Here are some common tactics︆ used by Estonian corporations to erode their tax base. These tactics are often perfectly legal︇ and commonly used but can be controversial due to their impact on the corporate tax︈ base:
1. Transfer pricing: This involves manipulating the price at which goods or services are︉ sold between different entities within the same corporate group. Companies might artificially set these prices︊ to shift profits to low or zero tax jurisdictions.
2. Income Shifting: This involves moving︋ profits to lower-tax jurisdictions. A parent company in Estonia might set up a subsidiary in︌ a low-tax country, and then transfer profits to the subsidiary.
3. Use of intangible assets:︍ Intellectual property such as patents and trademarks can be assigned to subsidiaries in low-tax jurisdictions.︎ Royalties paid for use of these assets can then be used to shift profits to️ these subsidiaries.
4. Debt shifting: You can finance investments other countries with debt. The interest on this debt is then tax-deductible in the other country, reducing the tax base there, and at the same time you don't pay it in Estonia if you don't distribute profits.
5. Debt pushdown schemes:
In a debt-pushdowm scheme the acquired company will continue to service the loan taken for its acquisition, and the state will not receive any tax revenue. The following simplified example is given to illustrate this.
If company A wants to acquire company B, it acquires all the shares of B from the latter's shareholders. Now,︀ if A finances the purchase through a bank loan or other similar instrument (e.g. bonds),︁ the money to service the loan usually comes from B's profit. When profit is distributed︂ by B to A, however, income tax is due, which is why servicing the loan︃ is always more expensive by income tax. This is what a so-called conventional acquisition transaction︄ looks like.
In a debt push down structure, A establishes company C before acquiring B,︅ and the acquisition transaction is carried out between C and B. C is then a︆ separate company established specifically for acquisition. In that case, C, not A, takes a loan︇ to finance the transaction. After the acquisition transaction, A owns a stake in B through︈ C, which has obligations to the bank. However, in addition to the acquisition, according to︉ the debt push down structure, the merger of C and B also takes place, as︊ a result of which C ends and merges with B (among other things, the obligation︋ to pay the loan to the bank is transferred to B). In this case, however,︌ in order to service the loan, it is no longer necessary to distribute the profit︍ on which income tax would be payable, but the loan is serviced by B from︎ the income obtained from his daily economic activities, and this is what the impermissible tax️ advantage consists of.
The tax authority has been expressing its position in one way or another for years, and in their opinion, the repayments of the loan taken by the acquired company for its own acquisition and the interest paid must be considered as non-business related payments, on which corporate income tax is due. Among transaction advisors, this topic continues to be divided, with some taking a more conservative approach and others taking a more liberal approach. This is, among other things, caused by the fact that, according to the current income tax law, all domestic mergers and divisions are theoretically tax-neutral, and the fact︀ that as a result of the merger, all the assets, liabilities and rights of the︁ merging company are included, should not be considered a tax advantage, which contradicts the content︂ and purpose of the income tax law.
So far, the tax authority is not known︃ to have challenged any such transaction and tried to tax loan and interest repayments. However,︄ relevant answers to inquiries have been given. Different approaches can also cause some uncertainty among︅ foreign investors. It is also true that when the current income tax law was drafted,︆ the use of the so-called debt push down structure was not intended, therefore it is︇ not regulated, and the tax authority is based on the provisions for the requalification of︈ transactions/payments.
To conclude - with a little planning and cost zero tax is possible.
