Lack of records = hidden profits? Taxation of cars in Estonian CIT
The lump sum tax on corporate income, colloquially referred to as Estonian CIT, is a form of taxation alternative to the 'classical' CIT. The attractiveness of this solution has significantly increased since January 1, 2022, when the stringent conditions for entering the Estonian system, maintaining an appropriate level of investment and the income threshold for switching to the lump sum tax were abolished.
What is subject to the taxation?
The main premise of Estonian CIT is a lack of taxation of a company’s income until it is distributed to shareholders in any form. Thus, not only dividends are taxed at the company level, but also other forms of profit transfer, including the services performed in connection with the right to participate in the profit, the beneficiary of which is a shareholder or an entity associated with him (the so-called hidden profits).
The following are examples of such benefits: loans granted by the company to a member, the surplus of the market value of a transaction above the agreed price, donations, gifts, entertainment expenses, etc. However, not every benefit received by a member is subject to Estonian CIT. The CIT Act provides for certain exemptions, which include:
- remuneration due under an employment contract, contract of mandate or contract for a specific task, managerial contracts as well as remuneration due to members of management boards, supervisory boards or audit committees;
- expenses and depreciation write-offs related to the use of passenger cars, aeroplanes and ships (in the amount of 50% in the event that they are not used exclusively for business purposes);
- the principal amount of a loan returned by the company to the shareholder.
Is record-keeping necessary?
It is the use of cars by a company taxed with Estonian CIT that was the subject of a recent tax ruling. A taxpayer asked the Head the National Revenue Information Service (KIS) whether personal cars used by the taxpayer exclusively for business purposes without keeping a mileage register should be accounted for as hidden profits and hence taxed.
The Company’s cars are actually not used for private purposes at all. The absence of mileage records is purely for practical reasons. Nevertheless, the company was of the opinion that this would not automatically imply their taxation as hidden profits, as they are in fact used solely for business purposes.
However, the tax authority did not agree with this position. The head of the KIS stated that 50% of the expenses and depreciation write-offs should be regarded as hidden profits and taxed under Estonian CIT. The Head referred to Article 16 (5f) of the CIT Act, pursuant to which, in the absence of a mileage register, a car is deemed to be used also for non-business purposes.
What does the legislation say about this?
However, we cannot agree with this interpretation. The Treasury has completely ignored certain basic issues which should be taken into account when making a qualification for hidden profits, namely:
1) the existence of a benefit;
2) performed in connection with the right to share in the profit;
3) whose beneficiary is the shareholder or a related entity.
The mere fact that the company possesses cars for which no mileage records are kept is not tantamount to their being used by the members for private purposes. The vehicles may, after all, be used by the company's employees (entities unrelated to a member) or by a member himself for business purposes.
In the business practice, numerous examples have been provided in which the mere absence of records of vehicle mileage does not prove the existence of a benefit related to the right of profit enjoyed by a shareholder. Therefore, we believe that a simple application of Article 16 of the CIT Act is inappropriate, and such an interpretation of the provisions will be challenged by the administrative courts.
Individual tax ruling of the Head the National Revenue Information Service of January 22, 2022 (docket no. 0111-KDIB1-2.4010.554.2021.2.AK).
Wojciech Jasiński, Tax Advisor, ATA Tax Sp. z o.o.
Interested in the topic?