Changes in the Estonian Income Tax Act regarding Profit Distribution and Hybrid Loans
The Estonian Parliament adopted on 20th of April 2016 changes in the Estonian Income Tax Act, which aim was to take over the changes made in the Council Directive 2011/96/EU on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States related to Hybrid Loans. Changes will be applicable starting from 1st of November 2016.
Hybrid loan is a financial instrument, which has both characteristics of a debt and an equity instrument. The taxation of an hybrid loan is therefore also different depending how the country classifies it, as an example in case of cross-border hybrid loan the tax on the payment can be deducted (in the payer country) and in the other country (in the recipient country) it could be classified as tax free profit distribution (dividend), which therefore can lead to unwanted double tax exemption.
According to parent subsidiary directive the taxation of dividends received from parent company is not allowed (double taxation).
Clause 50 from the Income Tax Act will be supplemented with sections 13 and 14, stating that section 11 points 1 and 3 and section 21 (i.e. income tax is not charged on distribution of dividends) will be applied if legal entity from whom the dividend is received, has no right to deduct it from the taxable profit; and sections 11 and 21 will not be applied in case of a transaction or transactions, which are not real as their main purpose or one of the main purposes is to receive tax advantage. The named sections will be applied in so far as the transaction or transactions are made for business purposes which reflect the necessary economic substance needed for the business activity.
This means that if:
- Disbursement cannot be deducted from the taxable profit in the country of company paying the dividends (i.e. its taxed), Estonia will apply exemption method;
- Disbursement can be deducted from the taxable profit in the country of company paying the dividends (i.e.it will be classified as interest), Estonia will not apply exemption method.
Taxpayer will have to be prepared to prove to the Tax Authority that all requirements to apply the exemption method are fulfilled.
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