The Estonian government is planning to implement tax measures to increase corporate income tax revenue. The problem addressed relates to long-term loans from subsidiaries to parent companies, which are not repaid and which can be treated as profit distributions. The government plans to implement so-called “collateral income tax” to improve tax revenue and hinder this hidden distribution of profits.
The draft bill covers loans and guarantees between related entities and groups using group accounts. The new tax is planned to be effective from 2018 and should cover all loans and guarantees from 01.07.2017. We have highlighted the main types of upstream financing transactions causing tax risks:
- A subsidiary has provided a loan to its parent company. Income tax is levied on loans issued to a parent company and a company located above the parent company, also loans to other subsidiaries of the parent company. Only large-scale profit-based loans will be taxed, ie loans exceeding contributions to the equity of the company and inbound loans. Tax must be paid upon issuing the loan.
- Providing collateral securing parent loans. Collateral provided by a subsidiary guaranteeing a loan to the parent company is taxed similarly to a loan. This may have significant importance when planning group guarantee structures and syndicated loans.
- Providing credit in other forms. Income tax may be levied on credit agreements and other agreements with a similar economic function. Excessive payment terms may qualify as a loan.
- Using group accounts. Using group accounts will not be taxed only if the financial means are made available for the other group members for a short term (up to one year), provided its purpose is to manage group liquidity. No specific details are provided on how to define this function of the loan.
Scheme: Which transactions may be taxed?
How to avoid tax liability? Assuming that the draft bill will be enforced in its current wording, solutions for avoiding tax liability (which is absolutely normal, even expected, behaviour) are the following:
- Restructure group financing.
- Refinance loans/guarantees through entities not in the group/foreign entities.
- Increase payments to the equity of the subsidiary or loans taken by the subsidiary.
- Merge the lender and the borrower (including cross-border merger).