Preliminary adjustment in estonian CIT – lump-sum tax on company income

The estonian CIT, or lump-sum tax on company income, is a form of taxation that allows the postponement of tax payment until the actual distribution of profits to an individual – a shareholder. A key element in the initial phase of applying this taxation model is the calculation of the so-called preliminary adjustment.

The essence of the preliminary adjustment

As stated in the explanatory notes from the Minister of Finance dated December 23, 2021, the effect of the preliminary adjustment of revenues and costs is to eliminate:

• double taxation of the same income;
• the possibility of excluding certain revenues from the tax settlement;
• double deduction of the same expenses;
• the possibility of excluding certain costs from the tax settlement.

In other words, the preliminary adjustment involves identifying discrepancies at the moment of implementing the estonian CIT taxation between the company’s tax result and financial result.

CIT/KW information

Taxpayers opting for estonian CIT are required to submit the CIT/KW form, which is an attachment to the CIT-8 declaration. The CIT/KW form must be submitted to the head of the appropriate tax office by the end of the third month following the end of the tax year.

The CIT/KW contains information about discrepancies in recognizing revenues and costs for tax and accounting purposes (preliminary adjustment) as of the last day before the first year of taxation under the lump-sum tax on company income.

As part of the preliminary adjustment calculation, the taxpayer should:

• include in taxable income:
  • revenues previously recorded only for accounting purposes;
  • expenses previously recorded only for tax purposes;
• include in tax-deductible expenses:
  • revenues previously recorded only for tax purposes;
  • expenses previously recorded only for accounting purposes.

As explained by the Director of the National Tax Information in the individual interpretation of March 27, 2024, reference number 0111-KDIB2-1.4010.626.2023.1.DD: “The primary purpose of Article 7aa of the CIT Act is to prevent double inclusion of a given category into income or costs, as well as non-taxation of certain flows. […] The adjustment should apply to transitional differences between the taxpayer’s financial and tax results.”

When does the preliminary adjustment not result in actual taxation?

The preliminary adjustment does not always lead to actual taxation. The nature of the discrepancy between the company’s tax and financial results may not result in income being shown in the preliminary adjustment. This happens if the transitional differences, before implementing the estonian CIT, led to an underestimation of the financial result compared to the tax result.

Furthermore, even if the company shows income within the preliminary adjustment, it will only be taxed at the 19% rate if the company loses the right to apply the lump-sum tax before the expiration of four tax years. If the company applies estonian CIT for at least four tax years, the tax obligation from this adjustment expires.

Summary

The preliminary adjustment in estonian CIT is a mandatory calculation of the difference between the accounting and tax treatment of income and costs, which may or may not lead to taxation. Correct preparation of the preliminary adjustment requires a careful assessment of the company’s financial situation, as well as proper completion of the CIT/KW form. The preliminary adjustment does not result in actual taxation, particularly if the company maintains the use of estonian CIT for at least four tax years.