Taxation system is one of the key factors that contributes to the country’s economic development and attractiveness for international business and investors. Estonia stands out as a unique and efficient jurisdiction among 38 OECD countries that are annually evaluated in the Tax Foundation’s International Tax Competitiveness Index. The country has been the Index leader for 9 years in succession! Why is it that Estonia is perceived by many analysts as the country with the world’s best taxation system?
5 Factors That Make Estonia’s Taxation System the Best in the World
Estonia’s high rank in the Tax Foundation Index is in many ways due to the loyal corporate income taxation mechanism which makes it possible to avoid fiscal burden in case of income reinvestment. However, this is not the only factor that contributes to the country’s success. Analysts single out 5 main reasons that made Estonia’s taxation system the best in the world.
Absence of Corporate Income Tax
The country’s laws give the right not to withhold corporate income tax from the income reinvested in the company. This motivates legal entities in Estonia to reinvest their income in business, which contributes to the economic growth. Exemption covers both active (for example, trade) and passive kinds of income (such as dividend, interest, royalty), encompassing capital growth from the sale of all kinds of assets (including shares, securities and real estate). This taxation mode is available to resident companies and permanent representative offices of non-resident companies registered in Estonia.
In fact, corporate income tax in Estonia is delayed until:
- Profit distribution in the form of dividends
- The moment when it becomes distributed (for example, in case of transfer pricing corrections if the company makes expenses and payments that have no business goals, including additional benefits, gifts, donations and administrative expenses).
According to the Estonian approach, this tax is considered as a corporate income tax and not as a tax on income at the source, so the rate does not depend on the double taxation treaty.
In 2018, a lower corporate tax rate of 14% was introduced in Estonia. However, it can only be used by the companies that regularly distribute profits.
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E-Residency, Estonian electronic residence program, helps individuals and legal entities from any country to create digital presence in Estonia and get access to digital services, including a possibility to submit taxes online.
Back in 2014 Estonia was the first country in the world to propose an innovative program to foreign citizens. Similar initiatives are currently being realized in Latvia, Lithuania, Dubai, Azerbaijan, Portugal, Ukraine, and many other countries all over the world.
“Electronic residency offers direct and indirect economic benefits for the receiving countries. E-Residency was an excellent instrument of image creation for Estonia as it strengthened the diplomatic power of the small country and contributed to the development of local entrepreneurship and economy as a whole. In total, the electronic residency and taxation system in Estonia stimulated innovations, and numerous successful enterprises brought considerable tax receipts to the country”, notes Lauri Haav, Managing Director of Estonian E-Residency governmental program.
According to Haav, the community of almost 90,000 electronic residents of the country currently helps to promote the Estonian national brand in more than 170 countries, spreading the success story of the digital community. “We have the grounds to believe that the value of the Estonian national brand will actively grow in the future thanks to our quickly-growing community of electronic residents and, as a result, the country’s diplomatic influence in the spheres of business, culture and foreign policy”, he noted.
If you are a non-resident and you wish to register a company in Estonia, here is an article for you.
Estonian value added tax payment system is also very simple and efficient. The standard VAT rate in the country is 20%. However, some goods and services are taxed at a reduced rate of 9% (books, drugs) or 0%.
One of the unique aspects about the Estonian tax system is the electronic VAT declaration and payment. Companies have to fill relevant forms online on a monthly or quarterly basis, depending on the amount of tax payable in the country. But this is easy to do as the VAT system itself is convenient and simple in Estonia. It helps legal entities to quickly and efficiently fill declarations, make payments, and receive value added tax cashback.
One more important peculiarity of the Estonian VAT system is the fact that it allows companies to receive cashback from its purchases. This possibility helps to avoid double taxation and guarantees that the legal entities will not be unjustly burdened by VAT.
On the whole, the Estonian VAT system is considered to be one of the most efficient ones in the world. Its simple and transparent rules, combined with convenient electronic document flow, simplify the company’s obligation to pay the value added tax.
World’s Simplest Taxation System
Estonia offers a fixed income tax rate in the amount of 20% that is applied to individuals and companies. This simplifies understanding and compliance with the tax code.
It should be noted that this fixed 20-percent income on individual income is not applied to personal dividends as the latter are taxed in Estonia at a reduced rate of 7%.
Besides, property tax in Estonia is only levied on plots of land rather than on real estate or capital, so no taxes are levied if the right of ownership to real estate (for example, land, improvements, or equipment) switches between individuals and legal entities.
Estonia has a territorial taxation system, which makes it possible to exempt the foreign profits received by local companies from internal taxation subject to certain limitations. A possibility to get an electronic residency and electronic document flow make it possible for Estonia to occupy a stable leading position among top competitive countries in terms of taxation issues.
Digital Estonia: Minimal Bureaucracy
Estonia simplified its taxation system and eliminated the majority of red tape that hampered business development. It helped to create a favorable environment that attracts entrepreneurs and investors from all over the world.
The single window system in the Tax and Customs Department considerably simplifies the tax payment and management system by providing access to governmental services in one place. Thanks to this system, 98% of all user data is stored in a single database, which helps to partially automate filling of declarations when they are opened. As a result, 96% of individuals and 99% of companies use digital services to pay taxes. In fact, Estonia’s electronic taxation system made the process of tax returns submission quick, simple, and accessible to everyone.
Compliance with taxation requirements takes minimum time in Estonia. To compare, OECD country companies spend on average 44 hours a year just to pay corporate income tax, while you only need to spend 5 hours on it in Estonia. It is also emphasized in the Tax Foundation Index that the VAT is also paid as quickly as possible.
The total of the above factors makes Estonia’s taxation system one of the best ones in the world. As a result, many companies that are thinking of international expansion to the European markets take this country as their launching pad.
International Tax Competitiveness Index
The International Tax Competitiveness Index (ITCI) is used to measure the degree to which the country’s taxation system adheres to two main aspects of the taxation policy: competitiveness and neutrality.
ITCI takes into account more than 40 taxation policy variables to determine whether the country’s taxation system is neutral and competitive. These variables measure not only the level of tax rates but also their structure. The Index takes into account the corporate laws of the country, individual income taxes, consumption taxes, property taxes, and compliance with the existing rules.
15 Leading Countries with the Most Competitive Taxation System:
|Country||Total score||Corporate tax score||Individual taxes score||Consumption taxes score||Property tax score||International taxation rules score|
Estonia’s taxation system is one of the most competitive ones in the OECD. However, taxation systems of the other leading countries can also get high scores for their advantage in one or several tax categories.
Latvia (that adopted Estonian corporate taxation system) has a very efficient labor income taxation system. New Zealand offers quite a small income tax that excludes capital gains to a large degree (the total maximum value is 33 %), a well-structured real estate tax and value added tax. Switzerland proposes a relatively low corporate tax rate (19.7%) and a low individual income tax that exempts capital gains from taxation to some degree.
Estonia made a revolution in the world business when it made a reform in its system and gave each person an opportunity to establish a company and fully manage it via the Internet. It has changed the context of the whole world business. The gap between the countries that take advantage of this experience and those that still adhere to traditional solutions will only grow with time.
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