The Global Minimum Corporate Tax Rate Will Also Affect Estonian Companies
In the autumn of 2021, 137 countries, including Estonia, agreed on rules under which large corporations around the world will pay at least a minimum income tax rate of 15 percent. At the end of last year, the European Commission also presented a proposal for a directive to transpose this international initiative into European Union law. The aim of the reform is to prevent tax evasion and to ensure that corporate tax is paid worldwide at least at the agreed minimum rate.
The tax rate is 15 percent
According to the international agreement and also the proposal for the directive, the minimum tax rate is 15%. In Estonia, the income tax rate is generally 20 percent, but the initiative will still have a direct impact on Estonian companies. The reason is that the minimum tax rate is based on the effective tax rate and not on the nominal rate prescribed by law.
Estonia has a unique corporate income tax system, where income tax is generally paid only upon distribution of profits. Therefore, the effective rate of income tax for Estonian companies depends on the amount of profits that the company pays out as dividends. For example, if a company earns a profit but does not pay dividends, the effective tax rate is 0 percent. If the company earns a profit of one million euros and pays half of it as a dividend, the corporate tax liability is EUR 125.000 and the effective income tax rate is 12.5 percent. However, this is less than the 15% resulting from the proposed directive. Consequently, the transposition of the Directive may lead to a situation where some companies will have to pay more income tax.
The minimum income tax affects about 300 Estonian companies
According to the proposal for the directive, the minimum tax rate will not apply to all companies, but only to groups with a consolidated income of at least EUR 750 million for at least two of the previous four years. There are less than five such groups in Estonia.
An international agreement stipulates that it is up to each country to decide whether or not to apply the minimum income tax rules to large domestic groups. However, the proposed directive does not allow Member States to determine differences for national groups. That is why we proposed to the Ministry of Finance to stand in the negotiations for the directive, so that the directive would also give countries more freedom in this matter.
Although there are not many large corporations in Estonia, it must be taken into account that the planned changes also apply to those companies that belong to large international groups. There are about 300 such companies in Estonia.
According to the proposal for the directive, the obligation to declare and pay the minimum income tax lies with the large corporation, not with its Estonian subsidiary. Therefore, the planned changes will not impose a direct administrative burden on the Estonian subsidiary. At the same time, the Estonian subsidiary must provide the group with the necessary information so that the group can submit a declaration. In addition, it can be assumed that the corporation will no longer pay the minimum income tax itself, but will withdraw dividends from the Estonian subsidiary to the extent that the effective income tax rate would be at least 15 percent.
Other Estonian companies will not be affected by the proposed directive. This means that the current corporate income tax system will remain in force, but additional provisions will be added to the Income Tax Act for companies belonging to large groups.
The specificity of small businesses
In practice, however, the directive may affect a smaller number of Estonian companies, as the directive does not affect the minimum income tax rules of subsidiaries of a large group if the group's subsidiaries in one country have total sales of less than ten million euros and profits of less than one million euros. Three-year average sales revenue and earnings should be used as the basis.
For example, if an international group has two subsidiaries in Estonia with sales revenue and profit below these limits, the directive will not affect the Estonian company. If the total sales revenue of the subsidiaries exceeds ten million euros or the profit is one million euros, the difference for small companies does not apply and the rules of the minimum income tax must be applied.
4-year exception
The proposal for the directive also includes a special clause allowing the group to defer the payment of tax on the subsidiary's profits for four years. This solution is intended for Estonia and other countries where income tax is paid on the distribution of profits, not on their occurrence. For example, if an Estonian subsidiary belonging to a Finnish group earns a profit of one million euros in 2023, the Finnish group may defer taxation of this profit until 2027. If the Estonian subsidiary pays a dividend in the interim years and pays income tax on it, the tax liability for 2027 will decrease accordingly. If an Estonian company has a loss, it can be used to reduce the tax liability for previous and future years.
The minimum tax will apply from 2023 on-wards
The proposed directive requires Member States to transpose the directive into national law by December 31, 2022. This means that by then Estonia must also make the necessary changes to the Income Tax Law.
Given that the proposal for the directive is still being negotiated in the European Union, i.e., that the wording of the directive has not yet been finally agreed and that the directive is very voluminous and detailed, it is unrealistic that Member States will be able to transpose it so quickly. Therefore, we proposed to the Ministry of Finance that Estonia stand in the negotiations for the deadline for transposition of the directive to be postponed by at least one year. If the deadline is not changed, Estonia will most likely transpose the directive with a delay.