Prospects for the development of the functioning of Estonian CIT in the Polish tax system

Estonian CIT following changes In the Polish Deal has become an attractive solution for a large group of taxpayers. However, further changes are needed, in particular the admission of capital groups and the abolition of the obligation to maintain employment at the indicated level. This publication aims to give constructive criticism to the Polish version of Estonian CIT in its original version and to assess the proposed amendments In the Polish Deal.

Estonian CIT was introduced 1 January 2021, as a lump sum on the income of capital companies. Changes that entered with Polish Deal, The entity requirements of the Estonian CIT have been incurred, which has now become a lump sum on company income.

The legislator has introduced beneficial modifications to the Estonian CIT that should unlock the potential of this interesting solution.

Furthermore, Estonian CIT may in the future become a growth promoter for small and medium-sized enterprises, provided that the entities covered by this tool are further expanded and that the legislator does not impose any restrictions on them and on them in the future.

Estonian CIT – the assumptions of the tax system invented in Estonia

Estonian CIT was introduced in Estonia on 1 January 2000 and was intended to be an innovative way of clearing economic operators with state administrations.

The scheme was to be characterised by a departure from taxing on income already at the time of its inception, which at the time was a widely used practice in the world, and the imposition of corporation tax only on profits transferred from the company.

This was to simplify the tax system as much as possible and to shorten the time that entrepreneurs in Estonia spent on settlements with tax offices.

The system of tax law in Estonia does not provide for an obligation on traders to pay income tax on income that has remained in the company or has been reinvested in order to generate future income. This applies to both companies that have registered their representation in Estonia as well as a branch of a foreign company.

In case of transfer of income outside the enterprise, the transferred income is subject to corporate income tax of the amount of 20% with the possibility of reducing this rate to 14% – where dividends are regularly paid. The revenue transferred shall include:

• 1) revenue transferred from the company during the tax year, inter alia in the form of dividends;
• 2) gifts, donations and representation expenses;
• 3) expenditure and payments not related to the business;
• 4) the assets of the foreign representation or branch of the entity transferred to that entity or to other entities.

The tax system in Estonia provides that dividends paid by companies registered in Estonia to foreign companies holding shares in Estonian companies are exempt from the so-called withholding tax. The legislator wanted to impose this one tax (CIT) on the income generated and transferred from the company[1].

The tax base is increased by adjustments to transfer prices, expenses and payments that do not meet the business objective, additional benefits, gifts, donations and representation costs. This tax system was designed to encourage foreign capital to invest in Estonia, as well as growth promoters for companies registered in Estonia.[2].

In the Estonian tax system, the tax records for corporate tax purposes of CIT were kept to a minimum. The companies are not required to keep records of the depreciation write-downs made, to split costs into constituting and not constituting revenue costs. Such a situation allows entrepreneurs to devote additional time to operational activities and reduce the cost of carrying out extensive accounting[3].

It should be stressed that Estonian corporate income tax was introduced in a particularly difficult period for Estonia's economy.

In the years preceding the introduction of tax changes, Estonia still felt the effects of the economic crisis in Russia, which continued from 17 August 1998 to 15 November 1998 and significantly affected not only the Russian economy, but also the economies of countries economically linked to Russia.

Moreover, immediately before tax changes are introduced In 2000 Estonia's capital markets were underdeveloped, which translated into difficult access for Estonian companies to external financing[4].

At that time, developing countries in Central and Eastern Europe, in particular the Czech Republic, Slovakia, Hungary, Poland, Lithuania, Latvia, Estonia, implemented legal solutions in the European Union.

The dynamic development of the capital markets of these countries, regardless of the tax arrangements applied, has made it difficult to see the real benefit for the economy of Estonia as a result of the tax changes introduced In 2000 5 .

A comparative analysis of the number of registered, active, entrepreneurs in Lithuania, where the standard CIT tax applies, and in Estonia, where the tax system is much more business-friendly.

Namely, during the period from 2014 to 2018, including agricultural sector operators[6] , and financial, Lithuania had a total of registered entrepreneurs about 211,297 – In 2014, 226,417 In 2015, 236,827 In 2016, 25,413 In 2017 and 261,036 In 2018[7].

