International Tax Planning and Transfer Pricing Planning: Estonia from a US perspective

• Author: Professor Dr. Rainer Zielke
• Profession: Professor in business economics at Østfold University College, Halden, Norway
• Updated at: April 2017

Professor Dr Rainer Zielke^[1]

Contenido 1 Abstract tax planning 2 Abstract transfer pricing planning 2.1 Introduction 2.2 The high tax country Estonia in the OECD context 2.3 Transfer pricing rules of Estonia 2.3.1 Laws and rules 2.3.2 Arm's length principle 2.3.3 Transfer pricing methods 2.3.4 Definition of related companies 2.3.5 Reporting requirements 2.3.6 Documentation requirements 2.3.7 Dispute resolution 2.4 Calculation of the case studies in international tax planning between Estonia and the USA 2.4.1 Design of the tables 2.4.2 The treaty Estonia-USA in brief 2.4.3 BEPS Project progress 2.4.4 Estonia in brief 2.4.5 The USA in brief 2.4.6 Design of case studies 2.4.7 Case study 1: Dividends from Estonia to the US 2.4.8 Case study 2: Interests from Estonia to the US 2.4.9 Case study 3: Royalties from Estonia to the US 2.4.10 Case study 4: Management and technical service fees from Estonia to the US 2.4.11 Case study 5: Capital gains with Estonia as asset country to the US as seller country 2.4.12 Case study 6: Dividends from the US to Estonia 2.4.13 Case study 7: Interests from the US to Estonia 2.4.14 Case study 8: Royalties from the US to Estonia 2.4.15 Case study 9: Management and technical service fees from the US to Estonia 2.4.16 Case study 10: Capital gains with the US as asset country and Estonia as seller country 2.5 Concluding remarks 3 Notes

Abstract tax planning

According to the International Monetary Fund, Estonia confirms in 2016 with a gross domestic product (GDP) of US$ 23,476 million the twenty-seventh-highest GDP of the European Union. In Estonia, the distribution tax is levied at a rate of 20/80 (approximately 25.00%) of the net amount of the profit distribution (20.00% on the gross amount (distribution + distribution tax) of the distribution). Thus, Estonia is a low tax country. Especially for multinational enterprises, it is interesting to realize profits in low taxing countries by means of tax planning measures. Estonia has introduced numerous anti-avoidance rules to avoid erosion of the taxable basis and to avoid profit shifting. According to the OECD, in Estonia, GDP growth is projected to gain momentum in 2017 and reach 2.9% in 2018, mainly driven by domestic demand. Private consumption will remain robust and public investment will pick up, sustained by EU funds. Despite a favorable business environment and good financing conditions, private investment will recover only slowly. Exports will strengthen backed by increasing external demand. This chapter provides a survey on the actual tax law frame conditions in Estonia and provides practical support in international tax planning and transfer pricing planning between Estonia and the US based on cross border case studies.

Abstract transfer pricing planning

With respect to transfer pricing Estonia applies the arm’s length principle and follows the OECD Guidelines, the following transfer pricing methods are applicable: the comparable uncontrolled price method (CUP), the resale price method (RPM), the cost plus method, the profit split method (PSM), and the transactional net margin method (TNMM). There is no hierarchy between the methods. A company holding at least 10.00% of the shares or voting rights in another company is regarded as related to that company. There are reporting requirements and documentation requirements. There are regulations on binding advance pricing agreements. In practice cost sharing is allowed. The tax authority may adjust the taxable income if transactions have been made not in line with the arm's length principle. General penalties apply.

Introduction

International tax planning and transfer pricing planning between Estonia, which is economically deeply integrated with the economies of its northern neighbors, Sweden and Finland, and - as a member of the European Union - is considered a high-income economy by the World Bank, and the US as most important national economy of the world based on cross-border case studies is of central importance. In addition, the USA confirm with a population of 321 million inhabitants in 2017 3rd place of the most populous countries in the world (4.40% of the world population).

According to the International Monetary Fund, ^[2] Estonia confirms in 2016 with a gross domestic product (GDP) of US$ 23,476 million the twenty-seventh-highest GDP of the European Union. In Estonia, the distribution tax is levied at a rate of 20/80 (approximately 25%) of the net amount of the profit distribution (20% on the gross amount (distribution + distribution tax) of the distribution). Thus, Estonia is a low tax country. Especially for multinational enterprises, it is interesting to realize profits in low taxing countries by means of tax planning measures. Estonia has introduced numerous anti-avoidance rules to avoid erosion of the taxable basis and to avoid profit shifting.

