Corporate reinvestments at 0% tax rate in Estonia
As already known Estonia stands out with its unique tax system in the world as there is no mandatory corporate tax if the profits are kept in the company, thus we could say that it provides corporate reinvestments, e.g. profits invested while followed by the interest of company’s growth, at a 0% tax rate. Such benefit in the tax system puts Estonia to a level where entrepreneurship is highly supported by the state and legislation. As said corporate reinvestments must be related to company’s interest such as expenses made for expansion, acquiring new machinery or some other expenditure which carries the purpose of company’s development thus it must be used with certain care.
According to Income Tax Act of Estonia „All certified expenses incurred by a taxpayer in relation to business during a period of taxation may be deducted from the taxpayer's business income“ – that certain clause provides reinvestments at 0% tax rate as annual corporate tax just does not exist.
In order to understand what is the definition of the expenses incurred in relation to business we should look into another specific clause described in the same act - „Expenses are related to business if they have been incurred for the purposes of deriving income from taxable business or are necessary or appropriate for maintaining or developing such business and the relationship of the expenses with business is clearly justified“. So considering the previous we can come to a conclusion that expenses not related to business activities are deemed as profit distribution and shall be imposed with 20% corporate income tax, quite clearly understandable.
As previously said then corporate income tax applies to profit distributions which is the most common case where such tax is being paid. In order to make it clear as possible, we shall follow the next example on how to calculate taxes on profits.
Let’s say that a shareholder would like to distribute profits to himself in the amount of EUR 1000. In this case EUR 1000 is the net amount comprising 80%, 20% (corporate income tax) would be the tax rate which will be added to this sum. All taxes are calculated on the basis of gross amount – 80% + 20%. So if the net would be EUR 1000 comprising 80%, then EUR 250 would be 20%. The company would have to pay in total of EUR 1250 (as 20% from EUR 1250 is EUR 250) which is the gross sum, from the gross sum EUR 1000 is paid to the shareholder and EUR 250 to the state as corporate income tax. Through the following calculation we can see from where it is coming from:
20%/80%*1000 EUR = 250 EUR (income tax)
and the profit which the shareholder will receive is:
1250-250 = 1000 EUR (distributed net profit)
It is important to know that tax liability for the payment of corporate income tax belongs to the company, followed by the previous example if the shareholder would like to receive EUR 1000 through profit distribution, the company must have earned at least EUR 1250 in order to cover the income tax amount.