The long-written guidance from the Tax Administration provides much-needed clarity

The article was published 1 August 2024 in Estonian on Äripäev.

The forthcoming guidance from the Estonian Tax and Customs Board (ETCB) on the taxation of acquisitions and restructurings of companies will not result in significant changes, but greater clarity is always preferable to uncertainty, according to Tõnu Kolts, co-head of tax advisory service line at COBALT.

The ETCB will shortly be publishing its guidance on the taxation of debt push-down structures. The ETCB has been writing this guidance for over a year and has held several discussions and meetings with market participants. Following these discussions, the guide provides examples and aspects to determine whether an aggressive tax planning practice is involved, which results in a tax advantage that is not in compliance with tax law and leads to the taxation of payments resulting from the transaction.

What will change?

The publication of the guidance is unlikely to result in significant changes, given that the ETCB has already adopted a more rigorous approach to the taxation of acquisitions and restructurings of various companies in recent years. The ETCB has demonstrated its willingness to challenge and address instances of potential abuse. One of the most beneficial aspects of the debt push-down guidance is that professionals engaged in acquisition transactions on a regular basis, such as funds, will be able to continue their activities without concern for potential taxation.

According to the MTA, abuses may occur in particular in the case of various intra-group transactions that result in an attempt to transfer profits out of Estonia tax-free. The guidance is therefore a valuable addition to the regulatory framework, providing clarity on the ETCB’s stance on these matters. Previously, there has been some ambiguity and uncertainty in the market, which the guidance addresses.

In addition to acquisitions, the MTA has also focused on a number of different corporate restructurings in recent years. It is therefore beneficial to be aware of the specific situations and aspects that are of particular interest to the ETCB, as well as the criteria they use to assess such cases.

What are the main areas of focus for the ETCB?

The ETCB considers that intervention or taxation may be required in cases where restructuring does not result in the deferral of tax liability but leads to a full income tax exemption through aggressive tax planning. For instance, a scenario may emerge where, due to transactions lacking economic substance, a tax exemption is established for redistributed dividends. Subsequently, the company may undergo a merger with a profitable second Estonian company. This enables its shareholders to receive tax-free dividends.

Furthermore, the ETCB is concerned about instances where taxable profits and exemption rights are combined through restructuring, resulting in no income tax liability on the profits earned. There are a number of instances from actual practice that illustrate this.

To illustrate, consider a scenario where a holding company is established in Estonia as part of a larger corporate group. This holding company then acquires another Estonian company within the group through the use of an intra-group loan or contributed equity. The holding company was established with no apparent commercial purpose, and the acquired company is subsequently merged with it. This enables the transfer of profits generated in Estonia out of the loan or equity without the imposition of tax.

Furthermore, a foreign parent company with two Estonian subsidiaries may choose to lend money to one subsidiary to acquire the other, rather than merging them. Consequently, the profits generated in Estonia are transferred out of Estonia tax-free (in the form of loan payments), either immediately or over a longer period of time. However, the two Estonian subsidiaries are merged following the acquisition transaction. In such a case, the loan may be used to transfer profits out of Estonia without paying taxes.

According to the ETCB, it is also not in line with the tax laws if a company that has been on the shelf for a long time, but has historically paid in taxable equity that allows for a tax-free distribution of equity, is merged with an operating profitable company, as a result of which the latter’s profits are transferred out of Estonia tax-free by means of a capital reduction.

The ETCB also monitors the use of funds following a restructuring to assess its link to the business. In other words, if a shareholding or other asset (e.g. immovable property) is transferred as a contribution in kind to a private company immediately before the sale, the funds generated by the sale must be used for business purposes only. Otherwise, the MTA may view this as an issue and consider it to be income of a natural person.

Clarity is always preferable

In conclusion, the debt push-down guidance does not entail any significant changes to the ETCB’s current practice, as this practice has already evolved in recent years with regard to both acquisitions and corporate restructurings. However, the guidance does provide some clarity, which should help to reduce uncertainty about the taxation of acquisition transactions.

The ETCB’s attention to these matters is certainly beneficial. Clarity is always preferable to ambiguity.

A new standard has been in place for some time regarding the taxation of company acquisitions and restructurings. Market participants and advisers alike will have to take this into account, as the former have sometimes been too liberal in the past. Court rulings are also expected in the near future, which should clarify the boundaries between permissible and impermissible actions.