Significant recent judgments have created a serious tax risk for certain relationships where “one-man companies” are used to provide services to another company (also known as LLC-ism). In the past few months, the Estonian Supreme Court has handed the Tax and Customs Board three relevant victories and found that service fees paid to a company can, in principle, be reassessed as salary.

The Tax and Customs Board (TCB) has already announced its intention to actively pursue the opportunity of taxing service fees as salary and has published its views on the issue. It also promised to begin contacting companies apparently involved in LLC-ism in the near future. It is therefore reasonable to proactively review the characteristics of these relationships and assess the tax risks in order to avoid surprises from a possible future conversation with a revenue officer.

According to the judgments and TCB guidelines, a significant tax risk can arise in situations where:

  • services are invoiced monthly, usually in the same amount;
  • all or most of the services are provided to a single customer;
  • the same person belongs to the management board of both the service provider and the service recipient;
  • a service agreement has the characteristics of an employment contract (eg, fixed working hours, subordination, supervision by employer)

However, the TCB’s reassessment opportunities are not unlimited – each relationship must be assessed on a case-by-case basis and the fact of providing services does not automatically lead to taxation. The burden of proof is on the tax authority to show that the service contract was ostensible and the parties were in fact acting as if under an employment contract.

Providing services through a one-man company may legitimately be a regular business which cannot be subjected to salary taxes. In particular, intervention by the tax authority would be unjustified if the company providing services had other operations as well or provided services to many companies or if the relationship did not have the characteristics of an employment contract.

Guidelines for determining the nature of a contract can be found in Supreme Court judgments in cases 3-2-1-82-14, 3-3-1-25-15 and 3-3-1-12-15.