According to the OECD, ^[3] in Estonia, GDP growth is projected to gain momentum in 2017 and reach 2.9% in 2018, mainly driven by domestic demand. Private consumption will remain robust and public investment will pick up, sustained by EU funds. Despite a favorable business environment and good financing conditions, private investment will recover only slowly. Exports will strengthen backed by increasing external demand. However, maintaining price competitiveness will be challenging due to increasing labor costs. Fiscal policy will ease slightly but remain tighter than the fiscal rule of a structural balanced budget. Remaining inefficiencies in insolvency procedures, barriers to SME lending and labor shortages all undermine capital spending and productivity growth, calling for reforming the legal system, promoting new forms of business financing and strengthening the supply of marketable skills further. With the lowest public debt in the OECD and a general government surplus in 2016, Estonia’s fiscal position is very strong and prudent. The opportunity cost of this policy is high given the extremely favorable borrowing conditions and the need to fund growth-enhancing policies. Fiscal room should be used on measures to boost competitiveness and to make growth more inclusive, in particular by expanding active labor market policies and cutting labor taxes.

According to Orbitax, ^[4] (Daily Tax News Digest of 5 January 2016), on 3 January 2017, the Estonian Ministry of Finance published a notice on important legal amendments entering into force in 2017. The main items covered include:

• The general income tax rate will remain at 20.00%;

• The social tax rate will remain at 33.00% (reduction by 0.50% originally planned);

• The VAT rate for accommodation establishments will remain at 9.00% (increase to 14.00% originally planned);

• The VAT Reverse charge for metal products mainly used in construction and the machine industry is implemented as of 1 January 2017;

• Excise duties on cigarettes, tobacco, and natural gas are increased from January 2017, and excise duties on alcohol and fuel are increased from February 2017; and

• Amendments made to the EU Directive on administrative cooperation in the field of taxation (2011/16/EU) will be transposed into domestic law concerning the exchange of cross-border tax rulings (Council Directive (EU) 2015/2376) and Country-by-Country (CbC) reports (Council Directive (EU) 2016/881).

The required legislation for most of the 2017 measures has already been enacted, although the legislation regarding the EU Directive amendments is still pending. However, the tax ruling exchange requirements will still generally apply from 1 January 2017, and the CbC reporting requirement will apply for fiscal year beginning on or after 1 January 2016, with the first reports due by 31 December 2017 (to apply from 1 January 2017 for non-Estonian parented groups).

Click the following link for the full notice on the Ministry of Finance website. ^[5]

According to Orbitax, ^[6] (Daily Tax News Digest of 31 August 2016), the Estonia Ministry of Finance has put forward draft proposals to transpose into domestic law the amendments made to the EU Directive on administrative cooperation in the field of taxation (2011/16/EU) concerning the exchange of cross border tax rulings and advance pricing agreements (APAs) and Country-by-Country (CbC) reports. The amendments were made by Council Directive (EU) 2015/2376 (previous coverage) and Council Directive (EU) 2016/881 (previous coverage) respectively. Regarding tax rulings and APAs, the proposal includes that Estonia will automatically exchange cross border tax rulings and APAs with other EU Member States from 1 January 2017. The exchange also includes rulings and APAs issued, amended or renewed prior to that date subject to certain conditions. Regarding CbC reports, the proposal includes the implementation of CbC reporting requirements for MNE groups operating in Estonia meeting a consolidated annual revenue threshold of EUR 750 million in the previous year. The requirements will apply for fiscal years beginning on or after 1 January 2016. The draft proposals must be finalized and approved by parliament before entering into force. Additional details will be published once available.

The pivotal question is therefore, how groups of affiliated companies with group companies in Estonia and in the US can – before the background of anti-avoidance legislation and other tax law frame conditions – optimize their strategies of international tax planning based on cross-border case studies.

Therefore and first of all the high tax country Estonia is to be reviewed in the OECD context (see section 2) – also with respect to the transfer pricing rules of Estonia (see section 3), and constructive hereon 10 case studies in international tax planning between Estonia and the US are to be calculated (see section 4). Finally the results of this survey are to be compiled in concluding remarks (see section 5), especially with respect to the deduction of strategies in international tax...