Estonian CIT in a Polish company – what is it and why does it pay off?
A Polish company, being a CIT payer, can be taxed in two ways: according to the general rules or as the lump-sum tax on income of companies, i.e. the so-called Estonian CIT. Due to the fact that effective taxation of the company’s income according to the Estonian CIT is lower than according to the general rules, more and more companies are deciding to adopt this taxation model.
What is the Estonian CIT?
The lump-sum tax on income of companies, commonly known as the Estonian CIT, is a preferential form of taxation of some payers of corporate income tax. Its main assumption is that the tax does not need to be paid until the profit is distributed. It means that a company does not pay income tax on a regular basis, but at the time of the profit distribution and its allocation for payment to shareholders (e.g. dividends) or for covering losses suffered before the period of taxation with the Estonian CIT.
The income tax rates applicable in the case of the Estonian CIT are:
10% – for start-ups or companies with the status of a ‘small taxpayer’,
20% – for other companies.
A company that for the previous tax year obtained no more than EUR 2 million of gross sales revenue has the status of a small taxpayer. Importantly, this limit does not apply to taxpayers who start a business, i.e. newly-established companies and companies established as a result of the transformation of a sole proprietorship.
Benefits from the Estonian CIT
The effective taxation of the company and its shareholders is lower in the case of the lump-sum tax on income of companies.
In principle, the company collects the tax at the rate of 19% on the dividend paid to the shareholder, but in the case of the Estonian CIT, shareholders have the right to deduct from this tax an appropriate part of the lump-sum tax paid by the company: 90% in the case of a company being a small taxpayer or a start-up and 70% in other cases. In the case of a shareholder being a tax resident of another country than Poland, to establish a tax advantage, it is also necessary to analyse the tax consequences of the profit distribution, taking into account the appropriate double taxation agreement made by Poland with the country of their residence.
The above deduction mechanism means that the effective level of tax burden for the company and its shareholders is up to 20% in the case of small taxpayers or up to 25% in the case of other companies. For comparison, in the case of CIT applied according to the general rules, the rates of the tax burden are approx. 26% and 34%, respectively.
Importantly, if the company does not allocate all profits for distribution, the effective taxation may be even lower – if in a given year the company does not distribute any profits among its shareholders, the company and its shareholders will not pay the income tax, and the funds saved may be allocated for new investments.
However, it should be noted that the mechanism of deducting the lump sum paid on account of the personal income tax of the shareholder is applicable only in the case of distribution of a ‘standard’ dividend. Such a deduction cannot be made in the case of a transfer of funds to the shareholder in a different form – e.g. by granting a loan, classified as so-called ‘hidden profits’.
Taxation of hidden profits and expenses not related to business activities
Apart from the standard payment of dividend to the shareholders, the so-called hidden profits and expenses not related to business activities are also subject to taxation.
Hidden profits are construed as benefits rendered by the company to its related entities (in particular shareholders), other than the profit distributed, if they are related to the right to a share of the profit. Examples of hidden profits include, e.g., a loan granted by the company to its shareholder or free-of-charge benefits used by the shareholder.
Nevertheless, it does not mean that all benefits for the company are considered to be a hidden profit. For example, the value of remuneration paid by the company on account of a transaction executed is not a hidden profit if the transaction conditions have been determined as the market conditions.
However if the company incurs expenses not related to its core business activity, e.g. it makes available to its employees cars that may be used by them for private purposes, the expense incurred may constitute a broadly understood non-business expense.
If the benefit is considered to be a hidden profit or non-business expense, its value (or relevant part) will be subject to taxation according to the CIT rate of 10% or 20%.
Estonian CIT – what conditions should be met?
The preferential form of taxation with the Estonian CIT may be applied by companies being CIT payers, i.e. limited partnerships and limited joint-stock partnerships, limited liability companies, joint-stock companies and simple joint-stock companies (except for a general partnership that in some cases has the status of a CIT payer).
Nevertheless, the possibility to choose the beneficial Estonian CIT taxation is also connected with the necessity to fulfil a number of criteria. First of all, no more than 50% of the company’s revenue may be passive revenue, e.g. interest on loans.
Moreover, the company is obliged to fulfil the following conditions:
the company must employ at least 3 people, excluding shareholders (the number of employees can be lower in the case of companies with the status of a small taxpayer and start-ups),
the company’s shareholders can be only natural persons (not possessing specific property rights),
the company does not hold any shares in the capital of another company, participation shares in an investment fund or collective investment institution, or general rights and obligations in a company not being a legal person (and other specific property rights),
the company does not prepare any financial statements pursuant to the IAS (International Accounting Standards) for the period subject to the Estonian CIT,
the company is not a financial enterprise within the meaning of the Polish CIT Act,
the company does not grant loans to consumers within its business activities,
the company is not a taxpayer generating income from business activities conducted in a special economic zone or in an area determined in a decision concerning support for new investments,
the company has not been declared bankrupt or put into liquidation.
Restructuring vs. transition to the Estonian CIT
The Polish CIT Act also provides for some time limits for companies that participated in specific restructuring activities, such as a merger, division, liquidation or non-cash contribution. In such a case, the company will not be allowed to benefit from the Estonian CIT in the year of the activity commencement and in the next year (for no less than 24 months).
Importantly, such limitations have not been introduced in relation to companies established as a result of transformation. It means that a company that is transformed will be allowed to benefit from the Estonian CIT immediately after the transformation. However, in such a situation it may be necessary to determine the so-called transformation income, i.e. the surplus between the value of individual assets determined pursuant to the accounting regulations as at the transformation date (net carrying value) over their tax value.
If such income is generated, it is subject to taxation at the tax rate of 19%.
Tax settlements before transition to the Estonian CIT
The transition to the Estonian CIT is connected with the close of the previous tax year, which results especially in the obligation to settle the standard corporate income tax and to submit a CIT-8 return for the tax year preceding the lump-sum tax on company income.
In the tax return for the period preceding, the direct transition to the Estonian CIT, except for the possible tax on transformation referred to above, the company should make a settlement of the so-called preliminary adjustment, i.e. the alignment of temporary differences between the balance sheet result and the tax result.
The disclosure of tax resulting from the preliminary adjustment does not mean that it will have to be paid. In principle, it must be paid within one month after the end of the last year subject to the Estonian CIT. However, if the Estonian CIT is applied by the company for the period of at least 4 subsequent tax years, the tax liability on this account will expire in full.
Are you wondering whether the establishment of a company in Poland and its taxation according the Estonian CIT rules constitute a cost-effective solution? Do you want to make full use of the possibilities offered by the Estonian CIT? Contact us!