On 12 August 2020 a draft amendment to the CIT Act introducing a new taxation system, the so-called Estonian CIT model, has been published on the website of the Government Legislation Centre.
We wrote about its basic assumptions here.
Propose changes may be further modified – the draft is currently under review.
Taxpayers will have a choice whether to benefit from the new system of CIT settlements or to remain with the traditional form of taxation and retain the right to tax reliefs. An alternative to the new solution will be a special investment fund that does not exclude the right to tax reliefs.
NEW MODEL OF INCOME TAXATION
The draft provides 2 alternative scenarios of income taxation under the new rules (without possibility to combine them):
- the flat-rate income of capital companies – a system modeled i.a. on the Estonian sone which binds taxable income to the categories of balance sheet law and assumes change of the moment of the taxable event, i.e. deviation from taxation of income defined as the difference between revenues and tax-deductible costs in favor of a tax on profit distribution – the tax will be paid only at the moment of profit distribution to the shareholder, e.g. as a dividend,
- special investment fund – a system modeled on the German investment reserve which enables taxpayers to settle fixed asset depreciation for tax purposes faster, without interference with existing tax settlements and to maintain the possibility to benefit from the preferences provided in “traditional” CIT system.
FLAT-RATE INCOME OF CAPITAL COMPANIES
The new taxation regime will be selected for 4-year periods (after the end of this period, if the taxpayer meets the statutory conditions, it may continue its settlements in subsequent 4-year periods).
Determination of a 4-year settlement period as a flat-rate is not absolute in nature, since if statutory conditions are breached, the taxpayer will lose the right to flat-rate income taxation also during this 4-year period.
Who will benefit?
- The solution is addressed to small and medium-sized capital companies (limited liability and joint-stock companies).
- Criteria – Estonian CIT will be available to companies:
- in which only natural persons are shareholders,
- whose total revenue does not exceed PLN 50 million per year (including the amount of VAT due),
- which do not hold shares in other entities (shares, titles of participation or all rights and obligations),
- which have at least 3 employees – apart from shareholders,
- whose passive income does not exceed operating one,
- which incur investment expenditures.
- All the above criteria must be fulfilled cumulatively.
Certain categories of taxpayers were excluded from the new system:
- enterprises operating on the financial market (financial enterprises referred to in Article 15c(16) and loan institutions referred to in Article 5(2) of the Act of 12 May 2011 on consumer credit) (permanent exclusion),
- taxpayers obtaining income from business activities conducted within the Special Economic Zone or the Polish Investment Zone (PSI) (permanent exclusion),
- taxpayers under insolvency or liquidation proceedings (permanent exclusion),
- entities participating in divisions, mergers and transactions of in-kind contributions in the form of an enterprise or an organized part thereof (temporary exclusion – a taxpayer participating in restructuring proceedings may select the option of taxation at the earliest in the second tax year after commencing its activity as a result of a merger, division or contribution in-kind).
The subject of taxation and tax rate
The subject of taxation of Estonian CIT will be below categories of income:
- distributed profits,
- profits allocated for loss coverage if it arose in a period prior to taxation in that system,
- hidden profits,
- expenditures not related to business activity,
- changes in the value of assets,
- undisclosed business operations, and if a taxpayer ceased to apply this form of taxation (including as a result of the acquisition by another entity) – income determined in the amount of the flat-rate income taxation of net profit generated in each tax year of application of this taxation in part in which this profit was not previously distributed or was not allocated for loss coverage.
In the case of a larger taxpayer, the tax rate will be 25%. For entities with the status of a small taxpayer, the tax rate will be 15%. The above rates may be reduced by 5 percentage points if the investment expenditure incurred by taxpayers exceeds the statutory thresholds.
Terms and conditions for applying a flat-rate
- Before applying the new form of taxation, the taxpayer will be obliged to adjust existing settlements to the new system requirements, i.e. include in the tax base those categories of services that would otherwise remain untaxed or could be subject to double taxation.
- During the period of application of a flat-rate, the taxpayer will not be entitled to deductions indicated in the CIT Act, such as donations, R&D reliefs, bad debts relief, and other reliefs deducted from the tax base.
- The taxpayer will not be able to settle previously incurred tax losses – the losses may be settled after leaving this system unless the period for their settlement expires (if they were incurred not earlier than in the fifth tax year preceding the last year of application of this system).
The requirement to incur capital investments
- The taxpayer will be obliged to systematically increase fixed assets, measured by the increase of expenses actually incurred in the tax year for the manufacture or purchase of new fixed assets included in groups 3-8 of the Fixed Assets Classification or fees set out in the lease agreement (except for operating lease), in part constituting the repayment of their initial value.
- The increase in expenditure should be:
- 15% (not less than PLN 20,000) over a two-year period and
- 33% (not less than PLN 50,000) over a four-year period respectively.
- Capital investment expenditure shall not include expenses incurred on passenger cars, means of air transport, and other assets mainly used for personal purposes of shareholders or their family members.
SPECIAL INVESTMENT FUND (ACCOUNT)
- Using the investment fund will require setting up a special investment account at Bank Gospodarstwa Krajowego (BGK) or another bank that has an agreement with BGK on cooperation in the exchange of information on funds accumulated on that account.
- The taxpayer will be able to apply the existing taxation rules, including tax reliefs.
- The taxpayer will have to submit to the head of the tax office information about the planned investments and to pay funds allocated for these investments into the fund.
- The taxpayer will be able to recognize deductions to the fund as tax-deductible costs. The number of write-offs will depend on the taxpayer’s profitability.
- The spent funds shall not derive from loans, credits, grants, subsidies, and other forms of financial support. The taxpayer will have 3 consecutive years from the date of the write-off to spend these funds.
- If the taxpayer will not spend the collected funds for investment purposes or will not spend them in the designated period, it will be obliged to withdraw deductions from tax-deductible costs, i.e. to increase taxable income.
If you have questions about the Estonian CIT model, please do not hesitate to contact us:
Head of Tax, Board Member