Binding preliminary decision helps to hedge tax risks related to transactions

The scarce and inconsistent implementation of Estonian tax laws often leads to situations where tax advisers, let alone accountants or average taxpayers, are not able to clearly assess the tax obligations deriving from contemplated transactions or acts.

The complexity of vital circumstances and the excess laconism of tax laws are often the reason why the instructions of a tax authority are needed for uniform application of laws. Instructions that are binding in the meaning of tax laws can be requested from a tax authority that will provide a binding preliminary decision.

Preliminary decision and uses thereof

The concept of a binding preliminary decision has been incorporated in the Taxation Act for almost 7 years now. By a binding preliminary decision, the Estonian Tax and Customs Board provides, on the application of a taxable person, a binding assessment of taxation of an act or set of acts (transaction) to be performed in the future. Such a position is binding on the tax authority even in case the legal interpretation of legal provisions changes already the next day. For taxpayers, a binding preliminary decision helps to avoid the potential tax risk deriving from a single act or a set of acts.

However, a binding preliminary decision cannot be requested from a tax authority with regard to all the taxes applicable in Estonia. Estonian Tax and Customs Board tackles only applications regarding state taxes, and a binding position of the tax authority cannot be requested with regard to local taxes. Estonian Tax and Customs Board issues a preliminary decision regarding an act or set of acts to be performed in the future, and such an act must be an actually contemplated economic transaction. Applications concerning theoretical and hypothetical issues shall be returned and the tax authority can respond to them only by the procedure for general provision of information.

Binding force of preliminary decision

One of the major advantages of a preliminary decision is its binding force. From the legal perspective, the preliminary decision of a tax authority is binding only on the tax authority itself, and the taxpayer is not required to act according to the preliminary decision. If the taxpayer that requested the preliminary decision does not agree with the positions set out therein, the taxpayer is free to act according to the interpretation regarded correct by the taxpayer. If the tax authority does not accept it, the final lawful solution will be found as a result of possible tax proceedings and the subsequent judicial proceedings.

Only the person that filed the application may rely on the binding preliminary decision of a tax authority, and one may rely only on such an assessment of a tax authority that is not evidently unlawful. If the taxpayer, upon receipt of the position, is aware of its unlawfulness, the taxpayer has no right to rely on the decision. Therefore, from the practical point of view, it is important that the application is filed jointly by all the persons concerned by the contemplated transaction. Otherwise it may result in a situation where parties will be subject to different taxation as a result of one and the same transaction.

In order to ensure that the preliminary decision shall be binding on the tax authority, the act or transaction to be performed shall correspond to the description set out in the preliminary decision in all respects that are important for the purpose of taxation, and it must be performed within the term set out in the preliminary decision. The term for performance of an act is determined by the tax authority, but a respective proposal can be made by the taxpayer.

As to the binding force of a preliminary decision, it is also important to notice whether the laws and regulations, regarding which the tax authority has assumed a position, will still be substantially in force at the closing of the transaction. In a situation where a law is substantially amended after the making of a preliminary decision but before the closing of a transaction, then to be on the safe side, it would be reasonable to ask for an additional confirmation regarding the validity of the preliminary decision from the tax authority.

Applying for preliminary decision

To apply for a preliminary decision, a written application shall be filed with Estonian Tax and Customs Board, and the application shall include a comprehensive description of the planned act, analysis of the circumstances significant in terms of taxation, as well as an assessment given by the applicant concerning the legal bases for the taxation of the act. The application shall also set out the details of the applicant and it shall not be anonymous. The application shall also include a list of existing documents and drafts of the documents relevant for performance of the act. Documents need not be appended but the tax authority may ask for the existing documents in the course of processing the application.

As a tax authority cannot process an application that does not contain sufficient information, it is reasonable to describe in detail all aspects related to the act. A detailed description of the circumstances is also important to enable the tax authority to differentiate between an actually planned transaction and a hypothetical transaction. The tax authority has to be reasonably convinced on the basis of the application that the taxpayer has an intention as well as the means to perform the transaction described in the application. For example, a tax authority may have a reason to refuse to make a preliminary decision regarding taxation of transfer of a registered immovable in a situation where the applicant has no registered immovables whatsoever. However, the lack of intention and means, i.e. the hypothetical nature of an application, must be reasoned by the tax authority.

Before a preliminary decision is made, it is worth looking at the website of Estonian Tax and Customs Board where the tax authority publishes summaries of all preliminary decisions regarding the taxation of important transactions and acts repeatedly described in applications. In addition, several preliminary decisions have induced amendments to tax laws.

Refusal to provide preliminary decision

In addition to the circumstances described above, the tax authority is also entitled to refuse to provide a preliminary decision in case the tax consequences of an act are explicit and there is no doubt regarding the interpretation of the legal provisions regulating the taxation of the transaction; the act is aimed at tax evasion (area of application of Section 84 of the Taxation Act) or in case the preliminary decision is requested with regard to transfer prices.

Consequently, the position of a tax authority can be requested only with regard to rather complicated taxation situations which require more thorough analysis than usual as well as deep knowledge of the respective field. The tax authority may refuse to provide a preliminary decision only in case the answer to the question given in the application is explicitly clear to an average taxpayer. Therefore, it could be possible that the tax authority refuses to provide a binding preliminary decision with regard to the taxation of every single contemplated transaction.

The actual benefit of binding preliminary decisions lies in the binding force of the position of the tax authority and in hedging the tax risks related to transactions. Therefore it is reasonable to describe all the circumstances in the application in a detailed and truthful manner. The tax authority may invalidate preliminary decisions that have been prepared on the basis of incorrect information, but especially in a situation where the main aim of submitting incorrect information was to obtain a preliminary decision advantageous to the taxpayer.

Conclusion

The state fee for an application for a binding preliminary decision is relatively high (1180 euros for legal persons and 300 euros for natural persons). However, the state fee is paid according to the number of applications, not the number of applicants, and therefore the actual cost may be substantially lower. Another thing that has to be taken into account while applying for a preliminary decision is the average term of 60 days which can be extended by the tax authority by another 30 days if necessary.

Alternatively, the position of a tax authority can be requested by a request for explanation according to the general procedure. Such a request for information is free of charge and will generally not take any longer than 30 days, but the position given in such manner is not directly binding on the tax authority pursuant to law. The indisputable advantage of a binding preliminary decision is its binding force – it remains in force even if the court practice regarding taxation of acts changes substantially in the meanwhile.