Estonian CIT brings ‘no simplification’ for transfer pricing

From 1 January 2021, specific CIT taxpayers may choose the form of their income taxation: they may settle on general principles (already known) or opt for a new simplified form of taxation, i.e. the lump sum on the income of companies (the so-called Estonian CIT).

What is the difference? In a regular CIT, the taxation is on the income defined as a surplus of revenues over incurred costs, which the company obtained in a given tax year (the sum of revenues from all sources). In the case of the lump sum taxation, the income is the net profit determined pursuant to the accounting regulations and its equivalents specifically defined in the tax act.

What does it mean in practical terms?

Once the lump sum on company income is chosen, the taxpayer’s revenue and costs – determined for accounting purposes – also become tax categories. Therefore, taxpayers do not need to keep separate calculations for accounting and tax purposes (the so-called ‘transition’ from the balance sheet result to the tax result is no longer made) as required for the taxation under general rules. Apart from the tax base, the tax rate and the timing of the tax obligation are also different.

As described in the ‘Guide to the lump sum on company income’[1], released by the Ministry of Finance in December 2021, the lump sum is an alternative method of CIT taxation in relation to the regular CIT. However, the lump sum does not exclude the application of other provisions of the CIT Act, including the transfer pricing obligations.

The same conclusions were made in individual interpretations[2] recently published by tax authorities.

They state that provisions on transfer pricing (Article 11k-11t and Article 11e) also apply to taxpayers who have opted for the Estonian CIT. Thus, if a taxpayer fulfills conditions for the preparation of transfer pricing documentation (including the TPR form) for a given tax year (in the case of a lump sum, the tax year is aligned with the financial year within the meaning of accounting regulations), it is also subject to documentation obligations.

What does it mean in practical terms?

With such an unequivocal position of both the Director of KIS and the Ministry of Finance itself, it would seem that in terms of transfer pricing obligations of a taxpayer taxed with a lump sum everything is clear and simple.

But is it indeed? For instance, transfer pricing regulations provide for exemption from the obligation to prepare documentation for Polish taxpayers who (apart from other conditions) have not achieved a tax loss (on the source of income to which a given transaction is classified). So the question is how to check whether a taxpayer in the Estonian CIT regime is eligible for such an exemption? The taxpayer is not obliged to keep tax calculations and net profit is its tax base. Or, maybe by opting for the Estonian CIT the taxpayer deprives itself of the possibility to take advantage of this exemption?

On the other hand, the specific method of determining the tax base in the lump-sum on company income regime combined with lack of changes in transfer pricing regulations may lead to a conclusion that the issue of transfer pricing documentation in this taxation model should not occur at all.

You will not find answers to these questions in the justification of the position adopted by the interpretation authorities. What we get is a rather general argument featuring extensive quotes from Chapter 1a of the CIT Act, i.e. the chapter on transfer pricing. Therefore, the position adopted by the interpretation authority, even though – and it must be admitted – in line with the literal wording of the act, does not in any practical way take into account the specific interface between the lump sum taxation and transfer pricing.

Summary

The position made by the Ministry of Finance in the guidebook on the Estonian CIT confirmed by individual interpretations is good (although not entirely beneficial) news for taxpayers – yet only from the perspective of the consistency in the interpretation of regulations.

On the other hand, there is an overwhelming impression that the provisions on the lump sum on company income have been adopted – and are being applied – without reference to transfer pricing. The interpretation followed by the tax authorities, based solely on the wording of the law, completely ignores the practical aspect of how a ‘lump-sum taxpayer’ operates in the transfer pricing environment. We will follow the developments with interest – in particular, we are counting on the decisions of administrative courts. As a reminder: tax explanations are not a source of applicable law. You can disagree with them which the administrative courts have already pointed out.

[1] Explanations to the Lump sum on company income of 23 December 2021.

[2] Individual interpretation of 1 July 2022, ref. 0111-KDIB2-1.4010.99.2022.1.PB, and of 22 August 2022, ref. 0111-KDIB1-2.4010.132.2022.1.ANK