estonian form of limited liability company) and the Tax and Customs Office (Tax Office).

Because there is no corporate income tax in Estonia, it is a predominant practice to have services provided not personally, but through a company that is 100% owned by an individual, and consequently to pay less income tax. The subject of this decision was activity by an OÜ and taxation in this respect.

The decision was based on the following facts:

The Tax Office carried out investigations into the OÜ and concluded that the OÜ had neither calculated nor paid taxes correctly.

The Tax Office alleged that the OÜ’s board members had themselves provided services to the OÜ.

For this purpose, the members of the Management Board had used subcontractors who were contractually bound to the OÜ.

The Tax Office therefore assumed that the services provided by the subcontractors were in fact activities by members of the OÜ’s management board.

The income thus generated was to be regarded as remuneration for the members of the Management Board and had to be taxed accordingly.

The State Court did not agree with the Tax Office.

On the contrary, the court found that it was the intention of the OÜ to circumvent the wage tax by this arrangement and thereby achieve a tax advantage.

The board members behind the subcontractors would have wanted to raise funds for their companies in this way.

However, only the subcontractors were remunerated for the work performed for this purpose, not the members of the Management Board as natural persons.

When exercising entrepreneurial freedom in the context of an economic activity, it should be permissible to take tax considerations into account. For a legal relationship, however, no arrangement may be chosen which does not correspond to the actual economic circumstances.

Nevertheless, the State Court has made it clear that the taxpayer is under no legal obligation to act in such a way that the highest tax burden arises for them.

Thus, the OÜ was entitled to pay dividends to its board members, which, as passive income of the shareholders, are only subject to income tax.

According to the State Court, it is unclear under which circumstances an OÜ has to pay salary and wage tax or only dividends. This could vary depending on the individual case.




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