The growth of registered entrepreneurs in Lithuania was respectively 7.16% In 2015, 4.6% In 2016, 5.74% In 2017 and 4.24% In 2018. Median year-on-year 2014 to 2018 The number of registered entrepreneurs increased by 5.43%.

For comparison, approximately 73,472 In 2014, 78,624 In 2015, 81,837 In 2016, 88,186 In 2017 and 91,038 In 2018[8]. The growth of registered entrepreneurs in Estonia was respectively 7.01% In 2015, 4.09% In 2016, 7.76% In 2017 and 3.23% In 2018. Median year-on-year 2014 to 2018 The number of registered entrepreneurs increased by 5.52%.

This comparison partly proves that the reform of corporate tax in Estonia in 2000 did not lead to a greater interest in foreign capital vis-à-vis CIT countries.

In the author's opinion, the benefits of applying income tax may be more noticeable in the future. This position is supported by continued globalisation, digitisation and legal facilitation for foreign capital. The lack of extensive accounting and the possibility to postpone settlements with the tax office can be an attractive solution for foreign investors.

Aleksander Łożykowski, Director of the Department of Income Taxes at the Ministry of Finance, pointed out in the document The Impact Assessment (OSR) for the Estonian CIT that similar solutions were adopted, among others, by Georgia and Latvia. These countries have introduced a tax system to waive the tax on profits retained in the company. As in Estonia, Latvia and Georgia, the capital paid from companies in the form of dividends and economically similar payments are taxed[9].

Estonian CIT in Polish version 1.0

Polish legislature on the day 1 January 2021 introduced into the Polish legal system a solution modeled on the Estonian corporate tax CIT. From 1 January 2021 entrepreneurs in Poland had the opportunity to choose a flat-rate tax on the revenues of companies called Estonian CIT. Originally, the legislator introduced a lump sum on the income of capital companies 15% for start-ups and small taxpayers, and a rate of 25% for other taxpayers.

In the opinion of the Polish legislator, the introduction of a new form of taxation was intended to address the problems of the group of entrepreneurs, which, due to the weaker competitive position and the consequent lower opportunities for external financing and the accompanying lack of money for the implementation of the investment, cannot develop according to its potential[10]. The legislature assumed that the solution to the lack of access to external financing would be to allow capital companies to reinvest the amount of the current CIT tax that they would have to bear if Estonian CIT had not been introduced.

It should be stressed that the legislator in the draft Act introducing the Estonian CIT indicated that the new form of taxation is intended to serve entities belonging to the small and medium-sized enterprises sector, operating in real economic activity and having a simple shareholding structure.

At the same time, the legislator introduced a restriction which allows the use of Estonian CIT only to entities with limited liability or public limited liability companies.

At this point it should be stressed that the publicly available data from the CSO indicate that at the end 2020 the REGON system was registered together 457,600 limited liability companies and 9,900 public limited liability companies.

After deduction of companies employing more than 50 persons registered in Poland were around 448,000 limited liability companies and about 8,000 public limited liability companies[11].

The whole sector of small and medium-sized enterprises in Poland consists of 2,194,244 micro enterprises, 49,514 small and 14,433 Medium-sized enterprises[12]. The whole market for small and medium-sized enterprises consisted of 2019 including about 2,258,191 entrepreneurs.

In view of the above, limited liability companies and public limited liability companies constituted around 20.19% SME sector in 2019. This means that technically it could not qualify for a new form of taxation around 80% small and medium-sized enterprises.

Estonian CIT not for all capital companies

However, it should be stressed that the Act introducing the Estonian CIT contains significant entity restrictions also for capital companies. Namely, the possibility of using this form of taxation was deprived of capital companies whose shareholders/shareholders are other capital companies. The legislator limited Estonian CIT exclusively to capital companies whose shareholders are natural persons. Moreover, such companies cannot be shareholders in other capital companies[13].

However, this is not the end of restrictions. The legislator considered that it was also appropriate to deprive Estonian CIT of the possibility of being used by capital companies which, during the period up to 3 back years they participated in widely understood reorganisation transactions, i.e.

mergers, divisions, transformations, aport[14]. The bill does not contain any justification for such an exemption, so it can be guessed that the legislator was afraid that the tax revolution would result in a massive transformation of companies to meet the requirements for the Estonian CIT.

