Latvia established a social tax ceiling from the beginning of this year, prompting a welcome debate on whether Estonia’s taxation system was also developing in a successful and sustainable direction.

Besides international tax planning, much of our daily work is focused on comparative analysis of Baltic legal and tax systems. We explain to our clients the benefits of choosing Estonia, Latvia or Lithuania for a given activity. Latvia’s new social tax ceiling is another ticked box in the list of reasons why foreign undertakings entering the Baltic markets should target their investments and activities to Latvia instead of Estonia.

Since the late 1990s, Estonia had a lead in tax comparisons for a number of reasons, such as a presumably simple and transparent system of taxation, zero corporate tax on reinvested profits, withholding obligations applicable to only a few types of payments. However, recent analyses are increasingly indicating that Estonia may no longer be the preferred tax environment for a rational entrepreneur. The scales are tipping towards Latvia.

The social tax ceiling is just one of recent visible steps putting Latvia ahead of Estonia in what used to be our strength internationally – creating a business-friendly environment. Latvia levies a 15% corporate tax and zero tax on share transfers, provides a favourable tax environment for holding companies and micro-companies and offers a number of tax incentives/reliefs. All these measures contribute to business development, job creation and, in the longer term, a rise in employment levels and tax revenue. Meanwhile, Estonia’s recent tax law developments are less than laudable and the country is falling behind in regional tax competition.

This is because Latvia is not the only country out to attract development-minded investors to the region. Finland is also taking steps to facilitate business, for example by slashing its corporate income tax rate from 24.5% to 20% from the beginning of 2014. Lithuania is promoting its free zones and takes care of small businesses by offering a 5% corporate income tax rate for companies with less than 10 employees and an annual turnover of less than EUR 289,000.

Meanwhile, Estonia has opted for hostile short-term solutions for tax collection (like rushing through the obligation to declare all 1000-Euro invoices, which failed the constitutionality test). Such steps cast doubt on the stability of Estonia’s business environment and make it even harder to explain to clients why they should choose Estonia over its neighbours as an investment location.

Recent debates on tax amendments indicate that the state is out to improve tax collection by burdensome measures instead of facilitating the business environment to secure an increase in tax revenue and prosperity in the future. We urge Estonian policymakers to view the system of taxation and collection in a longer term than just the next annual budget and come up with changes to ensure government revenue after five, ten or fifteen years as well. A social tax ceiling would be a welcome first step towards this, but further action is needed: the overall income tax rate should be gradually lowered to 15%, while abolishing income tax on the sale of shareholdings, licence fees and profits from international trade. These steps would improve the attractiveness of Estonia’s business environment and its competitiveness among its closest neighbours.