Transfer Pricing in Estonia
Transfer pricing in Estonia
Where goods, intangibles or services are transferred across the borders within multinational enterprises, transfer pricing becomes an important issue for the taxpayers as well as for the national tax and customs authorities which have the responsibility of overseeing these cross-border flows. Transfer Pricing is the price that is assumed to have been charged by one part of a company for products and services it provides to another part of the same company, in order to calculate each division’s profit and loss separately. International transactions between related parties (parent companies and affiliates) are playing increasingly significant role in world trade and economy. Transfer pricing has become the number one issue in the international tax arena.
General rules are established by the Income Tax Act; Organisation for Economic Co-operation and Development (OECD) compliant methods and pricing principles are established with the Decree by Minister of Finance. Transfer pricing rules are applicable to all types of transactions. Rules are applicable to inter-company transactions concluded between the following parties:
• An Estonian company and its related party;
• An Estonian sole proprietorship and its related party;
• An Estonian permanent establishment and its foreign head office;
• An Estonian permanent establishment and a party related to its foreign office; and
• An Estonian company and its foreign permanent establishment.
Individuals are related if they share a common economic interest, or if one person has a dominant influence over another. The following companies and individuals qualify as related parties:
• An Estonian company and its group company;
• An Estonian company and a direct shareholder that owns more than 10% of the share capital;
• An Estonian company and another company that has a common shareholder or at least two direct shareholders, which are related parties and own more than 50% of the share capital;
• An Estonian company and another party that each separately own more than 25% of the share capital;
• An Estonian company, its employees, board members and direct relatives of these persons and another legal entity that has exactly the same members of their respective management boards.
Companies not covered by the existing formal definition may be regarded as related parties if they have a common economic interest or if one company has control over another.
Transfer pricing principles
The Estonian regulation is based on the arm’s-length principle that requires the prices charged between related parties be equivalent to those that would have been charged between independent parties in the same circumstances. Arm’s lenght is a transaction or relationship where there is an absence of control of the one over the other. Any hidden distribution of profits is subject to Estonian corporate income tax.
Besides the OECD Guidelines, there are some Estonia-specific issues (e.g. preference of local comparables) that should be considered. Furthermore, sufficient attention should be paid to the present Estonian corporate income-tax system, which taxes only direct and deemed profit distributions.Under the present Estonian corporate income-tax system, transfer pricing adjustments are treated as deemed dividend distributions subject to corporate income tax. Consequently, transfer pricing adjustments do not increase the taxable income of the taxpayer and are not treated as non-deductible for corporate income-tax purposes.
Transfer pricing methods
The methods are not hierarchical and are all treated as equal. The Estonian regulation introduces five transfer pricing methods:
• Comparable uncontrolled price method - is calculated on the price at which a transaction between related persons have been made and is in accordance with the principle of the market value of comparable transaction between unrelated parties (similar to a transaction) price.
• Resale price method- is applied if the property or service is purchased and resold to a person of non-related party. The comparison is based on the dealer mark-up. The estimated selling price is less than resale margin compared to a comparable transaction to add a mark-up. The mark-up to covers the costs incurred by the taxpayer of the transaction, a proportionate share of the costs and the period of leave to the individual with the completed transaction by the staff.
• Cost-plus method- is used on property transactions and services and in particular the manufacture or assembly related activities. Application of cost-based method is based on transaction costs related to execution, shall be borne by the taxpayer's controlled transaction. Equally important is the added level of profit, which must correspond to the market value, and based on acceptable cost, which must be relevant.
• Profit split method - is used when the transactions are highly related to each other and cannot be assessed separately, and the parties to the transaction using the transaction context of valuable intangible property or other unique assets. Profit divided by the application of the method does not require the presence of comparable transactions. Each operating companies contribution is based on an analysis of the contribution. It shall be assessed to the extent that this is possible on the basis of reliable market data.
• Transactional net margin method – it compares a controlled transaction return rate of return comparable to the transaction’s rate of return: a transaction operating profit divided by the total transaction costs, revenues, or assets used to complete the transaction.
In addition, the taxpayer is entitled to apply its own method provided that it achieves a more reliable result. Taxpayer is entitled to apply only one method for calculating transfer price for a transaction. Under the Estonian corporate income-tax regime, all undistributed corporate profits are tax-exempt. This exemption covers both active (e.g. trading) and passive (e.g. dividends, interest, royalties) types of income, as well as capital gains from sale of all types of assets, including shares, securities and immovable property. This tax regime is applicable to Estonian companies and permanent establishments of foreign companies that are registered in Estonia.
In Estonia, corporate profits are not taxed until the profits are distributed as dividends or deemed profit distributions, such as transfer pricing adjustments, expenses and payments that do not have a business purpose, fringe benefits, gifts, donations and representation expenses. Registered permanent establishments (including branches) are subject to corporate income tax only in respect of profit distributions, both actual and deemed, as defined in domestic law. The period of taxation is a calendar month. The combined corporate income tax and payroll tax return must be submitted to the local tax authorities and the tax must be paid by the tenth day of the month following a taxable distribution or payment.
As a general rule, all Estonian group companies and permanent establishments are obliged to prepare transfer pricing documentation to prove the arm’s-length nature of the inter-company transactions. Required documentation requirements apply to the following persons:
1) resident credit institutions, insurance and stock exchange listed company;
2) if the transaction is a party related to a person located in a low tax rate territory;
3) the resident company with 250 employees (turnover at least EUR 50 million; or balance sheet total is at least EUR 43 million);
4) non-resident who operates through a permanent establishment in Estonia and who has employees (including at least 250 persons; or annual turnover of transactions with related parties prior to the 50 million or more; or balance sheet total is at least EUR 43 million).
An exemption applies to small and medium-size enterprises (SME) unless they have conducted transactions with entities located in low-tax territories. A company or permanent establishment is deemed to be an SME, provided that the previous financial year consolidated results of an Estonian company or a permanent establishment together with its associated enterprises or head office are below all of
the following criteria:
• Annual sales below EUR50 million;
• Balance sheet below EUR43 million; and
• The number of employees below 250.
Although the formal transfer pricing documentation requirements do not apply to SMEs, they may still be required to prove the arm’s-length nature of their intercompany transactions to the tax authorities in the course of a tax audit. There are generally no limitations and restrictions in relation to the form or type of evidence the
taxpayer can submit to defend transfer prices. Transfer pricing documentation should be submitted to the tax authorities within 60 days of the request. The transfer pricing documentation does not have to be in Estonian, but the tax authorities may ask the taxpayer for a translation.
Categories of documentation required:
- Company analysis
- Industry analysis
- Functional analysis
- Economic analysis
Additional assessments and any penalties imposed by the tax authorities can be appealed by the taxpayer within 30 days of receipt of the tax verdict. The appeal may be submitted to the tax authorities, with review of the appeal occurring generally
within 30 days. If the appeal is unsuccessful, the taxpayer is entitled to submit a new appeal to the court within 30 days of receiving the decision from the tax authorities. As a general rule, regardless of whether an appeal has been submitted, the taxpayer is required to pay the imposed tax within 30 days of receipt of the tax verdict. Under certain circumstances, the tax authorities or court may postpone the payment of tax until the tax dispute is resolved.
Limitation of double taxation and competent authority proceedings
There is no special regulation to provide relief from double taxation of domestic intercompany transactions. The general procedure of refunding overpayments of tax may be insufficient for some cases and may trigger double taxation. Relief from double taxation in cross-border inter-company transactions can be sought through the tax treaties concluded by Estonia that, in most cases, include provisions for a mutual agreement procedure.