Warsaw, 24th August 2020
Position of the Union of Entrepreneurs and Employers
on the draft act introducing the so-called Estonian CIT
On 12th August 2020, the Government Legislation Centre published a draft law introducing the so-called Estonian CIT. According to the assumptions therein, beginning in 2021, certain capital companies that will allocate their earned profit for investments in their enterprises will not pay income tax. A similar system of corporate income taxation has been in place in Estonia for 20 years, hence its commonly adopted name.
The Union of Entrepreneurs and Employers believes that the introduction of the Estonian CIT generally promotes investment and the development of entrepreneurship. Moreover, this solution significantly reduces the reporting obligations of companies covered by it, which may lead to even eleven-fold reduction of time necessary to fulfil all obligations related to taxes. With this in mind, we conclude that the Estonian CIT is a step in the right direction.
It should be emphasised that, in accordance with the current version of the draft, the material scope of the act is narrowed down to entities that meet all of the following conditions:
- total annual revenues do not exceed PLN 50 million,
- more than 50% of revenues come from real business activities,
- average annual employment is at least 3 people who are not partners,
- they operate in the form of a limited liability company or joint stock company, the shareholders of which are only natural persons,
- they do not hold any shares in the capital of another company, participation titles in an investment fund or in a collective investment institution.
As we can read in the explanatory memorandum, the target group of the new regulations are companies from the SME sector, which have a high development potential and thus their growth may constitute an impulse for the development of the entire economy. The Ministry of Finance justifies the selection of this group of entrepreneurs referring to problems with access to financing for these entities. It seems that such a definition of the target group of recipients of the new solution is absolutely correct. Large companies already have a catalogue of tools enabling the reduction of CIT in connection with the investments made (e.g. IP-box). Therefore, it seems justified to designate a separate path to stimulate investment for representatives of small and medium-sized businesses running real economic activity (criterion of the source of income and average annual employment).
As emphasised by the representatives of the Ministry of Finance, by way of public consultations, it is possible to “loosen” certain restrictions limiting taxpayers’ access to Estonian CIT. Such declarations of readiness to continue working on the regulation should be appreciated. We believe that the group of entities covered by the new solution should be as wide as possible, which is why we count on the project’s evolution towards an even greater openness to business. One could consider, among other things, modification of the employment criterion so that all persons reported by the employer to social insurance were taken into account (a similar formula was used for the distribution of the Polish Development Fund’s “financial shield”), and not only those employed under an employment contract. In the long-term, it would also be possible to consider a solution enabling companies covered by Estonian CIT to develop through the acquisition of other companies – the draft in the current wording prevents Estonian CIT taxpayers from holding shares or stocks in the capital of another company.
Some doubts may arise when it comes to excluding limited joint-stock partnerships from the subjective scope of the draft act. In the justification, the Ministry of Finance motivates limiting the regulation only to limited liability companies and joint-stock companies with the same method of taxation of these entities in the classic CIT system and the need to develop consistent system assumptions as to the method of taxation and the amount of the tax burden in the lump sum system. The aforementioned argumentation seems convincing, but it would be worth reconsidering the possibility of extending the subjective scope of the new regulation also to limited joint-stock partnerships.
If the above conditions are met, the “Estonian” taxpayer will not pay income tax until the dividend is paid, i.e. until the profit remains with the company or is allocated to investments. On the practical side, taxpayers will be able to choose from two available options. Under the first one, they will stop paying monthly or quarterly advances and making annual settlements. As part of the second, they will pay the equivalent of CIT advances to a special account. Then these write-offs will be recognised as tax deductible costs. Then, as the Ministry of Finance assures, the same economic effect will be achieved as with maintaining classic CIT settlements.
Estonian CIT rates will be higher than the classic ones, yet the Ministry of Finance ensures that the effective tax rate for entrepreneurs who settle their taxes in the new system will be lower thanks to the new mechanism. As before, when the dividend is paid, entrepreneurs will pay CIT and PIT on the dividend. This is a significant difference to the Estonian model system, where there is no double taxation with respect to income generated by the company and then paid as dividends.
It should be remembered that in the classic CIT system, the company has to pay 19% or 9% in case of a small taxpayer. Moreover, the dividend is covered by a 19% PIT. Ultimately, the total tax rate is 26.29% for small and 34.39% for larger entities. Interestingly, in the Estonian system, the nominal CIT rate for larger taxpayers will increase to 25% for larger and 15% for smaller entities. The Estonian system also provides for a five percentage point reduction in the rate for entrepreneurs who meet additional investment requirements. Despite the higher rates, the Ministry of Finance assures that the new system includes a mechanism of deducting the amount of CIT from PIT from the dividend.
As a result, the effective tax rates after the changes are to be as follows:
- 25% for smaller entities or 20% in case an additional investment criterion is fulfilled instead of 26.29% in the classic system,
- 30% for normal taxpayers or 25% in case an additional investment criterion is fulfilled instead of the current 34.39%.
The difference in effective tax rates under the Estonian system indicates that the use of this settlement formula will ultimately result in actually lower taxation of the income generated by a company than in the “traditional” model. Therefore, the proposed system will be attractive to taxpayers both due to the postponement of the moment the tax obligation arises and due to the overall lower effective tax rate.
As we have mentioned earlier, a necessary condition for maintaining the preferential method of taxation is incurring certain outlays on investments. Taxation with Estonian CIT will cover the period of 4 years and will be automatically extended for the following years. If the required expenses are not incurred for investments, the entrepreneur will lose the right to “Estonian” taxation and will only be able to apply for it again after 3 years. In this regard, the possibility of modifying the planned regulation should be considered in such a way that a taxpayer who has lost the right to settle accounts in the amended CIT system could apply for it again at the beginning of the next tax year.
To sum up, we believe that the Estonian CIT is a necessary idea that might significantly support investments and development of entrepreneurship. The regulation in question is therefore a step in the right direction and ought to be evaluated positively.
Fot. loufre / pixabay.com