Time has shown that the legislator should not have been so afraid.

Neither are financial companies, in particular banks, investment funds, investment firms, as well as the possibility of using Estonian CIT. Borrowing institutions and taxpayers with tax-exempt income in the Special Economic Zones or the Polish Investment Zone and taxpayers put into bankruptcy or liquidation.

Reinvestments price for new tax

At the same time, the legislator introduced the criterion in question in the form of an obligation for the clearing entity under the Estonian CIT to incur investment outlays of an appropriate amount.

The amount of the expenditure incurred was fixed at the last day of the review period, which was standardised as two years, and in the case of taxable persons carrying out a significant investment for their business activities, the settlement was to take place over a four-year period.

The increase in the value of fixed assets in the primary two-year period must have been above 15%, but not less than 20,000 PLN. In the case of investments of significant importance for business activity, investment outlays should increase by 33% on a four-year basis, not less than 50,000 PLN[15].

At the same time, the legislator allowed the investment criterion to be met by increasing wages, by at least 20% – not less than 30,000 PLN, for identical expenditure in the year preceding the two-year period of taxation of the Estonian CIT.

Such investment requirements could represent a significant risk on the part of those companies which, without having access to external financing, accumulated revenue in order to carry out a significant capital investment.

In their case, the requirement to reinvest income may have been met by increasing wages or making less significant investments, the legitimacy of which may have been undermined.

In such a situation, the companies could depend on the fact that the construction of the capital would create a significant burden on the budget, which would be a significant increase in the remuneration of employees, which would remain unchanged after the investment.

Such a situation could lead to a loss of financial liquidity for companies and consequently their bankruptcy.

Estonian CIT not for passive income

The legislator introduced an additional entity criterion in the form of an exemption from the Estonian CIT of those economic operators whose income is mostly based on so-called passive revenues.

For such taxable persons, a requirement was made that the maximum 50% the income of the taxpayer may come from passive sources, including interest, copyrights, benefits on all types of loans, part of the interest-rate lease, guarantees and guarantees, transactions with related entities within the meaning of Article 11a(1)(4) The CIT Act − where the value added in economic terms is not generated in connection with these transactions or the value is negligible.

This means denying access to the Estonian CIT for most companies in the sectors – insurance, finance, loan, leasing.

The legislator in the fight for employment

The legislator introduced a criterion in the law whereby only those companies which employed at least three persons on a full-time basis, other than shareholders, shareholders or shareholders of that taxpayer, for a period of at least 300 days in the tax year and where the tax year is not a subsequent period twelve calendar months — for at least 82% the days of the tax year. This requirement shall be deemed to be fulfilled if the taxable person bears the expenditure specified in the Act for the payment of remuneration to employees employed under contracts other than the contract of employment.

It was also introduced that Estonian CIT could be used by start-ups. In their case, the condition of hiring at least third persons only In the third the full tax year since the start of business. In the meantime, these companies are subject to an annual increase in employment from second tax year, by at least 1 full-time work up to the level of employment corresponding to at least three people.

In the case of small taxpayers, the legislator has introduced an employment requirement, at least one an employee or payment, at least equivalent to the national average in the enterprise sector, to a natural person employed on a basis other than a contract of employment.

Obligation to notify by the end of January 2021 late companies must wait a year

It is important that the legislator introduces the obligation for the taxpayer to notify the head of the tax office of the choice of this form of taxation by the end of time. first months first the tax year in which the lump sum is to be taxed. So outlined deadline for notification while announcing the Act on two months before the deadline, it could significantly reduce interest in a new form of taxation.

Development yes, economies of scale no

The legislator considered that the new tax form should be intended exclusively for the small and medium-sized enterprises sector and introduced a limit to ensure that the taxpayer’s total operating income in the previous tax year does not exceed 100,000,000 PLN or the value of the average operating income, calculated at the last day of the previous tax year from the flat-rate tax period, did not exceed 100,000,000 PLN, This revenue is calculated taking into account the amount of tax due on goods and services.

The introduction of this solution significantly weakened the interest of Estonian CIT in Poland. It should be noted that the non-excess criterion 100,000,000 PLN revenue has a different effect on the perception of Estonian CIT by companies operating in different industries.

