Published date: July 7, 2021. 21:10
As a shareholder, it is reasonable to expect dividend income from your profit-making company. As mentioned above, all retained earnings of an Estonian company are tax exempt, and it is only when you decide to distribute dividends that the 20/80 CIT on the payment is triggered. We’ll come back to why the tax rate is expressed in such a way.
To be more precise, the effective corporate income tax rate applicable to profit distribution can vary from 14% - 20% depending on the company’s dividend policy.
The lower end of the CIT rate can become available for your company if it pays dividends on an annual basis. There is a special rule which says that regular profit distributions which are less than or equal to the average dividend payment that the company has made in the three preceding years are subject to CIT at a lower rate of 14/86 – note that special rules apply for making use of this, as described below.
The formal procedure for effecting a dividend distribution is regulated by the Commercial Code, more specifically by Chapter 19. But even if you fail to follow certain legal formalities, the tax treatment does not change and distribution of profits is still taxed as dividends – we call this the “substance over form” principle in tax law, and it is useful to keep this in mind at all times.
Substance over form principle
The legal form of an arrangement or transaction is ignored and the actual economic substance is looked at for tax purposes. This helps prevent artificial structures from being used to avoid tax.
Dividends are paid from the net profit or retained profit of a company in accordance with the decision of the shareholders or other competent body.
Dividends are normally considered passive income for the recipient, as opposed to employment income.