Essential legal and risk-related obligations to be aware of when setting up your company in Estonia — Part Two
A few weeks ago, we published the first of two articles regarding some of the most important legal obligations relevant for an e-resident starting their company in Estonia.
In part one, we covered the beginning of the company establishment process:
In this second article, we will cover the first year of operating your business and introduce some of the main duties you should know about as a company founder regarding dividends, net assets, taxes, annual reporting, employing staff, and intellectual property. Being aware of these obligations and building them into your business setup is the first step towards ensuring you are running a legally-compliant business in Estonia.
It’s important to note that we clearly cannot cover ALL legal obligations that could be relevant for you and your company in Estonia or elsewhere. So, think of the ones we cover as the most essential to be aware of at the beginning of your e-Residency journey as a company founder.
This article was written in consultation with PwC Estonia, who provided valuable inputs and feedback during the drafting process.
1. Know how to distribute dividends
One of the most well-known aspects of Estonia’s corporate tax system is that all retained earnings of an Estonian company are tax-exempt. Only when a company decides to distribute profits to shareholders in the form of dividends (or make other taxable payments), is corporate income tax (CIT) on the payment triggered. The standard CIT rate is 20/80 and lowers to 14/86 if dividends are paid out regularly.
The formal procedure for effecting a dividend distribution is regulated by chapter 19 of the Commercial Code. The strictest aspects of the procedure exist for the sake of protecting company creditors. Yet, the Code does allow some aspects of the procedure to be varied for a private limited company if recorded in its articles of association. In this section we will describe the usual procedure according to the law and standard practice of private limited companies, so make sure to check your company’s articles of association in parallel with this guide in case some of the more flexible aspects differ for your company.
Profit distribution is in the remit of the shareholders’ general meeting. In practice, this means that if you are the sole shareholder in your company, it is your decision whether and when to distribute profits and you can do so by digitally signing a shareholder resolution. However, there are a few legal requirements to be aware of before doing so.
Firstly, dividends can only be paid to a shareholder if the company’s minimum share capital contribution has been reached (€2,500 for private limited companies). Also, the decision to distribute dividends are made based on the company’s most recent annual report, and accordingly cannot be paid until the annual report for the last financial year has been approved by shareholders (see part 3 of this article below).
Dividends can only be paid to a shareholder from the company’s net profits or its profits retained from previous years from which the losses of previous years have been deducted. Dividend payments cannot be made to shareholders if the company’s net assets are less than — or, after the payment of the dividend, would be less than — the total of the company’s share capital and reserves which, pursuant to law or the articles of association, must not be paid out to the shareholders. The decision to pay dividends is to be taken by shareholders taking into account the net assets recorded in the company’s annual report approved at the end of the previous financial year.
Dividends can be paid in money or, with the consent of all shareholders, also in other company assets. The standard rule is that a dividend must be proportional to the nominal value of a shareholder’s share, but for private limited companies, the Estonian Commercial Code allows this requirement to be varied in the company’s articles of association.
Read more in the e-Residency Knowledge Base.
2. Net assets
Like in many other countries, the net assets (total assets minus total liabilities) of a company established in Estonia must equal at least half of its share capital and may not fall under €2,500 (the minimum share capital for a private limited company) at any time.
If the net assets are less, the shareholder must decide how to rectify the situation. There are many possibilities, ranging from a capital injection to more complex solutions. The best choice depends on the specific situation.
As mentioned under the dividends section above, Estonian law protects a company’s creditors by prohibiting a company to make payments to shareholders if the net assets of the company — as evidenced in the annual report approved at the end of the previous financial year — are less than or would be less than the total of the share capital and reserves which, pursuant to law or the articles of association, shall not be paid out to shareholders.
3. Annual report
Compiling an annual report is mandatory for all Estonian companies under the Commercial Code (see § 60), even if the company doesn’t have any activities during the financial year. It has to be prepared in Estonian and in the official currency (EUR) and submitted each financial year. The length of a company’s financial year is twelve months, usually coinciding with a calendar year. The annual report shall be prepared by the company’s management board (or their representatives) and must be approved by the shareholders’ general meeting. This requirement is enforced by the Estonian Tax and Customs Board.
Read more in our blog post from earlier this year.
The annual accounts of a micro-sized entity following the Estonian GAAP shall comprise at least two main statements (balance sheet and income statement) and explanatory notes. Micro-sized entities are private limited companies that comply with all the following criteria:
- total assets at the end of the financial year are up to 175,000 euros,
- liabilities do not exceed the share capital at the end of the financial year,
- one shareholder is also a member of the management board, and
- revenue earned in the financial year is up to 50,000 euros.
The annual report must be submitted to the Commercial Register within six months of the end of the financial year. If prepared under the Estonian GAAP, the annual report needs to be submitted electronically through the Company Registration Portal.
4. Tax obligations and deadlines in Estonia
If the payment of taxes in Estonia is applicable to your company, take note of the following obligations and deadlines.
a) Corporate income tax:
As already noted above, Estonia is regarded as a country that offers a relatively favourable income tax regime, because all corporate profits that remain undistributed are exempt from tax.