In other words, Estonian CIT falls in the assessment of an initial capital company in the service sector and otherwise in the assessment of companies, inter alia, in the commercial, gaming, new technologies or RES sectors for which the income threshold is exceeded at the level of 100,000,000 PLN is real in a few years.

It should be stressed here that the science of economics sees important benefits in so-called economies of scale. Such a company policy enables the operation of larger markets and results in a significant increase in sales revenue.

In order to achieve economies of scale, it is necessary to increase production volumes to such an extent as to minimise unit costs.[16]. Such a business policy, e.g.

in the retail sector, can rely on the rapid creation of a large number of shops and the creation of its own distribution network, which would lead to, among other things, a minimisation of the cost of the supply of products (no margin of external entities), improved negotiating position with counterparties and a large increase in business revenues.

The Estonian CIT fiasco 1.0?

The introduction of a new revolutionary form of taxation was to lead to a revolution in the small and medium-sized enterprises sector. The Ministry of Finance assumed that the target group for the new form of taxation was 200,000 capital companies[17]. The difficult to meet the subject-matter criteria led to little interest in the new solution in small and medium-sized enterprises.

Consequently, all first the year of application of the Estonian CIT to this form of taxation only about 367 companies 18 , what constitutes 0.18% target group. Several factors have had a significant impact on this situation.

First, It should be pointed out that the legislator has wrongly aligned the Estonian CIT with the diagnosed problems of the small and medium-sized enterprises sector, the most important being the lack of access to finance.

At this point, it should be questioned whether a change in the form of taxation can solve the problem of companies facing a lack of access to capital. This is usually needed at a specific point in time, during the tax year, and its amount is much higher than that part of the revenue of the company which remained due to the Estonian CIT.

The real solution to the issue of access to external capital could be to introduce additional loans to small and medium-sized enterprises, on preferential terms, while reducing the requirements that the credit applicant company must meet.

Another reason for the lack of interest in Estonian CIT at the beginning 2021 there are subjective conditions allowing for a new form of taxation only capital companies, the majority of which also do not meet the corporate conditions.

It should be stressed that the legislator has not provided any reasonable basis for excluding non-capital commercial companies from the new form of taxation.

The legislator considered that the competitiveness of companies belonging to capital groups should not be increased as they have access to intra-group loans and guarantees, and that they could exploit economies of scale and obtain better financing conditions[19]. This position of the legislator cannot be agreed.

It should be considered inappropriate to take the view that the mere existence of another company in the ownership structure of a capital company constitutes a competitive advantage vis-à-vis companies whose shareholders are exclusively natural persons.

Moreover, this argument cannot withstand criticism because the holding by the capital company in the ownership structure of a shareholder or shareholder that is another commercial company does not mean that these companies form a capital group.

According to Article 4(14) Act dated 16 February 2007 on competition and consumer protection (i.e. Journal of Laws of 2021, item 275) the capital group is a group of all entrepreneurs who are controlled directly or indirectly by a single entrepreneur, including that entrepreneur.

In turn Article 3(1)(44) Act dated 29 September 1994 on accounting (i.e. Journal of Laws of 2021, item 217 as amended) points out that whenever a capital group is referred to in the Act, it is understood by that parent entity together with subsidiaries.

In view of the above, it should be assumed that the legislator made a mistake in seeking to exclude the capital groups from the taxation of Estonian CIT, and by introducing a much broader restriction excluding companies with a legal structure.

There is a significant proportion of companies whose shareholders are other legal entities and yet there is no direct or indirect dominance. In the case of such companies, there is no competitive advantage vis-à-vis companies whose shareholders are exclusively natural persons.

In the margins, it should be pointed out that individuals are often richer than capital groups and have better credit standing than them, which can help with the possible increase in the share capital of a company whose shareholders are only natural persons.

Another issue that may have had a negative impact on interest in lump sum on the income of capital companies (Estonian CIT) is the level of confidence of entrepreneurs in the legislature in Poland. This is probably affected by a number of factors, including the lack of stability of the corporate tax system in Poland, which is characterised by notorious changes, and the extensive legal regulations concerning this tax.

Estonian legislator from January 2013 to 31 January 2022 passed a total 44 Act amending the Corporate Income Tax Act[20]. During the same period the Polish legislature passed 134 laws amending the Corporate Income Tax Act and 7 laws introducing uniform text, which together gives 141 set it together.

