Estonia applies the incorporation doctrine for corporate income tax purposes, meaning that a company incorporated under Estonian law is tax resident for Estonian tax purposes and subject to Estonian taxation. However, in determining the tax residency of a company in an international context, the national rules may not prevail. For example, there may be a tax treaty providing for specific rules on tax residency. In that case, criteria other than those in national law may apply. The application of these other criteria is contingent upon the assessments of the relevant tax authorities. The place of effective management, however, is the decisive factor in most tax treaties concluded by Estonia, including the tax treaty with the Republic of India.
Therefore, if a foreign national permanently residing abroad incorporates an Estonian company and manages it from abroad, it can often be argued that the company is not actually an Estonian tax resident for Estonian tax purposes. Non-resident companies are subject to tax in Estonia only, if:
- there is some business presence in Estonia (g. a sales representative) that constitutes a permanent establishment;
- there is Estonian-sourced income (g. income from immovable property located in Estonia).
Tax treaties ensure that double taxation, which occurs when both states simultaneously exercise their taxing rights on the same income, is avoided. If a treaty stipulates that an income may be taxed in the contracting state where the income is sourced, there is normally a corresponding obligation for the residency state of the taxpayer to grant double tax relief in the form of an exemption or foreign tax credit.
Alternatively, a company incorporated under Estonian laws and effectively managed from Estonia may create a “foreign permanent establishment” for tax treaty purposes if its business is carried on abroad.
Example 1: A company incorporated under Estonian laws effectively managed from India with no Estonian business presence
A company with such features is most likely not subject to corporate tax in Estonia: it would not be considered a tax resident for the purposes of the tax treaty between Estonia and India, and due to the absence of local business presence, Estonia is not entitled to tax any of its business profit. However, the non-applicability of Estonian tax law is not automatic. The taxpayer must initiate a formal procedure to solicit a mutual agreement between the competent Indian and Estonian authorities as to its tax residency according to the tax treaty. In the absence of such formal agreement between the competent authorities of Estonia and India, the taxpayer is potentially subject to double taxation, in which case both countries would apply their domestic tax laws.
Example 2: A company incorporated under Estonian laws effectively managed from India with Estonian business presence
A company with such features could be subject to corporate tax in Estonia if its Estonian business presence constitutes a permanent establishment for the purposes of the tax treaty between Estonia and India. For example, if it has a local sales representative who has, and regularly exercises, his authority to conclude contracts, the profit attributable to that sales representative would be taxable in Estonia. Still, for the purposes of taxing its worldwide profits (i.e. profits that are not attributable to its Estonian permanent establishment), a conflict between Estonian and Indian domestic tax law arises and resolution should be sought via the mutual agreement procedure outlined in Example 1.
Example 3: A company incorporated under Estonian laws effectively managed from Estonia
Estonian tax legislation does not set forth specific guidelines for the interpretation of the "place of effective management" concept. However, as Estonian tax treaties are based on the OECD Model Convention, the OECD Guidelines are helpful in this respect. According to these guidelines, "the place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entity's business as a whole are in substance made". Furthermore, OECD Guidelines make a note that India is of the view that the place where the main and substantial activity of the entity is carried on is also to be taken into account when determining the place of effective management. Therefore, careful consideration of all the relevant facts and circumstances is crucial in determining whether the place of effective management is in Estonia or India, or in a third country. If the conclusion of such analysis is that the place of effective management is Estonia, the double taxation risk does not arise and the company is taxed only in Estonia.
The purpose of this overview is to highlight the tax aspects of Estonian companies managed by e-residents. Importantly, tax residency is different from e-residency. E-residents are not automatically tax residents and companies established by e-residents, if effectively managed from abroad, can actually be tax residents of another country. In the latter case, a certificate of residence for such company from another country should be submitted to the Estonian Tax and Customs Board to initiate the double taxation avoidance proceedings (more information available at www.emta.ee).
This overview has been prepared for general guidance only, and does not constitute professional advice. Please reach out to your tax advisor for a case-specific advice.
Law Firm GLIMSTEDT