This article is crucial for getting an understanding of taxable events in an Estonian company other than making dividend payments or other profit distributions.
Short overview
The Estonian corporate income tax system works somewhat in the opposite way compared to classical corporate income tax (going forward, CIT) systems. If you are used to running your business in a country that has a classical corporate income tax system, then you know that each year prior to submitting the annual tax return and paying the CIT due, the taxable base of the company should be calculated to know how much tax is due. In order to do so, the company is allowed to deduct expenses which are related to the company’s business activities in accordance with local law and that reduces the tax base and tax cost.
In Estonia, instead of subtracting such deductible expenses once a year, making business-related expenses has no immediate tax effect. However, if a company makes a payment which is not related to its business, then it triggers an immediate CIT charge. Under the Estonian CIT system, all non-business-related payments trigger 22/78 CIT on the net amount of the payment. It becomes payable already in the next month from making the payment. Compared to classical corporate income tax systems, then such payments are essentially “non-deductible” expenses.
Although the nature of the payments (whether being sufficiently related to business activities or not) should be decided on a case-by-case basis, then the law provides some examples of types of costs which are always taxable – we will discuss this in more detail below.
Therefore, when making a payment from your Estonian company, first understand whether it is business-related or not. If it is not related to your company’s business, you must pay 22/78 CIT on the net expense and declare the payment in the monthly CIT return of the company in the month following the payment. Sometimes the cost may also be a fringe benefit meaning that a social tax of 33% should also be paid.
What kind of expenses can my company cover?
The short answer would be that your company should be able to cover most business-related expenses without triggering tax.
Making business-related expenses is similar to the concept of making tax deductions in a classical income tax system. In most countries, a company can deduct business-related expenses from its annual tax base to reduce its tax burden. Since the Estonian system operates in an opposite manner, then payments made by a company should be assessed on a monthly basis to determine if they trigger taxation. Of course, there will be no need for an in-depth analysis of routine reoccurring overheads such as office rent, accounting fees, supplies, office utilities and other such routine business expenses. However, if a payment made by a company is not related to its business, then it should be declared and taxed with CIT, i.e. it would be considered “not deductible”.
As there is an unimaginable range of different business activities, which all require different goods and services for operating, then a business-related expense for one company might not be sufficiently linked to business activities for another.
In case of doubt, always ask yourself the question about the goal of the expense: “Is this expense necessary or appropriate for maintaining or developing my business activities?”
Secondly, check that the expense does not fall in the scope of the special purpose taxable payments discussed below.
Are there any limits to how much my Estonian company can spend?
Generally, a company is free to decide on costs necessary for carrying out its business. However, for certain types of costs, the law limits the extent to which these can be made without incurring a tax cost.
Costs incurred for entertaining business guests and partners
A portion of expenses related to entertaining or hosting business and cooperation partners can be made exempt from tax. Entertaining or hosting is generally understood to include catering, accommodation, transportation and entertainment of guests and business partners which are therefore partially related to business activities.
By law, a fixed sum of 32 euros per month plus 2% of the payments which have been subject to social tax (i.e. the salary fund of the company) in the relevant month are exempt. Amounts above this threshold which is different for each company are taxed with CIT. Tax return “TSD” Annex 5 keeps automatic track of the balance.
Note that if employees or management board members partake in these events, then costs related to them are not deductible and instead should be taxed as fringe benefits.
Gifts and donations
Gifts have to be with a value that can be expressed in money i.e. with a clear consumable value for the recipient. Advertising printouts, product samples or presents with a value of less than 10 euros (net of VAT) are not taxed as gifts since they hold little consumable value. Anything above 10 euros is taxed with 22/78 CIT which applies to the full amount.
Concerning charitable donations, then it is possible to make tax-exempt donations to non-profit organisations and foundations that have been verified and put on a list managed by the tax authorities. The List of associations benefiting from income tax incentives can be found on the website of the Estonian Tax and Customs Board under Public Data Inquiries.
To know how much tax-exempt donations a company can make, two alternative calculations can be compared:
1) the company can choose to either apply 3% of payments subject to social tax from the beginning of the calendar year (personalised payments such as salaries); or
2) 10% of the previous financial year’s accounting profits
In order to have the option to choose the more beneficial threshold, be sure to insert last year’s profit into the tax return.
All donations both under and over the relevant threshold should be declared on tax return TSD Annex 5. Gifts to employees and management board members are taxed as fringe benefits.