During the period from 1 January 2000 The Estonian Act has been amended together 121 times. During this time the Polish legislature passed 239 laws amending the Corporate Income Tax Act.

This means that Polish entrepreneurs in the last period 9 years had to three often more often to check whether the legal changes implemented concern his situation right from the Estonian entrepreneur.

Another issue is the scope of the Corporate Income Tax Act itself. The Estonian Income Tax Act is based on 178.18 pages a[4] (53,454 words divided by 300 words per page), while the Polish law is based on 425.48 pages (127,645 words / 300 words per page).

The broadness of the Polish law on corporate income tax and the frequency of changes make the average Polish entrepreneur have to sacrifice about 334 hours 21 in a year for settlement with the tax office. The average Estonian entrepreneur sacrifices about 50 hours 22 to settle with the IRS.

On the margins, it should be added that in recent years Poland has a growth trend of around 24% from 2015 (269 hours In 2015 to 334 In 2019), while in Estonia there was a downward trend of around 38% (81 hours In 2015 to 50 hours In 2022).

The above outlined differences in the way tax legislation was conducted were aimed at presenting the legal realities in which Polish entrepreneurs conduct business activity and in which Estonian entrepreneurs.

Such a large discrepancy has a real impact on the level of confidence of entrepreneurs in the Polish legislature and the remote 40. Poland's place in the ranking of business friendly places[23].

In the light of the above, it is highly likely that Polish capital companies went untrustworthyly to the new form of taxation and preferred to wait to decide on this form of taxation.

It is worth noting that the legislative process of the Act introducing the Estonian CIT has been less than two months – 30 September 2020 the bill was submitted, on 28 November 2020 the bill was passed and on 30 November 2020 The bill was announced in the Official Journal of the Republic of Poland.

It means that in the process two months of capital companies which met strict requirements could choose a new form of taxation. The result of this irrational action by the legislator was a negligible percentage of the capital companies that decided on a new form of taxation for Estonian CIT.

Estonian CIT 2.0 – whether the new form of tax has second A chance?

The Polish legislator saw the need for significant changes to the original version of the Estonian CIT, which led to a major revision of the rules on lump sum on the income of capital companies within the framework of Act dated 23 November 2021 amending the Personal Income Tax Act, the Corporate Income Tax Act and certain other laws, item 2105 Called the New Polish Deal. A number of beneficial changes were introduced for taxpayers, which should significantly increase the interest of Estonian CIT in Poland.

Removal of restrictions on other capital companies

First, It should be pointed out that the legislature has enabled all commercial companies to benefit from taxation in the form of a lump sum on company income. This is a significant entity expansion, as the use of the Estonian CIT is currently also available for simple public limited liability companies, limited liability companies and limited liability companies.[24]. The change in this respect should be assessed positively and contribute to a greater interest in the new form of corporate taxation. However, it should be borne in mind that the company opting for Estonian CIT cannot have:

• (i) shares or shares in the capital of another company,
• (ii) participation in an investment fund or in a joint investment institution,

(iii) the total rights and obligations in a company which is not a legal person and other property rights relating to the right to receive a benefit, as the founder (founder) or beneficiary of a foundation, trust or other entity, or a legal relationship of a trust nature.

It is critical to leave the criterion of ownership based solely on natural persons as well as the prohibition on holding shares in another company. Originally, the legislature considered that all companies holding shares of other companies should be excluded from the Estonian CIT, or in which the ownership structures of other companies appear. Such a position cannot withstand criticism and this restriction should be abolished.

Abolishing the investment obligation

Another significant change in the right direction is the abolition of the obligation to reinvest in unpaid income. The taxpayer’s commitment to cyclically incur greater capital expenditure or to pay did not take into account the specific characteristics of the various industries.

It should be noted that the disadvantage was the situation of taxpayers who wanted to build funds for a significant investment and had no creditworthiness.

In their case, it would be possible to meet the condition of reinvesting capital by increasing remuneration, which would distance them from the investment purchase for which they built savings. It is therefore important to assess positively the amendment in the area where the obligation to reinvest income has been abolished.

Decisions on the payment of investment expenditure in the companies concerned should be taken on the basis of the management bodies of those companies which know best how to achieve a stable growth of their companies.

