On 4 and 11 July 2017, the Cabinet of Ministers approved several draft laws that introduce significant changes to the Latvian tax system as from 1 January 2018. Note that the draft laws were adopted by the Parliament on 28 July 2017 in an expedited procedure. This tax news reports on the main alterations to corporate income tax (CIT).
Latvia follows the footsteps of Estonia by introducing 0% tax rate on reinvested profit
The most significant change as from 2018 will be application of a 0% CIT rate to reinvested profit or, in other words, CIT will be paid only when a company pays dividends or other payments with the aim of actual profit distribution (conditionally distributed profit).
Starting from 2018, a company’s profit will be exempt from CIT but the company will pay 20% CIT from the amount paid in dividends. In the meanwhile, individuals who receive these dividends will not be required to pay personal income tax (PIT). Although the draft law specifies that the CIT rate is 20%, together with the regulation that the taxable base should be divided by a coefficient of 0.8, the effective tax rate is in fact 25%.
CIT will be applied not only to dividends but also to deemed dividends and expenses comparable to dividends. Although definition of dividends is not new concept for Latvia, deemed dividends and costs comparable to dividends are new concepts in the new law. A conditional dividend is a decrease in the share capital (also in the case of company liquidation) that was previously increased by retained earnings on which tax was not paid under the present CIT regime.
On the other hand, conditionally distributed profit has several forms, of which the most significant are listed below:
- costs not directly related to economic activities, for example, costs of employees’ rest, cost of representatives’ cars, fines;
- interest payments to non-financial companies and individuals exceeding certain limits (thin capitalisation requirements, as from 2018 one existing restriction will remain – the debt ratio to equity capital is 4 to 1, and a new restriction will be introduced if the amount of interest paid exceeds EUR 3 million);
- if a bad debt is to be written off;
- transfer pricing adjustments;
- liquidation quota.
It is important to note that loans to related companies will be comparable to payment of dividends and will be subject to CIT unless they are exempt. For example, in situations if the amount of issued loans does not exceed the amounts of received loans from unrelated persons or the loan will be issued to a subsidiary or loan maturity will be up to 12 months. During the taxation period when the loan is repaid, the company is allowed to decrease the CIT base by the amount of the repaid loan. The draft law provides that the tax administration will be likewise entitled to assess loans issued in 2017.
In the new tax system, the taxation period will be one month (with certain exceptions regarding conditionally distributed profit, which will be calculated and included in the tax statement for the last taxation month of the reporting year).
Several existing tax allowances to be maintained
The new draft law maintains several existing tax allowances, as well as introducing transitional provisions allowing use of retained earnings as well as use of accrued tax losses.
The intention is that a company will be entitled to divide profit accrued over previous years without paying 20% CIT. Nevertheless, it should be taken into account that both written-off receivables and losses of future periods will decrease accrued profit.
Likewise, companies are expected to be allowed to use accrued CIT losses. Companies can use only 15% of these losses for a term of five years, starting from 2018. These losses can be used to decrease CIT payable for dividends, but not more than 50% of CIT payable on dividends.
Likewise, a slightly changed version of Latvia’s greatest international advantages will be maintained – dividends received will not be taxed in Latvia unless they are not subject to CIT in the country of origin. In addition, share disposals will not be subject to CIT unless the company has held the disposed-of shares for less than 36 months.
Likewise, CIT deductions for donations have been retained for public benefit organisations. Companies will be allowed to choose either to donate an amount related to profit from previous year or salary fund in previous year (5% of the amount for the previous reporting year or 2% of the salary fund in the previous reporting year) and not to pay CIT for donation, or to receive a discount upon paying CIT but to pay CIT on donated amount. The intention is that a donor could decrease CIT payable on dividends by 75% of the donated amount but not exceeding 20% of CIT payable.
A company will be allowed not to apply CIT to representation expenses and costs of personnel sustainability events that do not exceed five per cent of theyoyal amount of gross salary calculated in the pre-taxation year, and on which SSC has been paid, provided these costs have been recorded separately from other costs.
According to a request from the Ministry of Traffic, the existing tonnage tax regime will be maintained. Likewise, companies will be entitled to use previously granted discounts for large investment projects and CIT discounts for operations in special economic zones.
Non-residents’ life with the new CIT system will not undergo significant changes. However, a tax of 20% will be applied to management services that they provide. As of 2018 withholding tax from real estate disposal will be increased from2% to 3%. On the other hand, permanent establishments will pay tax as Latvian companies do – at the moment when the profit of the permanent establishment is transferred to the main company.
In the new system, tax will be paid by new subjects – partnerships – but investment funds, including alternative investment funds will also not be taxpayers in the new system. The tax should be paid by investors in the funds.
Taking into account that the new CIT taxation period is one calendar month, the expectation is that tax returns will have to be filed for the previous month by the 20th of the following month. For the first six months of 2018, a single CIT statement should be prepared; likewise, companies whose reporting period is different from the calendar year will be obligated to prepare an interim report as at 31 December 2017.