Estonia and Latvia – special solutions in the Baltics
How can these two countries in Northern Europe successfully overcome geographical disadvantages? Which special tax regimes did they implement? Can such implementations be used for an international tax optimization strategy?
Both Estonia and Latvia benefit from EU membership, Euro currency and Schengen system, which allows free movement of goods, people, and capital. These countries are also familiar with foreigners: with around 25% Russian population and a high level of education, locals offer their services not only in local language but also in Russian and English. Furthermore, IT is well established – especially Estonia who was a frontrunner in e-government solutions and one of the first countries that established an electronic identity system.
With regards to taxation, Estonia and Latvia apply special concepts of taxation to promote qualified investments and appropriate migration. Undistributed corporate profits are non-taxable even if funds are invested in a subsidiary. However, dividends payable to the shareholders are taxable. In addition, the countries have strict regulations when a payment qualifies as a deemed dividend.
Advantages of a Holding in Estonia or Latvia
A holding company in these countries can benefit from a tax-free status and creates profits from interests, royalties, capital gains and chargeable management fees to the subsidiaries.
For dividends from subsidiaries in the EU/EAA, based on the EU Parent and Subsidiary Directive (Directive EU 2011/96), a holding company in Estonia or Latvia can receive tax-free dividends from a foreign subsidiary in the EU / EEA. This directive helps to avoid taxation between connected EU enterprises if certain conditions are met. The dividend from the subsidiary is a tax-free income, so the holding can then declare these profits as dividends to the shareholder (also tax-free from the payers’ side).
Unilateral regulations allow incoming dividends from subsidiaries outside the EU to remain tax-free in the holding. Depending on the local law and on the existence of double tax treaties, there may be a withholding tax in the exit country. However, incoming dividends from blacklisted countries (https://www.consilium.europa.eu/en/policies/eu-list-of-non-cooperative-jurisdictions/) are taxed at a rate between 15% and 20%.
To receive tax relief, an Estonian company must sometimes prove that it is a resident of Estonia with its residence certificate issued by the Tax and Customs Department.
Estonian and Latvian holding structures are suitable; not only for trading, receiving dividend payments, financing, and royalties, but also for the protection of assets.
Under the holding company regime, capital gains derived from the disposal of shares (other than shares in companies located in blacklisted countries and territories) are exempt from income tax (and losses are not deducted). There is no minimum holding period for this benefit and applies for shares in both private and public companies.
For private persons who move to Estonia or Latvia, there are regimes that allow investors to apply for a residence permit in the Schengen area.
Holding function for “residents without domicile”
If the owner of a company is resident in a country that does not tax dividends on private level or benefits from the status of “resident without domicile”, he is entitled to receive a dividend from a holding company established either in Estonia or in Latvia tax free subject to the following conditions:
- The shareholder receives the dividends outside of his country of residence and the money is not remitted.
- The country of residence applies the imputation principle. This means: If the profits were taxed already one time, the same profits shall not be taxed again. Taking Malta for example: When the Maltese subsidiary pays tax and the foreign holding receives the dividend (and the refund), the imputation principle states that the funds can be remitted to the shareholders of the foreign holding in Malta tax-free.
Holding function for residents in high tax countries
If the shareholder of a company is not entitled for such benefits, there may be an option to create a partnership in a country that applies the “residence without domicile” principle. This partnership can be shareholder of a Latvian or an Estonian entity. A subsidiary then pays dividends to the holding, which forwards it tax-free to the partnership. Article 7 of the double tax treaties usually allocates the right to tax to the country of the partnership. However, this country sometimes will not tax the profits of the partnership from passive income outside the territory.
Note that such structures need substance in the country of the partnership and acceptance in the country of residence which must be checked with local tax experts.
The registration of a holding company in Estonia or Latvia is usually simple and takes up to a couple of weeks to be finalized. The shareholder and director of the company may be non-residents in both countries and the EU. Standard documentation is the only requirement.
In order to open a bank account; it is recommended to remit multiple applications with different banks and payment providers at the same time because there are often delays. Also, proof of substance and the presence of a confirmed connection between the company’s activities and the country are frequently required.
Preferably, one may consider applying for a bank account in other jurisdictions where requirements are less strict. Alternatively, one may also take into consideration the specialized online payment providers (such as Paysera, TransferWise, Revolut, etc) where the opening of a bank account happens over the internet easily and much faster. Despite this, it is often the case that a holding company does not require a bank account.
Like almost everywhere in the EU, receiving a VAT number is a challenging procedure for a holding because the company must provide evidence that it is doing active business in Estonia or in Latvia or is about to start one. Within 5 days from the registration, the tax authorities decide whether to assign a VAT number to the company, to invite a company representative to speak with an inspector, or to refuse to register completely. It should be noted that a VAT number is only required if the holding operates an active business or if it needs some activities in order to be entitled to recover such.
An audit review of the annual financial statements of companies in Latvia is mandatory if two out of the following 3 criteria are met: 400.000 Euro assets, 800.000 Euro net turnover or 25 full time equivalent employees. In Estonia, the threshold is 800.000 Euro assets, 1600.000 Euro net turnover or 24 full time equivalent employees. For a holding, these thresholds are rarely met.
There is a second threshold that defines the requirement of a full audit.
Estonia and Latvia offer interesting options for holding companies, especially for those who reside in a country where they can benefit from their tax advantages. Good flight connections and infrastructure, entertaining cities and reasonable costs attract high grade professionals who seek such amazing solutions.