Taxation of income received from financial assets
The Act on Amendment of the Income Tax Act passed by the Riigikogu (Parliament of Estonia) on 3 June (RT [State Gazette] I, 22.06.2010, 34, 181) granted from 2011 natural persons a possibility to defer the tax liability created on income received from financial assets until the time of taking the income into use, by using an investment account for this purpose.
An investment account may be used for deferral of the tax liability. An investment account is just an ordinary monetary account with an obligation to record all money transfers. An investment account may be opened in a resident credit institution of an OECD member state or in a permanent establishment of a credit institution located in that country. For attaining an objective by means of an investment account, financial assets may be acquired for the money in the investment account only, and income received from the investment account must be transferred to an investment account without delay. Several investment accounts may be used for subsequent tax exempt reinvestments of income received from financial assets. A taxable amount shall be created when the disbursements made from all investment accounts exceed the balance of contributions in all investment accounts after the disbursement. Balance of contributions shall be calculated after every contribution and disbursement. All transfers from the investment account are deemed to be disbursements, except for the transfers made for acquiring financial assets and transfers to another investment account. Account balance before the account is taken into use as an investment account and additional transfers made to an investment account is deemed to be a contribution to an investment account. Non-taxable income received from investment assets and money transferred from another investment account is not deemed to be a contribution. For example, if the balance of contributions in the investment account is 2000 euros, the taxable income will be created only after the disbursements not related to acquisition of financial assets exceed 2000 euros.
When a bank account used for everyday settlements is taken into use as an investment account, every contribution to and disbursement from the settlement account must be recorded. For example, wages and salaries received must be entered in the accounts as contributions, and payments of utility costs are to be recorded as disbursements, etc. If an investment account is taken into use only for transactions in financial assets, the record keeping of contributions and disbursements is much easier.
If the financial assets were acquired before 1 January 2011 and a person wishes to defer income tax on that income, the acquisition cost of securities or the deposited amount shall be declared as a contribution to an investment account for 2011. Income received from financial assets and declared as a contribution to an investment account must be immediately transferred to the investment account. If a person fails to do so, the derived income shall be deemed to be a disbursement from the investment account.
The principles of taxation of income derived from the transfer of financial assets not complying with the requirements specified in 171 of the Income Tax Act remain unaltered. The current taxation regulation may also be applicable when a person does not wish to defer the tax liability on income derived from financial assets through the investment account.
When using an investment account, a person must, in addition to information to be declared, keep records of the acquisition cost of the financial assets, so that it would be possible to determine the acquisition cost of financial assets acquired for money in the investment account, if necessary.
Interests on deposits of a credit institution of a resident of a Contracting State or interests on deposits received through a permanent place of business located in a Contracting State of a credit institution or on behalf thereof shall be exempt from tax. Tax exemption is not extended to interest on deposits that depend on the value of securities, deposits, currencies, other instruments or underlying assets or the changes thereof (hereinafter investment deposit). At the same time the interests of investment account subject to taxation can be carried to the investment account for deferral of tax liability and this is considered as an income received from financial assets. In case of interest on investment deposit on an amount deposited before 1 January 2011, the income tax exemption will be still applicable until 31 December 2013, provided that the deposited amount was not declared as a contribution to an investment account.
Life insurance contract with an investment risk
Upon taxation of income received under a life insurance contract with an investment risk (hereinafter insurance contract) the date of entry into the contract is relevant. In the case of a life insurance contract with an investment risk (IREK) concluded before 1August 2010, the amount to be received after 12 years of the conclusion of an insurance contract is exempt of tax.
If the disbursement is received within 12 years as of the entry into the insurance contract, the amount received minus insurance premiums paid under the same contract shall be subject to taxation. Tax liability arising from income derived from the life insurance contract concluded before August 2010 may not be deferred. An amount received under the insurance contract (taxable or exempt from tax) may be transferred to an investment account as a contribution for further reinvestments. Disbursements from an investment account in the amount of the contribution are not subject to taxation.
In case of a life insurance contract with an investment risk concluded as of 1 August 2010 there are two options for taxation of income. If the underlying assets of an insurance contract meet the requirements specified in § 171 (2) of the Income Tax Act, a taxpayer may opt for an investment account system. If a policyholder has notified an insurer beforehand that an insurance indemnity is received from the financial assets acquired for money in the investment account specified in § 172 of the Income Tax Act, the insurer shall be exempt from an obligation to withhold income tax. Upon receipt of a disbursement under an insurance contract it must be transferred to an investment account immediately. A person, who has declared the accumulated reserve of the insurance contract in the value available as at 31 December 2010 or notified the insurer of the investment account, must keep in mind that if he or she fails to transfer the received amount to the investment account immediately, it shall be regarded as a disbursement from the investment account.
An alternative is not to involve the insurance contract concluded as of 1 August 2010 in the investment account system. In such case the received amount minus insurance premiums paid under the same contract shall be subject to taxation. The investment account system is not practical if, for example, the recipient of a disbursement is a beneficiary or another person – other than an insurer, for both persons must declare the amount received as income.
Requirements established for financial assets (§ 171 of the Income Tax Act)
(2) Financial assets are deemed to be:
1) securities offered to the public in a Contracting State or an OECD member state within the meaning of the Securities Market Act or legislation of a foreign country;
2) securities accepted for trading in a regulated securities market of a state referred to in clause 1) or in the multilateral trading system (hereinafter market), or there is an application filed on acceptance securities for trading in such market, provided that financial supervision is exercised over the market and the market is accepted by the state and properly operated and would enable the public to acquire and transfer securities through it;
3) shares or units of an investment fund within the meaning of the Investment Fund Act not referred to in clauses 1) and 2), or shares or units of an investment fund established in a foreign state specified in clause 1) which are subject to financial supervision;
4) deposits opened in a resident credit institution of a state referred to in clause 1) or in a permanent establishment of a credit institution in that state, whereas according to § 17 of the Income Tax Act, interest payable on the deposits is subject to income tax;
5) life insurance contracts with an investment risk entered into as of 1 August 2010, where the underlying assets are the financial assets referred to in clauses 1) to 4) and in clause (3) 1) and which have been concluded with an insurer in the country referred to in clause 1);
6) derivative instruments not referred to in clauses 1) and 2), where derivative parties are a management company, investment firm or a credit institution of a state referred to in clause 1) and the financial assets referred to in clauses 2) to 4) constitute its underlying assets;
7) short-term debt securities not referred to in clauses 1) and 2), provided that a security is marketable (liquid) and its exact value may be determined at any time and it was issued by a resident of a state referred to in clause 1) who meets the requirements specified in § 257 (2) 1), 2) and 3) of the Investment Funds Act.
(3) Shares or units of an investment fund of a state not referred to in clause (2) 1) and securities accepted for trading in the market of that state are also deemed to be financial assets, provided that:
1) financial supervision is exercised over such investment fund or market;
2) a taxpayer concludes a transaction on financial assets with a resident credit institution, investment firm or management company of a state referred to in clause (2) 1) in the frame of provision of investment services specified in § 43 of the Securities Market Act.
(4) Contributions made after conclusion of a deposit or insurance contract or on the basis thereof are also deemed to be acquisition of financial assets.
(5) At the time of acquisition, financial assets must meet the requirements specified in subsections (2) or (3).
(6) Provisions concerning the financial assets are also applicable to the assets acquired as financial assets but which, at the time of transfer, receipt of income on it or termination of the contract do not meet the requirements established for financial assets in § 171 of the Income Tax Act.
(7) Insurance contract for a supplementary funded pension and units of a pension fund are not deemed to be financial assets (§ 28 and § 281).