Reduction of CIT from 15% to 10% and 25% to 20%

Another positive change is the reduction in the rate of the lump sum on the income of companies from 15% to 10% for small and starting taxpayers and reduction from 25% to 20% tax rates for other taxpayers. Moreover, the effective tax rate for shareholders' income including Estonian CIT and PIT is currently at 20% for small taxpayers and 25% for other taxpayers.

At the same time, it is possible to argue that the amount of PIT should be calculated taking into account the profit less the flat-rate payable. This would mean that an effective rate could be 18.1% for small taxpayers and 21.2% for other taxpayers. However, the above assumptions with the tax authority should be confirmed, e.g. by requesting an individual interpretation.

Elimination of revenue limit to 100,000,000 PLN

Another major amendment is the abolition of the revenue limit to 100,000,000 PLN.

In the current state of the law, companies were also admitted to the Estonian CIT, whose total operating income in the previous tax year exceeded 100,000,000 PLN or the average operating income, calculated on the last day of the preceding tax year from the flat-rate tax period, exceeded 100,000,000 PLN.

This amendment represents a step in the right direction, since the absence of an income criterion causes companies from market segments with strong development opportunities to benefit from a new form of taxation without having to consider the consequences of exceeding the threshold 100,000,000 PLN revenue in the tax year.

Positive Changes

The legislator introduced the possibility of notifying the choice of form of taxation to the Estonian CIT during the tax year. The obligation to make a notification has therefore been abolished until the end first months first the tax year in which the lump sum is to be taxed.

It should be considered that this change is beneficial for entrepreneurs and may have a positive impact on the interest of Estonian CIT in Poland. Tax payers from various economic sectors will be able to verify at a convenient time how the decision to join the Estonian CIT will affect their business.

Currently taxpayers wishing to settle in the form of a lump sum from companies are obliged to:

• (i) notification to the competent tax authority of the choice of this form of taxation;
• (ii) preparing information on the so-called transitional differences,

(iii) taxation of recognised income on a general basis.

The legislator also introduced a favourable change for taxpayers to abolish the obligation to pay the initial adjustment for income and costs in relation to those taxpayers who will benefit from the Estonian CIT for a period longer than 4 years. This is another positive change eliminating regulations that could negatively affect the choice of this form of taxation.

Company risk for shareholder activities

Special attention should be paid to the fact that an Estonian CIT company must comply with the requirement that its ownership structure is composed exclusively of natural persons. This requirement applies throughout the period during which the company uses Estonian CIT.

Failure to introduce appropriate regulations in the company's statutes governing the sale of shares or registered shares subject to the company's consent may result in the loss of the right to an Estonian CIT in the event of the sale of a share or shares to a legal person - disposal even one the shares will deprive the company of the right to an Estonian CIT.

Appropriate amendments to the statutes of the public limited liability company are possible on the basis of Article 337 section 2 ksh.

Estonian CIT 2.0 However, it is beneficial

The changes proposed by the legislator to the Estonian CIT should significantly increase the interest in this form of taxation among taxpayers who meet the subject-matter requirements.

It should be particularly important for the companies concerned to abolish the obligation to reinvest income, allowing decisions to be taken on the distribution of income according to the best economic choice of the management authorities.

This should improve the financial situation of companies and increase their ability to raise external capital. A potential investor or bank would take into account the lack of tax burden resulting from the reinvestment or accumulation of capital in the company.

There are still many irrational criteria for Estonian CIT which should be changed in the coming years. Such criteria include, in particular, the requirement that the ownership structure of the company is based solely on natural persons, which significantly limits the possibility of foreign capital to benefit from this form of taxation.

An important advantage of Estonian CIT is also the saving of time that the company would normally have to spend on carrying out extensive accounts and preparing annual accounts with the tax office. This saving of time and resources should affect the choice of taxpayers to benefit from the Estonian CIT.

It is worth considering the reorganisation of ownership structures in such a way that the (not so stringent) corporate requirements of the taxpayer are met to benefit from the Estonian CIT.

It should be stressed that taxpayers expect the legislator to continue to work on the Estonian CIT and to introduce further changes of a broader nature.

_________________________

24 R. Kowalski, Polish Deal: Changes in Estonian CIT, LEX/el. 2021.