Estonia levies a corporate income tax (CIT) only on profits that are distributed as dividends, share buy-backs, capital reductions, liquidation proceeds, or are deemed to be profit distributions. Distributed profits are generally subject to either a 20% or 14% corporate tax (20/80 or 14/86 on the net amount of the profit distribution). Lower CIT at the rate applies to those companies that regularly distribute profits.
The following transactions are subject to VAT in Estonia:
- Taxable supplies of goods and services (where the place of supply is Estonia),
- Taxable imports of goods, and
- Taxable intra-Community acquisitions of goods.
The standard VAT rate is 20%. A reduced rate of 9% is applied to books, periodicals (with few exceptions), hotel accommodation services, and listed pharmaceuticals.
c) Social taxes
Employers operating in Estonia (including non-residents with a permanent establishment or employees here) must pay social tax on certain payments to individuals residing in Estonia at the rate of 33% (of which 20% goes to finance public pension insurance and 13% to finance the public health insurance scheme). Social tax paid by employers is not capped and mainly applies to salaries, directors’ fees, service fees paid, and fringe benefits granted to individuals.
In addition to social tax, employers are also required to pay and withhold unemployment insurance contributions. Employers must pay 1% and employees 2% of the gross salary (collected by employers through payroll withholding). The contributions mainly apply to salaries and service fees paid to individuals.
d) Payroll tax
In addition to payment of the social tax, unemployment insurance contributions, and compulsory accumulative pension scheme contributions, employers should withhold personal income tax (PIT) at a flat rate of 20% after deduction of the employee’s contribution to the unemployment insurance scheme, the compulsory accumulative pension scheme, and, if relevant, a deduction on a personal basis, which may be up to €500 per month.
- CIT: 10th day of the month following the month of the distribution
- VAT: 20th day of the month following when the liability is incurred
- Payroll taxes: 10th day of the month following the payment
Read our comprehensive Business Guide for more information.
5. Employment relationships
It is not mandatory to employ local staff in Estonia. There is also no requirement to employ a certain ratio of local/foreign staff by an Estonian company. In fact, it’s possible to hire staff located in Estonia or another country. Be aware though that your obligations to your employees will depend on where they are from and where they are located.
Hiring employees in Estonia can increase your business presence here. A key benefit of an increased presence is that it can also strengthen your company’s connection to Estonia. This could make it easier to get a business bank account or boost your ability to have a corporate tax residency here. If you do decide to hire employees in Estonia, you need to register them with the Estonian Tax Board. Also, be aware that Estonia has strict minimum wage levels despite having a relatively open labour market.
Foreigners from third countries (i.e. non-EU citizens), who reside in Estonia with a residence permit, are, in general, permitted to work in Estonia. Separate work permits are not issued. Although the number of residence permits issued per year is limited, there are multiple exceptions for certain people who will not be calculated towards the quota. The exceptions include, for example, residence permits for those employed in the field of information and computer technology.
In addition to those who are permitted to work in Estonia because they hold a residence permit, a person may work in Estonia temporarily for up to 270 days during a year if (a) they are legally staying in Estonia on the basis of a visa or on the basis of a visa-free stay and (b) their employment has been registered prior to them commencing work. Registration of short-term employment in Estonia must be done by employer.
EU citizens may reside and work in Estonia without registration of their right of temporary residence for a term of up to 3 months. If an EU citizen decides to stay longer than 3 months, they must register their residential address in Estonia’s population registry by visiting the nearest local government authority office. Once they have registered, they have a right to temporary residence in Estonia of five years (extendable).
If you hire staff located in other countries, you will need to research the local labour laws and labour tax regimes and check how to register employees there as a foreign employer.
6. Intellectual property
The intellectual property (IP) of an entity is essentially all exclusive rights it has to intellectual creations. Under EU law, IP encompasses two types of rights: industrial property, which includes inventions (patents), trademarks, industrial designs, models and designations of origin, and copyright, which includes artistic and literary property. In an economic sense however, IP can have a more expansive definition: extending to trade secrets, company know-how, and even client lists.
IP is a valuable asset of a company and thus important to record, protect, acquire, and develop.
If in the course of doing business, your company creates or acquires IP, we recommend making an IP strategy. Several steps must be taken to form your company’s IP strategy. Firstly, map and record all existing IP (and any potentially arising IP) your company has an exclusive claim over as a result of business activities. As you create or acquire more IP, remember to add this to your records. Thereafter, it is important to protect any such intellectual property by:
- verifying the availability of and registering trademarks and domain names which are or will be in use
- if applicable, registering patents and industrial designs
- keeping valuable aspects of your IP, in particular your company’s trade secrets, specialist know-how, and client lists confidential and secure
- preserving business secrets and commercial/IP interests by signing confidentiality agreements with employees, freelancers, suppliers, and service providers
To protect copyright claims your company may have over intellectual creations by shareholders, directors, employees, contractors, partners, service providers, or any other person providing works, it is also essential to agree provisions regarding author’s rights in the works between your company and the author. This means guaranteeing the transfer of economic rights from the author of the works to your company and obtaining a license regarding moral rights in an agreement between your company and the author.