Estonian tax – a good solution, only….
Undoubtedly, the introduction of the so-called Estonian tax should be recorded as a plus for the current ruling team. It combines the possibility of protection against liability for company liabilities with the deferral of taxation until profit distribution and a relatively favourable overall tax rate. This combination allows business development without the threat to private assets in the event of failure and tax-free reinvestment of profits - something entrepreneurs and small companies have been waiting for for a long time (especially in view of the introduction of limited partnership taxation)," writes Michał Thedy, tax advisor, managing partner of Thedy & Partners, in Rzeczpospolita.
There are doubts and difficulties
In practice, the new regulations raise quite a few doubts and cause difficulties in their application for both authorities and taxpayers. This in itself is not unusual. Of course, we can complain about the quality of legislation (which has indeed not been very good recently), but it seems that interpretation problems with new regulations will always occur to a greater or lesser extent. It should be borne in mind that it is difficult to foresee all potential issues before a regulation is applied in practice. However, this is when a rational interpretation of the regulations by the authorities, taking into account the purpose for which they were established, is very important. Unfortunately, this is not always the case, as is well illustrated just by the example of the Estonian tax.
The need for the authorities to be rational
Situation one: an entrepreneur switches to Estonian taxation from a sole proprietorship by converting to a limited liability company. In the balance sheet of his business there are profits earned before the conversion, but which were not distributed, but reinvested. At the same time, these profits were already subject to PIT on an ongoing basis when they were made. It would therefore seem obvious that their distribution from the converted limited liability company should no longer be taxed. Unfortunately, the authorities believe that since the profit is paid out of the limited liability company, it should be taxed a second time. The worst thing is that the entrepreneur who reinvested the profits made in the further development of his business (did not “consume” them) is “punished” here.
Second situation: when transforming into a limited liability company, the entrepreneur excludes from the transformation the shop property, which is then used by the transformed company for a fee (it rents shop space from the owner and from other unrelated entities). The authorities automatically interpret this as an unauthorised benefit to the owner, constituting so-called hidden profit, which is subject to taxation. They forget that in the market it is common to separate the operational activities from the ownership of assets (especially real estate) for their better protection. In addition, the entrepreneur is planning for succession – the company with the operating business is to be ‘handed over’ to the successors, while the entrepreneur wants to keep certain real estate as collateral (his own and the company’s, should the successors fail to run the business). Undoubtedly, the real estate is needed by the company to run the business and it makes economic sense to spin it off. Thus, insofar as the remuneration for its rental is market-based, it is difficult to speak of a so-called hidden profit.
Hope in the courts
I believe that at the level of the courts both of the above issues will be resolved positively for taxpayers. However, the question arises as to why, in the case of a regulation that was intended to help Polish entrepreneurs run and develop their businesses, the tax authorities are throwing a proverbial curveball at their feet?
This commentary was published in Rzeczpospolita of 19 April 2023, page A14